"The Pig In The Python Is About To Be Expelled": A Walk Thru Of China's Hard Landing, And The Upcoming Global Harder Reset

Tyler Durden's picture

By now everyone knows that the Chinese credit bubble has hit unprecedented proportions. If they don't, we remind them with the following chart of total bank "assets" (read debt) added since the collapse of Lehman: China literally puts the US to shame, where in addition to everything, the only actual source of incremental credit growth over the same time period has been the Fed as banks have used reserves as margin for risk purchases instead of lending. 


Everyone should also know that like a metastatic cancer, the amount of non-performing, bad loans within the Chinese financial system is growing at an exponential pace.


Finally, what everyone learned over the past month, is that as the two massive, and unresolvable forces, come to a head, the first cracks in the facade are starting to appear as first one then another shadow-banking Trust product failed and had to be bailed out in the last minute.

However, as we showed last week, and then again last night, the default party in China is only just beginning as Trust failures in the coming months are set to accelerate at a breakneck pace.


The $64K question is will the various forms of government be able to intercept and bail these out in time, as they have been doing so far despite their hollow promises of cracking down on moral hazard: after all, everyone certainly knows what happened when Lehman was allowed to meet its destiny without a bailout - to say that the CNY10 trillion Chinese shadow banking industry will not have far more dire consequences if allowed to fall without government support is simply idiotic.

But what could be the catalyst for this outcome which inevitably would unleash the long-overdue Chinese hard landing, and with it, a new global depression?

Ironically, the culprit may be none other than the Fed with the recently instituted taper, and the gradual, at first, then quite rapid unwind of the global carry trade.

Bank of America explains:

QE and the Emerging Markets carry trade


The QE channel has worked through Emerging Markets and China is a key vehicle. By lowering the US government bond yields to a bare minimum, and zero –ish at the short end, a search for yield globally ensued. Emerging market banks and corporates have gone on an international leverage binge, yet another carry trade, the third in 20 years. The first one was driven by European banks, financing East Asian capex – that ended in 1997. The second one was global banks and equity-FDI supporting mainly capex in the BRICs. That ended in 2008. This time, it is increasingly non-equity: commercial banks and more importantly, the bond market – often undercounted in the BoP and external debt statistics that conventional analysis looks at.


Chart 9 shows the rise of EM external loans and bond issuance (both by residence and nationality). Since, end-3Q2008 to end-3Q2013, external borrowing from banks and bonds has risen USD1.9tn. Bank loans have risen by USD855bn and bond issuance in foreign currencies by nationality is up USD1,042bn. In the prior five-year period (i.e. end-3Q2003 – end-3Q2008), forex bond issuance rose only USD432bn. Clearly, the importance of external bond issuance is rising. See Table 5 for details.


In China, since, end-3Q2008 to end-3Q2013, outstanding external borrowing from banks and bonds has gone from USD207bn to USD849n – a net rise of USD655bn. Outstanding bank loans are up from USD161bn to USD609bn – a net rise of USD464bn. Bond issuance in foreign currencies by nationality is up from USD46bn to USD240bn – a net rise of USD191bn. In the prior five-year period (ie, end-3Q2003 – end-3Q2008), forex bond issuance rose only USD28bn in China. Clearly, the importance of external bond issuance is rising in China.



There is more to this story.


As mentioned earlier, for externally-issued bonds, USD1,042bn has been raised by the nationality of the EM borrower since end-3Q 2008, but USD724bn by residence of the borrower – a gap of USD318bn, or 44%. This undercount is USD165bn in China, USD100bn in Brazil, USD62bn in Russia, and USD37bn in India. The carry trade this time around was helped substantially by access to the bond market, especially from overseas affiliates of EM banks and corporations.


There are a lot of moving parts in the balance of payments that finally affect the change in international reserves at any EM central bank – eg, the current account, portfolio equity investment and direct equity investment, and debt flows – both from the bond market and lending from banks. We focus on the link between these debt flows and the international reserves in China. As Table 5 below shows, China’s external debt – from bond issuance and forex borrowing from banks – rose USD655bn during 3Q08-3013.



