Category: China

Global asset deflation: nowhere to run, nowhere to hide

Over the past several months global stocks, bonds and currency markets have hit a wall.  Just 6-8 months earlier the central banks of Europe, Japan and the US were signaling endless monetary accommodation which initially emboldened global speculators and their reach-for-yield mantra.  Now we look around for evidence or confirmation that the four year stimulus experiment is DOA.

First, emerging market stocks, bonds and currencies have all dropped somewhere between 7% and 12% the last few months as the carry trade (borrowing in low cost currencies in order to buy higher returning risk assets, thus capturing the spread) comes off the boil.  Second, political commentary out of China confirms our earlier thoughts that a credit bubble for the ages has begun to burst.  Since the central banking talking heads opened their mouths last month, Shibor rates (Chinese overnight unsecured lending rate amongst 16 largest banks)  have spiked to levels not seen since 2004:


Here is the latest on the Chinese banking system from Bloomberg:

Policy makers could be taking advantage of tight funding to “punish” some small banks, which previously used low interbank rates to finance purchases of higher-yielding bonds, Bank of America Merrill economists led by Lu Ting wrote in a report. Tight interbank liquidity could last until early July, according to the report.

‘Warning Shot’

“The PBOC [People’s Bank of China] clearly has an agenda here,” said Patrick Perret-Green, a former head of Citigroup Inc.’s Asian rates and foreign exchange who works at Mint Partners in London. “To fire a massive warning shot across the banks’ bows and to see who is swimming naked. Moreover, it fits in well with the new disciplinarian approach” adopted by the government, he said.

Chinese regulators are forcing trust funds and wealth managers to shift assets into publicly traded securities as they seek to curb lending that doesn’t involve local banks, so-called shadow banking, according to Fitch Ratings.

The tightening is “emblematic of some of the shadow banking issues coming to the fore as well as some of the tight liquidity associated with wealth management product issuance, and the crackdown on some shadow channels,” Charlene Chu, Fitch’s head of China financial institutions, said in a June 18 interview. She earlier estimated China’s total credit, including off-balance-sheet loans, swelled to 198 percent of gross domestic product in 2012 from 125 percent four years earlier, exceeding increases in the ratio before banking crises in Japan and South Korea. In Japan, the measure surged 45 percentage points from 1985 to 1990, and in South Korea, it gained 47 percentage points from 1994 to 1998, Fitch said in July 2011. [Emphasis mine.  Japan and South Korea experienced bubble economies during these periods which both burst.]

Look at the massive growth in nonbank (shadow) lending in China post 2008 credit crisis while keeping in mind most of this was indirectly backed by the largest banks under the “wealth management” label:

Chinese shadow banking

Maybe this is why China made the news last week when a proposed 15.5 billion renminbi bond offering failed (for the first time in nearly 2 years), receiving only 9.5 billion renminbi.

Over in Russia and Korea we see even more instability permeating the credit landscape.

Romania’s Finance Ministry rejected all bids at a seven-year bond sale yesterday because of market volatility, while South Korea raised less than 10 percent of the amount planned in an auction of inflation-linked bonds. Russia scrapped a sale of 15-year ruble-denominated bonds June 19, the second time it canceled an auction this month, and Colombia pared an offering of 20-year peso debt by 40 percent. A cash shortage led to failures last week of China Ministry of Finance debt sales.

More than $6.9 billion left funds investing in developing-nation debt in the four weeks to June 19, the most since 2011, according to Morgan Stanley, citing EPFR Global data. The exodus is reversing the $3.9 trillion of cash that flowed into emerging markets the past four years as China’s annual economic growth averaged 9.2 percent and spurred demand for Brazilian iron ore, Russian oil and gas and Chilean copper.

Romania rejected all 688 million lei ($200 million) of bids at a bond sale yesterday because of “unacceptable price offers,” according to an e-mailed statement from the central bank. It was the first failure since August.

South Korea sold just 9 percent of the 600 billion won ($524 million) it targeted from 10-year inflation-linked bonds this week. Colombia’s government pared an auction on June 19 of 20-year inflation-linked peso bonds by 40 percent, to 150 billion pesos ($77 million).

Russia canceled planned sales of 10 billion rubles ($311 million) of notes this week, citing a lack of demand within an acceptable yield range of 7.70 percent to 7.75 percent. Yields on ruble bonds due in 2028 jumped 30 basis points, or 0.30 percentage point, yesterday to 8.1 percent, the highest level since the debt was sold in January.

After endless monetary interventions the prior 3-4 years governments around the world temporarily created the illusion that interest rates would stay below nominal GDP growth targets.  The sleight of hand only lasted this long because so many of the “professional money managers” never questioned the actions of central bankers (a.k.a. asset inflationistas) .  As currencies, bonds and stock markets decline in unison around the world, one might pose the question “Have central bankers lost control of their monetary experiment?”  Or better yet, why would so many “investors” believe that a group of central banks with combined reserves of $11.5 trillion could levitate with over $240 trillion in global assets?   Which then begs the question,  where does one hide?

Hard landing underway in China

Ever since the global coordinated bailouts in 2008/2009 numerous market participants have debated the China hard landing thesis.  We wrote about this some time ago here and here so after various data points I think a reasonable decision can now be made.

