Xi's Tinkering Risks China Hard Landing

Asia Confidential's picture

There's been a lot of over-hyped talk of China tightening and deleveraging over the past few weeks. Sure, inter-bank rates and corporate bond yields have significantly increased over the past year. But if you include things such as central bank injections into the inter-bank market and unsterilised foreign exchange purchases - where the central bank buys foreign currency to maintain the partial dollar peg - it's clear there's been no net tightening at all.

As for deleveraging, figures released on China lending over the weekend should be enough to put that to bed. January lending was the highest in four years. More worryingly, total societal financing - a broad measure of credit including shadow financing - increased to 2.58 trillion yuan, smashing analyst estimates of 1.9 trillion yuan. China remains addicted to credit despite the racheting up of rates. 

The fact is that China's President, Xi Jinping, hasn't done nearly enough to deflate the country's credit bubble. He needs to do three things, and fast: 1) allow defaults of wealth management products so risk can be properly priced 2) accelerate structural reforms laid out late last year 3) lower Beijing's bottom line for GDP growth from 7% to a more realistic 6%. Without these initiatives, Xi risks a much larger economic blow-up in the not-too-distant future.

For investors, the question isn't whether China's economy will slow down from here, but to what degree. And more importantly, how much of it is priced into markets. In Asia Confidential's view, China's stock market, down two-thirds from the 2007 peak, is already reflecting a lot of (not all) of the bad news. But key China proxies, including the Hong Kong and Australian stock markets as well as large iron ore miners, aren't and remain most at risk from the coming China downturn.  

No deleveraging here
The Telegraph columnist Ambrose Evans-Pritchard wrote a recent piece on China which garnered much attention. Headlined, "World asleep while China tightens deflationary vice", he stated:

"China's Xi Jinping has cast the die. After weighing up the unappetising choice before him for a year, he has picked the lesser of two poisons.

The balance of evidence is that the most powerful Chinese leader since Mao Zedong aims to prick China's $24 trillion credit bubble early in his 10-year term, rather than putting off the day of reckoning for yet another cycle."

Great prose but the evidence that Evan-Pritchard provides to support his case is thin, at best. He acknowledges that China blinked in January when it stepped in to cover liabilities of $500 million for the trust fund, "China Equals Gold No. 1" (an unfortunate name, to say the least).

But Evans-Pritchard goes on to suggest that the evidence for Xi getting serious about deflating China's credit bubble can be found with the tightening of rates. He cites the central bank lifting of the 7-day repo rate, a gauge of inter-bank liquidity, by 200 basis points to 5.21% (since then, it's dropped to 4.4%). 

The columnist also cites the jump in corporate bond yields. Thus, the yield of corporate AA 1-year bonds has increased 272 basis points to 7.15% since June.

Evans-Pritchard then quotes several stock brokers about how China intends to raise interest rates right across the spectrum and this means that Xi is intent on popping the credit bubble.

In our view, the thesis is vastly overstated. Yes, repo rates and corporate bond yields have risen markedly. But both are coming off abnormally low bases and have only just began to normalise. 

Also, if you count net repo injections - central bank injections into the inter-bank market in order to provide liquidity - and unsterilised foreign exchange purchases, there is no net tightening in the system. China is still pumping money into the economy in an unsustainable manner.

Evans-Pritchard is on firmer ground when he talks about how the world is asleep to the potential fall-out from a China slowdown. Foreign loans to Chinese companies now total $1.1 trillion, posing a large risk to banking systems with exposure, particularly those in the UK, Hong Kong and Australia. We won't go into the details here but it's worth a read.

During the week, The Financial Times took Evans-Prtichard's lead and ran with it in an article called "Chinese-style tapering eclipses US tapering in scale". The article suggests the unwinding of monetary stimulus in China is greater in numerical terms than that of the U.S.. 

So, total societal financing in China fell to 7.1 trillion yuan in the second half of last year, from 10.2 trillion yuan in the first half. In other words, a net reduction of just over 3 trillion yuan.

The article then cites an analyst who suggests that China may now be entering a period of deleveraging.

Well, no. While the reduction in Chinese credit growth may be tapering, it certainly doesn't fit the definition of deleveraging. The latter means reducing debt, particularly versus GDP.

And as the figures over the weekend on lending show, Chinese credit is still growing strongly, well above nominal GDP growth rates. In other words, debt to GDP is still rapidly increasing, not decreasing.