We posit that this large rise was in part driven by the carry trade offered up by QE – China banks and corporates issued substantial forex-denominated bonds, and borrowed straight loans from international banks. We recognize the caveat that correlation does not imply causation. The USD655bn rise in China debt issuance is highly correlated to the Fed’s balance sheet since late-2008. As Chart 11 shows, the rise in China debt issuance of USD 655bn has (along with FDI and the C/A surplus), boosted international reserves by USD1,773bn since late-2008. Also, as Chart 11 shows, the USD1,773bn rise in China international reserves mirrors the rise of USD2,585bn in the EM monetary base. Lastly, the rise of China’s monetary base of USD2,585bn correlates well with the USD10.9tr rise in China’s broad money expansion.




As the Fed tapers, and the size of its balance sheet stabilizes/contracts, we should expect this sequence to reverse. Confidence is a fragile membrane. Not only does the Fed’s balance sheet matter as a source of funds, but we believe so does the attractiveness of the recipient of the carry trade – and the trust in its collateral. As Gary Gorton puts it...


The output of banks is money, in the form of short-term debt which is used to store value or used as a transaction medium. Such money is backed by a portfolio of bank loans in the case of demand deposits, or by collateral in the form of a specific bond in the case of repo. The backing is designed to make the bank debt as close to riskless as possible — in fact, so close to riskless than nobody wants to really do any due diligence on the money, just transact with it. But the private sector cannot produce riskless debt and so it can happen that the backing collateral is questioned. This typically happens at the peak of the business cycle. If its value is questioned, it loses its “moneyness” so no one wants it, and cash is preferred. But as we know, if everyone wants their cash at the same moment, their demands cannot be satisfied. In this sense, the financial system is insolvent. (interview with the FT) 


What makes sense for an individual carry trade - borrow low, invest at higher rates - falls prey to the fallacy of composition, when too many engage in the same carry trade. And eventually question the underlying collateral, now huge, and potentially suspect. China is a case in point. If our colleagues David Cui and Bin Gao are right, the trust sector in China could create rollover risks that reverse a gluttonous carry trade within China, but partly financed overseas. In China's case, this trade was between low global interest rates, low Chinese deposit rates, expectations of perpetual RMB appreciation on the one hand, and higher investment returns promised by Trusts on the other. A part of the debt funds raised overseas, we suspect were put to work in this Trust carry trade. The HK-based banks are big participants in intermediating the China carry trade - as Chart 12 shows, their net lending to China went from 18% of HK GDP in 2007 to 148% in late-2013.


There are always fancy names given to carry trades – financial liberalization of capital accounts, the Bangkok International Banking Facility, currency internationalization, etc. We remain skeptics of these buzzwords.




The potential consequences of Trust defaults and a China carry trade unwind


1. If the EM carry trade diminishes as a consequence of a changed Fed policy and/or less attractive risk-adjusted returns in EMs as collateral quality is questioned, the sources of China’s forex reserve accumulation will need to change. Perhaps to bigger current account surpluses, more equity FDI and portfolio investment through privatization and more open equity markets. If that does not happen, expanding the Chinese monetary base might require PBOC to increase net lending to the financial system and/or monetize fiscal deficits (this last part has not worked so well in EMs).


2. Potential asset deflation is a risk, as the carry trades diminish/unwind. Property prices are at risk – the collateral value for China’s financial systems. This is not a dire projection – it simply seeks to isolate the US QE as a key driver of China’s monetary policy and asset inflation, and highlights the magnitudes involved, and the transmission mechanism. Investors should not imbue stock-price movements and property price inflation in China with too much local flavor – this is mainly a US QE-driven story, in our view.


3. Currently, China’s real effective exchange rate is one of the strongest in the world. Concerns about China’s Trust sector, and its underlying collateral value, sees some of this carry trade unwound, the RMB could be under pressure.



4. Given HK’s role in the China carry trade, HK property prices and its banking system should be watched carefully for signs of stress.


5. UK, US, and Japan banking systems have been active lenders to China since QE. They should be on watch if the Trust rollover risk materializes and creates a growth shock in China. See Chart 15.




