Stratfor’s George Friedman: Long Turkey, Short China

December 16, 2009 What is the end game here?

Friedman: We have had two similar events in
Asia in our generation. The first was in
, where you had the same debt-driven economy growing at an extremely high rate. The West assumed that they were going gangbusters. What followed was the collapse of the Japanese banking system. Then we had the 1997 crisis in
East Asia, preceded by high growth. The collapse was caused by the same factor. Combine a debt-driven economy and a very high growth rate, and you end up with a very sudden collapse.

The difference with China is that neither
nor the other Asian countries had massive pools of utterly impoverished people. The Japanese could slow down their growth rate, preserve employment as their primary goal and survive without massive social instability.

Chinese resources, relative to its social issues, are dwarfed. They are trying to solve the problem by surging exports, as Japan and
East Asia did, but in a recession, that means subsidizing exports to the point that they’re losing money.

Today, the response you’re getting from the Chinese government is increased repression dealing with increased social unrest. People say that if
is doing so great, why are they cutting off access to the Internet? Well, either they’re stupid or they know something you don’t know.

Investment bankers love
China because they focus on the 60 million people and because once the transaction is done, they’re gone. But the reality of
China is far more complex than landing in Pudong and taking a car to the Shangri-la.

has expanded for 30 years. Each year you expand, the likelihood that you will expand the next year declines. They’ve had extraordinary expansion, but they have significant problems, which are manifested by their reserves. The inability of the Chinese to reinvest in its own economy is a significant problem. Will we see a massive wave of bank defaults when these debts come due?

Friedman: You’re already seeing them. The Chinese government doesn’t allow defaults no matter how high the nonperforming loan rate is. They step in and buy the debt, using their reserves to stabilize industry. That’s why the government tries to limit lending. But in many cases, the banks are lending to cover bad loans so they don’t have to book them.

The government is caught between allowing bankruptcies and shutting down the system. Let’s turn to
, which you have discussed in the past as a potential power in the future. A new ETF (PLND) just launched on
, so I’d be interested in hearing about what you think of the country as an investment.

Friedman: It’s the 18th-largest economy in the world, and the 8th largest in
Europe. That’s a pretty stunning reality.
is another country that has emerged. Major American companies like Dell are leaving Ireland and moving to
. It still has favorable wage advantages over other European countries, and it has a very sophisticated workforce. Plus, it’s part of the EU.

Basically, it is a sophisticated European country with a great wage variable and it is rising very, very rapidly. My question always is, why would you be surprised when the 8th-largest economy in
Europe is cited as an interesting place to invest?

Forgetting what I think about it strategically,
has already achieved more than almost any other Eastern European or Soviet country. When a company like Dell decides to give up on the darling of Europe [Ireland] and shift to
, it’s pretty telling. Flipping to the other side of the world, what about
? Is the Brazilian miracle real?

Friedman: Think of Brazil as
. It’s utterly isolated geographically. Most of the terrain around it is impassable. Overland, it can’t touch Venezuela, and it has a land bridge to
. Think of it as an island.

As an island it is an amazing story. It has a range of social issues, but it is the real thing. The only country in Latin America that parallels it is
. Brazil is the 11th-largest economy in the world and
is the 13th largest. We regard these two countries as extraordinary opportunities for the risk-tolerant investor. Both have tremendous economic opportunities, and you pick up social unrest as the flip side of that opportunity.

We don’t know how
will behave in a recession. The real test is how it manages a downturn. We know how it behaves in an expansion. But those who believe the business cycle has been abolished in countries like
, well, I’d be glad to take the other side of that bet.



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