Hedge fund manager bets on China as the next 'enormous credit bubble' to burst

Date: Monday, November 29, 2010
Author: Louise Armitstead, The Telegraph

Mark Hart, an American hedge fund manager who has made millions predicting the crises in US sub-prime market and European debt, has launched a fund to bet on the imminent implosion of China.

Mark Hart says complacency among market participants regarding China is eerily similar to the complacency exhibited prior to the United States sub-prime crisis and European sovereign debt crisis.

Mr Hart, who runs Corriente Advisors from Fort Worth Texas, has told potential investors in a presentation that China is in the "late stages of an enormous credit bubble".

When this bursts, the financier said he expects an "economic fall-out" that will be as "extraordinary as China's economic out-performance over the last decade".

Asking for a minimum $1m (£640,000) stake, Corriente said it will use sovereign and corporate credit default swaps, interest rate and foreign exchange options to cash-in on the collapse.

Mr Hart, who launched a record performing sub-prime fund as early as 2006 and, in 2007, a fund that bet on a European debt crisis, told investors: "Complacency among market participants regarding China is eerily similar to the complacency exhibited prior to the United States sub-prime crisis and European sovereign debt crisis."

In the presentation, which amounts to a devastating attack on the prevailing belief that China is an engine for growth, the financier argues that "inappropriately low interest rates and an artificially suppressed exchange rate" have created dangerous bubbles in sectors including:

Raw materials: Corriente says China has consumed just 65pc of the cement it has produced in the past five years, after exports. The country is currently outputting more steel than the next seven largest producers combined – it now has 200m tons of excess capacity, more that the EU and Japan's total production so far this year.

Property construction: Corriente reckons there is currently an excess of 3.3bn square meters of floor space in the country – yet 200m square metres of new space is being constructed each year.

Property prices: The average price-to-rent ratio of China's eight key cities is 39.4 times – this figure was 22.8 times in America just before its housing crisis. Corriente argues: "Lacking alternative investment options, Chinese corporates, households and government entities have invested excess liquidity in the property markets, driving home prices to unsustainable levels." The result is that the property is out of reach for the majority of ordinary Chinese.

Banking: As with the credit crisis in the West, the banks' exposure to the infrastructure credit bubbles isn't obvious because the debt is held in Local Investment Companies – shell entities which borrow from Chinese banks and invest in fixed assets.

Mr Hart reckons that "bad loans will equal 98pc of total bank equity if LIC owned, non-cashflow producing assets are recognised as non-performing.

As a final blow, Mr Hart says that the market belief that the Chinese government has "ample resources" to bail out its banks is flawed.

Corriente's analysis of the ratio of China government debt to GDP comes out at 107pc – five times higher than official published numbers. The hedge fund says this number uses "conservative assumptions" and the real figure could be as high as 200pc.

The result is that, rather than being the "key engine for global growth", China is an "enormous tail-risk."

He is so convinced by his arguments that he has warned investors that the fund, called the China Opportunity Master Fund, is prepared to "burn" 20pc of their cash each year until his theories are proved.