6. Safe haven bids for DM government bonds, overseas property and precious metals might emerge from China.


Could the party go on? Yes, if for some reason a significant deterioration in the US labor market, or a deflationary shock from China, or any other surprise that could lead to a cessation of the US tapering could prolong this carry trade. This is not the house base case. We believe it is better to start preparing for a post-QE world. As one of our smartest clients told us: “the main theme in the past five years was QE. If that is coming to an end, investments and themes that worked in the past five years must therefore be questioned.” We agree.

* * *

Yes, Bank of America said all of the above - every brutally honest last word of it.

The question, however, in addition to "why", is whether the Fed also agrees with BofA's stunningly frank, and quite disturbing conclusion, perhaps finally realizing that aside from the US, the biggest house of cards that would topple once the "flow"-free emperor is exposed in his nudity, is that of the world's largest "growth" (and credit) dynamo of the past two decades - China. Because, as noted above, if Lehman's collapse was bad, a deflationary collapse brought on by Chinese hard landing coupled with a full unwind of the global carry trade, would be disastrous and send the world into a depression the likes of which have never before been seen.

Finally, for those who want the blow by blow, here is BofA's tentative take of what the preliminary steps of the next global great depression will look like:

If we do experience a sizable default, the knee-jerk market reaction will be cash hoarding since it will strike as a big surprise. Thus, we expect the repo rate to rise first, while the long term government bond would get bid due to risk aversion flows.


However, what follows will be quite uncertain, aside from PBoC injecting liquidity and easing monetary policy to help short term rate come down. It has been proven again and again the Chinese government will get involved and be proactive. The bond market reaction will be different depending on the government solution.

Alas, at that point, not even the world's largest bazooka will be enough.

At this point one should conclude that reality - through massive, unprecedented liquidity injections - has been deferred long enough. It is time to let the markets finally return to some semblance of uncentrally-planned normalcy: there is a reason why nature abhors a vacuum. Even if it means the eruption of the very painful grand reset, washing away decades of capital misallocation, lies and ill-gotten wealth, so very overdue.

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HyBrasilian's picture

If things ever REALLY get bad, there's always the holy hand grenade of Antioch.

TheFourthStooge-ing's picture

Maybe not so bad. If river pig in python is expelled on roadside, may go unnoticed.

nope-1004's picture

The reset is way overdue - I agree.  But the current plan seems to be to buy time and trade fiat for gold until the reset.  They all know their currencies aren't worth shit, so a grand rotation has to happen first.


Nostradamus: (Cent. 8 Quat. 28)

Les simulacres d'or & argent enflez,
Qu'apres le rapt au lac furent gettez
Au desouvert estaincts tous & troublez.
Au marbre script prescript intergetez.

Translates as:

The copies of gold and silver inflated,
which after the theft were thrown into the lake,
at the discovery that all is exhausted and dissipated by the debt.
All scripts and bonds will be wiped out.


We will return to sound money at some point.


Pure Evil's picture

Not to worry.

Walmart is bringing jobs back to America.

It seems with more and more people bringing their pets to Walmart stores to go shopping with them, the slogan "Cleanup in Aisle 4" is about to take on a whole new meaning.

johngaltfla's picture

Worry. When the banks start unraveling another major holder of UST's will be zapped. Look for Japanese naval vessels to be sunk and China to occupy any disputed islands with a strong military force. The Japanese government will use this an excuse to void the Constitution (like we have) and mobilize for war. It will be a bloodbath in the South China Sea and on Wall Street as a result.


Along with our Pussy in Chief crying for peace like a little bitch.

zaphod's picture

But China is suppose to be the next reserve currency, half of ZH's articles lately told me so.

And some people wonder why the Chinese are buying real estate in the US hand over fist.

johngaltfla's picture

Who said they are "buying"??? They are simply trading UST for MBS and taking deeds in lieu.

Stackers's picture

They learned their lesson with lehman. They will bailout everyone and everything until the whole system hyper inflates.

bunzbunzbunz's picture

All these charts just make me want more free bitcoins from http://freebitco.in/?r=25727

The Vineyard's picture

Yeah, yeah.  The sky is falling.  We know the drill.  Blockheads.