First, our curiosity began during the credit build up in early 2002 until the great recession in 2009.  Fixed investment to GDP surpassed anything witnessed to date in the emerging market frontier.  Of course most of this “growth” was financed with the help of the state and local governments.  Today, after unprecedented debt growth since the ’09 structured finance debacle, local governments are experiencing  difficulty when rolling over close to $600 billion in bank debt.

People’s Bank of China Governor Zhou Xiaochuan said in a March 13 press briefing that about one-fifth of loans to the financing arms of local governments are risky. Net debt issuance by these entities surged 179 percent in 2012 to 1.132 trillion yuan ($182 billion), accounting for 50 percent of corporate bond sales, according to Bank of America Corp. data.

Is it any wonder that people both inside and outside the country are asking real questions?  Latest questioning from Fitch:

The balance sheets of China’s banks have been growing by over 30% of GDP a year since the Lehman crisis and are still growing at a 20%, wildly exceeding the safe speed limit.

Fitch Ratings said fresh credit added to the Chinese economy over the last four years has reached $14 trillion, if you include shadow banking, trusts, letters of credit and off-shore vehicles. This extra blast of loan stimulus is roughly equal to the entire US commercial banking system.

The law of diminishing returns is setting in. The output generated by each extra yuan of lending has fallen from 0.8 to 0.35, according to Fitch.

Mr Magnus said credit has reached 21% of GDP – far higher than other developing countries – and only half of new loans are “plain vanilla” under the full control of regulators.

Chinese Money Supply

Chinese corporate debt to GDP

Recently I had the privilege to join the program where well versed host Gordon Long and author Charles Hugh Smith discuss both Japan and China.   For those of you interested in the similarities and differences feel free to listen at the following link:

China: Terra firma or quicksand?

As Bloomberg reported today, China’s statistics bureau claimed its economy grew 11.5% in the 3rd quarter. Meanwhile, the 2nd quarter clocked in at an 11.9% rate, the highest in 12 years. While we have little faith in these numbers, the authorities seem intent on tempering the boom:

Central bank governor Zhou Xiaochuan said last week that steeper or more frequent interest-rate increases are possible and expressed concern at rising asset prices.

But what really caught our eye was the size of the stock market bubble:

The stock market added $2.5 trillion in value this year — the equivalent of GDP in 2006 — as the CSI 300 Index more than doubled.

In other words, China’s market cap – at $5 trillion plus – represents over 200% of GDP. This ranks right up there with past manias:

  • U.S., 1929 – ~80% of GDP
  • Japan, 1989 – ~150% of GDP
  • U.S., 2000 – ~175% of GDP

The U.S. equity market has a capitalization today of roughly 135% of GDP. Let’s see… China’s best customer, the U.S. consumer, is doped up on credit and barely responding. And its economy appears to have a severe gambling problem. Is this the foundation the global economic boom bulls are standing on?

China bill coming due

According to Charles Dumas at Lombard Research:

The bill from the China Shop is arriving…

Summary: The Goldilocks economy and markets, arising from the initial benefits of globalisation combined with structural Eurasian surpluses (savings glut), are ended. Globalisation shifted manufacturing to cheap-labour Asia; and frenetic financial market growth recycled the savings glut. Deficit countries obliged by spending more than their incomes, capital inflows driving up wealth nonetheless. Subdued inflation was the first link in the chain to break, as wasteful Asian usage of energy and metals drove up resource prices from 2004-05. Recently, food prices have also started to surge. The boom meanwhile shifted central banks from easy money policies adopted after the Bubble burst in 2000-02. Higher interest rates and soaring prices sapped housing affordability so that US prices have stagnated or fallen for two years now. But the obviously impending end to over-spending incomes was postponed by the mortgage machine the financial industry had put in place. Quality of loans got worse as pricing became more aggressive, and the repackaging of loans into asset-backed securities ever more exotic and opaque. The credit bubble started to burst this year, as sub-prime mortgage defaults rippled through global markets.

Main Points:

– Liquidity is shrinking while the savings glut mounts further. Wider credit spreads reduce credit appetite, raise banks’ cost of funds, and cut the volume of balance sheets in any credit “chain”. “Quality” of money (bank deposits) is also in doubt.

– US mortgage delinquencies of $1 trillion are likely, and loan losses of $300 billion. The obscurity of asset-backed repackaging could raise ultimate investor losses.

– Despite central banks holding overnight money rates close to targets, 3-month Libor reflects distrust of bank credit and contagion from commercial paper. Central banks cannot and should not socialise any losses until full disclosure is achieved.

-The US economy may avoid recession, but income and jobs growth will be sharply cut, and savings rates could jump as house prices slump. Expect a tax cut in 2008.

– The European economy is growing above its potential this year, but pronounced slowdowns in Britain and Spain could ensure growth is at best on-trend in 2008. In Japan, MoF’s fanatically tight budget policy is grinding the economy to a halt.

– China’s economy is out of control and massively disruptive. Its export growth alone displaces ?% of world GDP. Its surplus, $250 billion last year, could be $370-400 billion in 2007. Gross overheating could ensure current food price inflation is soon followed by goods prices generally. Major yuan revaluation is needed.

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