Christine St. Anne: With China, are you still optimistic about the country?
Ian Huntley: I have been positive in China for a long time. Ever since '93, we had a seminar and we had the then Economist for RIO explaining that China was the next Japan, which was the explosive growth story in the '60s and '70s; and then just behind it was India. Early in 2000's, we saw China take off and we looked at India and China, 38% of the global population wanting to catch up, and that's a tremendous force. It's no way a credit battle, that's sort of typical of a number of American observers looking - I could say some rude words about it, but somewhere else. You just got to focus on 1.4 billion people in China who for 200 years went through a series of civil wars and got nowhere.
Surveys of sentiment in China actually show that about 80% happy. We might not like their system, but you've got to remember, the system they have has improved the lot of their living tremendously in the last 20 years, and it's continuing to do it. That's the driving force. For god's sake, I read an offshore commentator the other day saying, look at all these vacancies, they are comparing it to Britain. What's it got, about 60 million people and this is 1.4 billion. Some people cannot get it into perspective. I‘m looking for China in 2012, my worst case would be 7% growth, I think it's more likely to be 8%. I think they've already started to ease their monetary pressure, which is bringing down pressure on the relatively high priced residential real estate market. But I'm looking for them to start dropping interest rates in about March.
I don't think Europe is an enormous major problem at all. It will carve off a bit. But you got to remember, the major driving in China is those 1.4 billion and they need from still, almost scratch, to develop their infrastructure. It's just an enormous driver and there is so much more to do, and they are doing it, and they are doing it well. And what they are doing at the present time is, stopping too much heat. But then people, they listen to all those wonderful experts throughout the world telling that the real estate market is crashing and that's the end of the world. Now these jokers can't even look at the fact that China's building 10 million affordable houses per annum as part of their current five year plan. They conveniently forget that, and that is absorbing a huge number of materials. It's not dissimilar in materials consumption to the upper market stuff. I just get lost listening to it all.
Look, sure China is going to have some speed bumps, but I would think for the next 10 years with -- maybe with something -- obviously there has got to be some downturns. But I guess this is going to be a wonderful background to Australia; and as for margins, yes they are very high and a number of our major resource groups like BHP and Rio, but alot of other companies are struggling in a two-speed economy. Now of course, if China did slump their currency would fall, and then a number of those other companies would do a lot better; and of course a major component of our index is the banks. The banks, I don't think they could be terribly affected by an easing off in China. But I think we'd actually do quite well, because interest rates would come off and the housing market would improve. There are lots of balancing acts in our economy, and I'll just leave at that, because you'll ask more questions. But I've got strong views in China and they've been very-very thoroughly researched.
Daniel Needham: So with - just some comments on that - I mean, I think that I agree that there are some very powerful fundamentals in China. I mean the population story is very clear, you know, that they are going to be increasing, like their wealth is increasing. Their share of output globally is going to increase, I agree with all that, but how assets are capitalized, you can't conjure up investment spending on infrastructure, and be almost -- ignore the price that you're paying for the assets, and effectively the price of capital in China is being heavily distorted. There's huge amounts of unproductive investments that are happening. The growth that's being in China is an investment led growth, it's not being led by sustainable investment driven by consumption - internal consumption needs. It's government controlled, government directed investment and it's being capitalized by a shadow banking system.
China doesn't have a secret sauce or a magic pudding. They are subject to the same economic principles that have dictated capital systems throughout the world, throughout history; and the credit aggregates are scary, 187% debt-to-GDP in China. The credit growth has been, extraordinary.
Needham: So, the government debt is estimated to be about 100% of debt-to-GDP. The shadow banking system, added to that, gets you near 200% debt-to-GDP. Credit growth in China is extreme, and that's what driving growth at the moment.
I agree that the increase in productive capacity from these infrastructure investments is going to add long-term growth to China, but how that's capitalized matters. How it's being financed, matters; and whether it comes out via - you can manipulate a banking system as much as you like. It's either going to come out of via inflation, it's going to come out via civil unrest, or it's going to come out via capital leaving China and moving somewhere else via capital flow. So, I think there is a potential for risk in China around how these investment spending, infrastructure spending, property spending is being financed, and they're not subject to different rules than any other economy. Japan is a good example. Japan was great. What about the '90s in Japan, after the property boom?
Huntley: Hey, that was after 30 years.
Needham: Sure. But the growth we're seeing in China, is happening at a much faster rate that happened in Japan.
Huntley: Not particularly, not in the early years. I think my friend here needs to look at American history in the 19th century. That's when America built its infrastructure. American growth then was driven by infrastructure growth, and that was - there was ups and downs right? But they sold land an all this sort of thing, railways went through across the country.
Needham: Like the 1830's in Chicago?
