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.

The other concept to remember is what we call CRAAP, or “Chinese regularly accepted accounting policy.” The further down you drill on China, the more bearish you get, until you finally get to the actual individual companies—and most look questionable to us. That’s true of U.S.-listed Chinese companies. If you really want to be contrarian, one simple idea is to short the Chinese currency through a U.S.-based exchange-traded fund such as the WisdomTree Dreyfus Chinese Yuan Fund.

I would never short the Macau casinos. You can trust their accounting a bit more, and all those Chinese company executives who have been milking their companies for personal gain are probably still going to go gamble, even if the economy slows down. So we’re long on the casinos in Macau, and we’re long on corruption in China.

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