Thus, the January figures show Chinese banks lent 1.32 trillion yuan, beating a 1.1 trillion yuan forecast and more than 3x December's level. It isn't unusual for January lending to spike but this was the strongest month in four years.

More concerning was the total societal financing number. This figure increased to 2.58 trillion, way above analyst estimates of 1.9 trillion. 

China total financing - Jan2014

In sum, there's no net tightening in China nor deleveraging at present, despite claims to the contrary. It doesn't mean that there won't be tightening or deleveraging in future, but that's pure speculation at this stage.  

What Xi needs to do
What the weight of evidence indicates instead is that China's President Xi Jinping has tinkered with policies to reduce the country's credit dependency, but hasn't done enough to make substantial inroads.

Let's be clear: Xi inherited a credit bubble of gargantuan proportions. Chinese credit grew some $12 trillion, or 2x total GDP, in the four years prior to him coming to power. To put that into perspective, US bank credit grew around $1.5 trillion over the same period.

Given what he inherited, Xi had no good choices. He could choose to deflate the credit bubble and endure short-term pain. Or delay deflating until later and risk an even larger bubble developing and larger subsequent pop.

It's not yet clear whether he's chosen the former option but if he has, he certainly hasn't acted decisively enough. And without hard choices, Xi risks a bigger economic fall-out later on.

So, what does Xi have to do to properly address the issue? There are three key things:

  1. He needs to allow defaults of wealth management products. Remember, these products are private loan management vehicles, which will often promise 12% returns or higher on assets. People have bought these products because they think the government stands behind these instruments. Xi needs to send a clear message that the government won't stand behind these products. Only in this way can risk again be properly priced.
  2. He needs to speed up implementation of last year's proposed reforms. There's much talk that there are fiscal reforms coming soon. And deposit interest rate liberalisation will also happen quicker than expected. Bring them on. Reform is needed to re-balance China's economy and propel the next phase of growth.
  3. It's widely known that Beijing sees 7% GDP growth as the bottom line for growth, without risking social stability. We believe this needs to change to 6%. And in my view, if GDP growth fell to that level, it wouldn't risk social stability. The key reasons are: i) China's tight labor market means unemployment won't be a major issue even at those lower levels ii) Xi has consolidated power and has a strong mandate for change. The government is paranoid about social stability but 7% GDP growth ain't going to effect change; 6% will. 

These ideas will undoubtedly receive some push back. For instance, allowing defaults of trust fund products and the like may risk widespread defaults. My retort to this is that this is a possibility, but further government bail-outs will just delay and inflate the problem.

Structural reforms also have the potential to be a sharp drag on economic growth. Particularly if implemented at the same time as deflating credit. This is true. You could choose to deflate credit first, then roll out reforms. Doing both at once though makes some sense as it will take some time for reforms to filter through to real economy.

Lastly, some will see 6% GDP growth as a disaster scenario for China. Many government officials will see it as such. I'd suggest it isn't though and it's a realistic appraisal of the short-term pain needed to decrease China's credit dependency and to put the economy on a more sustainable footing. And it's not even close to a worst case scenario, where the credit bubble is inflated for a further year to two and then bursts. Under that scenario, 6% growth would be wildly optimistic.

What it means for investors
For investors, the key message is this: a China downturn is coming, one way or another. And the more that Xi Jinping tinkers with policy and fails to make hard decisions, the greater the probabilities of a sharp economic downturn.

Let's assess the potential fall-out for China first. French bank, Societe Generale, says an economic hard landing would entail GDP growth troughing at 2%, with two quarters of contraction. That would result in a decline in China stocks of 30%. 

Let's face it, Soc Gen's scenario is guesswork. No-one really knows what a GDP trough would be in the event of a hard landing, or the ultimate impact on Chinese equities.

It's important to recognise that China's stock market is already down two-thirds from the peaks reached in 2007. At 8x this year earnings, it's the second cheapest major market in Asia behind South Korea. A lot of the bad news is already priced into Chinese stocks.

In my experience though, the Chinese stock market doesn't move on economic data or fundamentals, but policy change. This means that if the President gets serious in reducing credit, then the stock market should decline. Ironically, that would be a positive sign for the economy.

Conversely, if Chinese equities were to rise from here, that would indicate that the President is choosing to further inflate the credit bubble. That would be a bad sign for the economy.

