How to Short China

Managing global risk exposure requires a China play. That could be a short strategy, and there are many ways to do it. To start off, add these terms to your vocabulary: LGFV and CRAAP. LGFV stands for local government financing vehicle—joint ventures between local governments and developers to build condos, stadiums, and new roads. The problem is that those local governments have piled up massive debts they are unlikely to repay—$1.6 trillion, according to China’s national audit agency. The banks are lending and lending, but a lot of it is for absurd projects. Most people in China (97 percent) can’t afford the luxury of those condos that are going up one after another. And the construction quality is terrible. Now you’re seeing that borrowing begin to sour, foretelling a process akin to the first cracks in U.S. subprime lending.

One short idea is Agricultural Bank of China, which has one of the highest percentages of risky loans to LGFVs when compared with other major Chinese banks. Once the cracks in the LGFVs widen and the building boom slows, the first victims are the industrial commodities players. You could also look at the Hong Kong Stock Exchange, where a cooling off in Chinese growth could hurt new issues.