Huntley: Land became a lot more valuable. Sure, but that was the big picture all through that period, with ups and downs, and you had - if you look at the American economy in the early 1900s, which - there is a wonderful book 2007-1907. If you put the figures on the American economy, the growth rates, up on the board and said, who is this? Everyone would say China. No sorry, it's the United States. High single-digit growth; and that was as late as that. I'm listening to people arguing about China - I say, this is what was happening in America in the 20s. They've just left out a whole damn 120 years.
Needham: The 20s was a fuel for one of the greatest depressions, effectively finance and speculation related depressions in the world.
Huntley: I have studied the depression very closely. But as I said, they just left out 120 years, and I reckon that with China, it probably needed to go back at least 50. Now, the China banking system isn't the same size as the overall debt market, and China has probably got a lot of very good things in it. Because, what's happening there is private enterprise banks are beginning to understand what debt and recoveries are all about, and I certainly don't agree with the level of debt that our friend is talking about, nor do I look upon the Chinese banking system as the same as the Western worlds. I look at it, in some ways, as the way the central government is channeling, what we would think of subsidized capital into the economy. And I don't think the infrastructure is being overcapitalized.
St Anne: Moving on to upper parts of world. Daniel, what's your view on Europe? Do you think the situation there can be resolved?
Needham: Europe is a challenging situation, because the fact with a single currency, I mean it's been spoken about a lot. You have significant amounts of debt and in the peripheral parts of Europe, and they don't have a currency and so they can't devalue their currency and make themselves more competitive. They also can't ease financial conditions. I mean, I think we're getting closer and closer to a unified Europe, and I think that we're going to see Germany take a much stronger position in Europe, and I think that there is going to need to be some painful deleveraging depressions in the peripheral parts of Europe, and that's going to have to be subsidized by Germany and the larger European nations.
It's happening at the moment. I mean, the potential for that to just fall out of hand and one of the big European banks to go down is very high at the moment. We actually see Europe, there is some good investment opportunities in Europe. I think that there are parts of Europe that look quite attractive. I mean, people are pricing an Armageddon in many-many good companies that are not solely focused on generating profits in Europe. I think there is a lot of excessive pessimism about Europe, although there are some big challenges and there is potential for a financial crisis to occur. But, we're actually buying European companies at the moment. We think there are some good opportunities and I think that it's one of those classic areas where investors get overly pessimistic and in that environment, you are able to pick up some bargains.
St Anne: Ian, do you see the same sort of opportunities in Europe?
Huntley: I'm more an investor in Australia, but I think there will be opportunities in Europe. That's the reason why I think the markets will come back towards the middle of this year and it could be a fair bit of panic. I think that will come from Europe. Then I think there would be good buying in Europe, but you've got a sort of a German lover, an Italian financier and a French policeman trying to run Europe. Look, they don't get along; and Germany wants to keep its money to its chest.
They don't like spending money on Italians, the Spanish. They are in trouble, that's their problem, nein! nein! There is a problem there. I agree that there is too much fear about it and it's very-very interesting how that fear has driven down the multiples in Australia and in the United States. Whereas the companies underneath are doing pretty well. I think there is certainly some opportunity there.
I think there may be better still opportunities in Europe, a bit down the track, and I would be watching the Euro continue to fall. Because the period of Euro's strength, while the banks were pulling capital back into Europe, I think that's ended. And now the Euro is coming down as people see more and more strife there. Of course, it's putting the U.S. dollar up a touch. But I'd be a bit more slow with Europe, but not if I was major investor, I'd be looking for value, sure.
St Anne: What about the U.S.? The commentators have been quite pessimistic about the country. Daniel, what's your view on the U.S.?
Needham: I think the U.S. economy is actually in better shape than people were giving it credit for in 2011. I think there was some one-off effects that slowed the economy down. There was ridiculous wrangling over a debt ceiling which was ultimately always going to be approved.
I think that Europe, you can see growth has clearly being slowing in Europe, but the U.S. to me still looks fairly strong from a growth perspective. They've got bigger issues in 2012, as they see the austerity measures or the budget cuts being introduced. But as an economy, I think that the U.S. is a very diversified economy. They are very innovative and productive and they can move their technology and capital around, probably better than almost any other economy. So, I am not as bearish as some commentators are, but from a valuation perspective, the measures that we think have some type of medium term predictability about them, suggest that the U.S. isn't cheap. But I think that - there aren't any as many value opportunities in the U.S. as there are in Europe. But at the same time, I think the earnings and growth is much stronger there than people are giving it credit for.
Huntley: I agree with my friend about the United States, but I think that it's large economy and there is a number of sectors in it which are doing very well. A number of businesses are doing fine; and I think there is actually some good value there too. It's amazing how innovative that country is. Hey, I'm not disagreeing with my friend.