Put simply, you should expect further pain in Chinese stocks from already low levels. But it could soon turn into a fabulous buying opportunity for long-term investors. I'd focus on sectors which will benefit in the "new" consumption-driven China, including consumer discretionary and staples, telecommunications and internet companies. Cheap ways to play the future of China, in other words. I like retailer, Giordano, telecoms giant, China Mobile, China Mengniu Dairy as well as internet play, Tencent, though expect to pick them all up at cheaper prices.

While Chinese stocks may have partially priced in a sharp downturn, many markets and sectors outside of China certainly haven't. Take mining. There's no doubt commodities and commodity-producing countries have started to feel the pain from declining demand growth from China. But the impact is likely far from finished.

Soc Gen suggests a China economic hard landing would lead to a 50% crash in copper prices. Again, that's guesswork. But it's undoubtedly right that China is the largest and most important consumer of most commodities.

In my view, iron ore is even more vulnerable than copper given the limited price correction thus far and the fact China is the key driver, accounting for around 50% of global consumption. If correct, Australian iron ore miner, Fortescue Metals, is an easy short.

Australia's economy is particularly susceptible to a fall in metals. Mining is 9% of GDP, up from close to 1% in the late 1990s. If mining reverts back to below 3% of GDP over the next two years, that spells big trouble for Australia's economy. It isn't hard to foresee a deep recession starting next year. The Aussie dollar and Australian banks are both expensive and vulnerable to sharp corrections.

australian resources construction

Lastly, banks with direct Chinese exposure may be vulnerable. Hong Kong banks would have to be near the top of the list. China accounts for close to 30% of Hong Kong bank loans. Moreover, bank assets are now an astonishing 7x the size of Hong Kong GDP.

It's a scary number that equates to the size of Iceland's prior to its 2008 crisis. The circumstances are very different but Hong Kong banks are susceptible due to their exposure to China as well as a gigantic local property bubble (which the Chinese have helped inflate).

Incidentally, commentary on the fall-out from a China downturn to date has failed to make mention of the potential impact on global property markets. In Hong Kong, Australia, Canada and, to a lesser extent, Singapore, Chinese have been key investors over the past three years. 

It's difficult to get any hard numbers on the extent of Chinese investment in the residential property (and other property segments) of these countries. But it's substantial and any reduced Chinese investment would be keenly felt by residential developers and banks in these countries.

AC Speed Read

- There's a lot of talk of China tightening and deleveraging, when neither has occurred.

- China's President, Xi Jinping, hasn't done nearly enough to deflate the country's credit bubble. 

- If he doesn't soon act to deflate credit, Xi risks a much larger economic blow-up in the not-too-distant future.

- To a large degree, China's stock market has priced in a steeper economic downturn. But key China proxies, including Hong Kong and Australia, haven't and remain most at risk from the coming China downturn.

This post was originally published at Asia Confidential:

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kurt's picture

Did you ever get the feeling that articles like this are written specifically to be "discovered" in the wild by the Chinese leadership?

TheRideNeverEnds's picture

Everything is fine, S&P is going straight up, we will be over 1900 by this time next month, green shoots errywhere.  



mobydick's picture

Don’t worry about Chinese banks, Stevens told

The chairman of China’s second biggest bank has told the RBA’s Glenn Stevens not to worry about China’s shadow banking system despite the collapse of a high-profile investment fund.

laomei's picture

I love these quips, I really do.  People whining about China as if they have even half a clue, while at the same time cherry-picking to tell the story that supports their narrative and ignoring all the rest of the data.  It's classic bear-baiting the way it always has been.  Bitch about China using coal.  China builds out infrastructure to support alternative solutions, then bitch about them.  China starts burning less coal... bitch about it.  China starts consolidating and shutting down the most useless of the coal producers, bitch about it.  China could overnight swap to pure renewable, move away from gas-burning cars, and institute strict regulations on polluting factories, and the idiots would still find a reason to bitch whine and moan about it somehow.  China isn't the EU, where the idiots decided that unifying the currency while not unifying anything else was a great idea. China isn't the US, where the war criminals make up their own little rules about how things should work and sic teams of lobbyists and lawyers to ensure "correct" interpretation of whatever bullshit loopholes they wrote for themselves and bribed the government to pass.  


Hell, not even the points being presented are accurate.  

"WMPs over 12%", um, no.  That shit is rare as fuck, risky as hell, has very high standards to buy into, and none of it is insured.  If you are able to part with a million bucks for 4 years and think 12% returns are realistic, you deserve your losses.  Most are generally around 5~6%, relatively short term, and if you bother to dig into the guides, tend to be fairly clear as to what you're investing it, how risky it is, and if it's insured or not.


