China Narrowly Averts Credit Bubble Pop With Latest Government Bailout Of First Domestic Bond Default
When conventional wisdom worries turn to China, the prevalent consensus is that the biggest threat to the country is a housing/real estate bubble. And certainly, China has a massive housing and overbuilding bubble as can be seen on the chart below, presented previously, showing the "concrete scowl" or the cement consumption per capita vs GDP per capita. The only other country which is in dire a housing bubble situation as China is Saudi Arabia.
Of course, having a housing bubble does not mean China is immune from that other traditional corollary to excess spending: a credit bubble. In fact the two virtually always go hand in hand (see US 2003-2007). However, due to economic reporting standards out of China that are, how should we say this, lax, when it comes to getting a clear picture of state finances nobody really has any clue. As a result, due to sovereign debt being an arbitrary, and naturally low, number, few if any are concerned about the grievous credit bubble in the land of the dragon (although GMO's Ed Chancellor and Mike Monnelly have a few very critical things to say about it - more on that later).
Yet one place where not even China can hide what is now a clear credit bubble is in its soaring corporate debt. As we showed in November, China's Corporate debt as a % of GDP is now the highest in the world and closing in on 200%.
So what is any credit-funded empire which needs growth at all costs, irrelevant of how much bad debt is accumulated in the process, supposed to do? Why stick its head in the sand and deny everything of course. Just like the US did until it couldn't do it any longer.
Sure enough, what may come as a surprise to some, is that despite having trillions in corporate loans, China has had precisely zero corporate defaults to date. That's right: zero.
How is that possible?
Simple: just like the US Fed and global central banks are doing everything to mask the fact that the entire financial system is insolvent, that absent tens of trillions in new money created out of thin air (and collateralized by ever crappier assets) and used by dealer banks to buy up risk assets, there is no incremental demand for goods and service as the entire loan-deposit based fractional reserve banking system has imploded and has not even recovered the loan levels last seen in 2008, so China is proceeding with bail out after bail out of any company that threatens to expose the reality that Chinese corporations are massively undercapitalized, and that absent Chinese state support this particular 180% debt/GDP bubble would pop immediately and have dire consequences around the world.
In fact, for the just most recent example of what really goes on in China vis-a-vis said bubble, go no further than today's Reuters which tells us that "China's first bond default averted again after local govt steps in" as the government's "zero-tolerance" policy for default continues. In it we read:
A Chinese solar firm which nearly produced the country's first domestic bond default will complete an interest payment on schedule after a local government intervened on its behalf.
Investors say the latest instance of a government riding to the rescue of a troubled Chinese firm has led to moral hazard and inefficient credit allocation.
The government of Shanghai's Fengxian district persuaded Shanghai Chaori Solar Energy Science and Technology Co.'s banks to defer claims for overdue loans worth 380 million yuan ($61 million), the company's chairman, Ni Kailu, told creditors at a meeting on Wednesday.
In previous near-defaults, local governments had stepped in directly to arrange bailout funding. But as in past cases, the deal flouts legal notions of debt seniority by allowing one group of creditors - bondholders - to get paid in full, even as a pre-existing default remains un-cured.
The implications of sticking one's head in the sand by now are clear to everyone:
Analysts say the market does not effectively price in risk because investors assume the government will never allow a default.
Funny: that sounds vaguely familiar about what investors say about the Fed in broader terms...
This assumption appears well-founded. In April 2012, a local government in Shandong province stepped in to prevent a bond default by a state-owned textile company, Shandong Helon .
In July, a local government in Jiangxi province announced it would use taxpayer funds to repay the trust loans of LDK Solar , a U.S.-listed solar equipment manufacturer.
Sure enough, there are those who lament the fact that instead of tackling what is a huge and rising problem, China has once again instead decided to throw good money after bad:
Many market watchers had believed that the government would allow Chaori Solar to serve as a long-awaited lesson in credit risk and a test of the country's little-used bankruptcy laws.
Unlike Helon, Chaori was not state-owned, nor was it a leader in its sector. Its location in prosperous Shanghai also meant that it was not viewed as integral to the local economy.
"It seemed like it could be a perfect test case for the first default," said a Chinese bond trader at a European bank in Shanghai.
It did... But the government decided not to do it. Why? GMO's Ed Chancellor has a chart that explains why not.
In other words, the time is nigh for the Chinese bond bubble to pop, and every government bailout will merely incentivize many more companies to "near default" only to be rescued by the government, until such time as the government can no longer sustain the entire corporate bond bubble nearly two times greater than the entire economy.
It gets worse: if and when the corporate bubble pops it would immediately unravel all the other underwater forms of debt in the country, among them sovereign, financial (SOE and otherwise), corporate, municipal, and of course household. For a sense of just how big all of this combined is we go to GMO and an extract from a report we will post shortly:
Loans are being taken off the banks’ balance sheets and placed in shadow banking products. By law, these credit instruments are non-recourse. But skeptics suspect that the banks will be forced to compensate customers for any future losses. Bank loans are officially around 130% of GDP; add on interbank assets, other assets held on balance sheet, and various off-balance-sheet exposures, and the banks’ total credit exposure is close to 300% of GDP.
Add tot his 180% in corporate debt, and you get....
A very, very big number. And a number that is massively impaired, but which courtesy of daily government interventions to mask a very dire reality, will not see the light of day until there is no choice, and the whole house of Chinese broke and insolvent cards comes crashing down.
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