The Chinese stock market... It's literally a joke, no one plays it anymore, they just don't.  It can jump 50% or dive 50% and it has literally zero impact on anything.  Do the math, calculate the total market cap, it's a joke.  The only people who play it are either clueless fools soon parted from their money, or insiders who use it as an ATM.  Most of the larger companies there have a listing just to get the west to shut up about not allowing investing.  It tends to be trivial token amounts of shares that do not in any way shape or form influence anything.  Hell, it's not even a thing to be reported on in the news, because no one actually cares.


No matter what China does, it'll always be a target for nitpicking.  Simultaneously it seems, it must rapidly become a mirror of US values, while at the same time avoid every single pitfall the US and the west made, and it had better not get too powerful either, or else it's deemed evil.  Not allowed to protect its own interests or security, because afterall, any and all claims it has or makes are illegitimate for some reason.  Oh, and it also has to be cut up into several smaller countries as determined by people because reasons and the government needs to be trashed and replaced with something the west can understand and is exploitable and corrupt to us interests.  That about sum it up?  China's not dumb, it's been at the center of this bitching for decades, China doesn't care.  China tried that whole thing of listening to the US lines of bullshit back in the 80s, saw the horrendous instability it caused, saw the USSR crash and burn because of it, and then saw the US vultures fly in to pick apart the Soviet corpse in the 90s.  Oddly, that's when they stopped paying attention.

The China game plan is pretty simple:

  • Ignore everything the US wants, but pretend it cares
  • Allow those hilarious NGOs in, but restrict their ability to actually influence anything, again, it's all part of the "opening up".
  • Use said "goodwill" to increase trade and reliance on China.
  • Infest every major economy with deep roots and create webs of systemic risk linked into any economy possible
  • Make large domestic investments to set solid groundwork for more self-sufficiency and reliance
  • Work towards a position where China, in the end, holds the stick at the table
  • Maintain domestic stability
  • Move towards higher levels on the value chain with strong brands

The US is fully reliant on China now and there's not really an exit strategy.  If not for the cheap goods, SoL would have fallen off a cliff long ago.  China is also one the few remaining growth markets left on the table for an entire slew of US industries which otherwise would have gone bankrupt long ago.  You can see this in pricing levels, wherein in China they jack up the prices relentlessly to subsidize the hidden inflation and losses in the west.  China is also in a position of eating up economies by buying up resources.  If China starts to lag, all those economies are gonna be in deep shit really fucking fast.  It'll hurt China, but not as badly as everyone else.  Pushing for more consumerism isn't all that bad, as most shit's made domestically anyways.  The key goal is to shift the grunt work away to emerging economies while maintaining control of the brands and IP. Ideally, the grunt work positioned in economies reliant on China.  Effectively, China is building through trade and commerce what the US built through violence and blackmail.  One of em's sustainable, the other is not.

The largest difference is... major reforms that are needed are carried out rather quickly.  We don't have to sit back and listen to the war criminals cry about how it's "not politically viable, please give us money", we don't have to watch party x pick a retiring member to be the scapegoat for not doing something everyone wants.  It just doesn't happen.  And we don't have to worry about petty state rivalry either.  For a country that claims "rule of law", from state to state it's not even uniform and it's retarded.  Policies might be regional, but laws are uniform, albeit the local policy might be to not enforce certain laws because reasons, they are still on the books.  The economy doesn't rely on a single person coming out and deciding monetary policy... and oddly enough, the US fucking hates China for it.  It's far harder to corrupt an entire board than it is to corrupt a single person and it doesn't make for dazzling fake news either.

TimmyM's picture

Thanks for your post. What do you do about the unsustainabilty of credit growth at a multiple of economic growth?

new game's picture

411-info alert; you are so biased even if the light came on you would be blinded.  keep the room dark so your shrooms can flurish.

i have moved to a foriegn land and left after one year. you gloss over so much relevant shit it amazes me.  leaving your homeland is a bold step. but i have and didn't like a thing about the new land. every thing was wrong down to the funny looking people and even the trees looked stupid. so have a nice ride with all your slaves on your power trip. china matches your personality to a tee.

home is home unless you were born to a wack. fuck you...


satoshi411's picture

excellent, ...  can you imagine if you were a poster here rather than the same-same daily talking shit-heads?

nobody here has a fucking clue about china, ... the ZH site is just narrative for morons, not unlike your description of people who play CHINA stock-market, ZH is a fodder for morons who play USA market,...

Anybody worldwide that play's paper stock markets is a moron, and all POST's are just SHIT to feed mushrooms and keep them in DARK.

If you want to KNOW asia, go live there.

P.s. You will NEVER return to USA.


The #1 thing I hear from guys that have bailed the USA, and came here to ASIA is "I will NEVER again, live with, fuck, or marry a white woman".

In Asia the women are women. And money is GOLD, go figure.

mobydick's picture

She'll be right, mate

No real estate bubble here & you can take that as fact, because the RBA & all the major Bank CEO's who know these things have told us so.

In the lucky country we make our damn own luck, by Christ. So there.



UselessEater's picture

She'll be right indeed.....introducing the 40yr home loan to Aussies we're doing so well at painting the illusion of doing well, guess there are still a few more bucks to extract from us here and there in the self-reinforcing bubbles....





mobydick's picture

Complements of Greg Caravan


For Australia, the real interesting point about China's trade figures was the absolutely huge iron ore import figure of 87 million tonnes, a 33% year-on-year increase. At the same time, China's ports are bulging with near record levels of iron ore inventories.

--So what's going on? Bloomberg has the story...

'China's iron ore imports climbed to a record in January as some buyers used the commodity as collateral to get credit, swelling inventories that are already approaching the highest level ever.

'Companies seeking funding amid government efforts to rein in lending and shadow banking are shipping more ore to use as collateral, said Xu Xiangchun, chief analyst at researcher Mysteel.com. Rising purchases by China, the world's largest user of the material, may reduce a global glut forecast for this year by Goldman Sachs Group Inc. and Credit Suisse Group AG.

'“Steel prices have fallen sharply and demand remains weak, so there are no fundamental reasons supporting such a big jump in the raw material imports,” Xu said by phone from Fuzhou today. “The only plausible reason is financing deals.”'

--Copper imports rose to a record monthly level in January as well, so we assume that the punters in China are using 'commodity collateral' to get their hands on cash for use elsewhere in the credit casino.

--So they get a short term letter of credit from a bank or whoever, buy a boatload of iron ore (or a few slabs or copper) and sell it for cash. They punt with the cash for a few months, then repay the loan, presumably making a nice profit along the way. 

--What could possibly go wrong?

--This is the sort of shenanigans that happen when the authorities lose their grip on a credit boom. Attempts to tame it prove elusive...until it eventually tames itself.

--By the way, another trust product in China just defaulted. They're trying to 'restructure' it to avoid investor panic. Expect more of this to come.

--Your remaining China-bearish analyst,

andrewp111's picture

Xi Jumping isn't going to do shit to pop his country's credit bubble. He already blinked over a tiny wealth management fund. What makes anyone think he will let something larger blow up.  He is just going to ride that bubble until it blows of its own accord. This means it may not blow up for many years - until energy prices spike and put an end to the bubble just like they did in 2008.

old naughty's picture

Not so sure, i am taking a wait-see...

We see evidence some of his oppositions met with total defeat.

TheGoldMyth's picture

If the Economic CO2 greenhouse of China crashes, our last remaining big CO2 producer might plunge the globe into a more intense iceage than we currently allready have?

Marco's picture

You're a little too US centric ... over here in Western Europe we've had a rain age (about two days of frost all winter where I am).

andrewp111's picture

A little bit of CO2 isn't going to have any effect at all on short term weather patterns. The notion that it could is ridiculous. If there is another ice age, the driver is likely to be the sun.

Shad_ow's picture

If there is another ice age, the driver is almost entirely the inactive phase of the sun.

TheGoldMyth's picture

weburke, i aggree, it is difficulat to know how cold it will get in the Chinese region if CO2 emissions become depleted because of slowing economic factors as those outlined in the article about Xi, so i will use the opportunity to further point out that even australia has had a very mild cool summer also due to our slowing economy in our region, appart from CO2 produced by bushfires that are intensified by introduced, fast growing weeds that came with the early settlers who wanted a fast growing grass to feed cows with. Native Australian vegetation grows incredibly slowly and all that was necesarry for the orignal inhabitants here was to set fire to selected areas during early spring when the fires would less intense. Sophisticated Australian Aboriginals (SAA)  controlled their CO2 emissions and hence the climate was allways excellent in those days with the right amount economic stimulus at the right time to produce perfect drought or flooding rain as desired, GM fast growing grass had not been perfected to the level of using-the-lawn-mower-each-week to keep the grass down like we have these days.