TwoShortPlanks's picture

Perhaps the Finish Line isn't Hyperinflation, Deflation, or Debt Deflation. Perhaps it's merely a game of positioning at the new/next Bretton Woods Table?


hobopants's picture

"The foundation of all mental illness is the avoidance of legitimate suffering." The majority of people just have their head in the sand and don't want to acknowledge that their way of life is slowly falling apart around them. It's becoming harder to look away everyday. This is panic and desperation we're seeing, not confidence.

We give the people up top too much credit I think, The short term thinking and back stabbing going on could never lend itself to any "Grand" plan. These people are parasites, and parasites don't create or build anything... they die with their host.This isn't 1984, this is decay, the fall of Rome.

One Blessing of the QE "program" has been time, a pretty fair gift to those who see the writing on the wall. Learn to garden, hunt and defend yourself and your own. Plan and prepare, watch and wait. We'll all regret being "right" soon enough.

dontgoforit's picture

It does seem an inevitability.  Too bad.  There's far too much nuclear stuff out there for anyone to think having gardening knowledge and guns will keep the suffering at bay.

jeff montanye's picture

"They learned their lesson with lehman. They will bailout everyone and everything until the whole system hyper inflates."  a similar point is made in the original article.  imo this points to a false policy duality.

the lehman debacle was not because the creditors/shareholders were not bailed out but because the failure was disorganized.  the fdic oversees, to this day and for decades, the reorganization of insolvent banks.  these typically involve shareholder wipe outs, bondholder haircuts and no losses to depositors.  this should have been the template for recovery from 2008. that it was not is testimony to the self-serving, corrupt political power of the too big to jail, not that a better idea was not available.

Seer's picture

The person you're responding to mentioned Bretton Woods.  That That came to be pretty much turns your notion on its head that they can't do something just like it: they did it before, they'll do it again.

That said, I'm NOT saying that it'll succeed: please note that given a short enough time frame just about anything can be said to succeed.  As time marches on and population increase we get ever-so-closer to the point at which the consequences of overshoot cannot be denied/avoided.  I think that time is pretty much here, in which case the tricky part in all the global negotiations are really coming down to chosing who lives and who dies (as far as countries go)- those with resources make it (and they'll demand a price for those resources; this is proper given that resources are limited).

"Learn to garden, hunt and defend yourself and your own. Plan and prepare, watch and wait. We'll all regret being "right" soon enough."

Sound advice. (though, time waits for no one- we ought to be busy, each and every day, till we die...)

viahj's picture

i've been saying this for quite a while now TSP (read your blog the other day).  the SDR will be the global reserve currency.  currently the Yuan is not in the basket, but with all the gold they are buying, the Yuan will be included in the basket with the USD/Euro/Pound being rebalanced in the mix.  not sure about the % of the basket that the Yen will keep and how the Ruble will join in the mix.

akak's picture

Frankly, the whole SDR-as-reserve-currency scenario makes utterly no sense to me.

How does combining a number of shitty fiat currencies make the mix any more stable than merely holding the individual shitty fiat currencies?  Divide up the SDR among those who would hold it as a 'reserve', and what you fundamentally have is everyone holding THEIR OWN currencies as a 'reserve'.  Where is the logic in this?

Maybe it's just me, but I would find a basket of turds no more palatable than an individual turd.

Seer's picture

But, BUT...  If we all hold hands as we jump over the cliff it'll be just so much better!

DerdyBulls's picture

until the whole system hyper inflates.

"Until" seems to be in permanent stasis. No economic school wants to face this. Nobody. Check the reserves parked the FED and M1. They mirror each other. So what the monetary base has expanded. Comercial banks are NOT lending into the general economy. M1V is diminishing. This anom has screwed any prior system for projecting inflation and given even broader power to digit creators. What we have here is a very successful PR campaign to nationalize capital markets.  

SDShack's picture

Actually, it is projecting inflation, it just isn't being measured. But it is being felt by the consumer. The capital markets are completely broken by design. The nexis of central banks controling the bond market, PLUS the printing press, means the Ponzi is perpetual. The PR campaign is really a bribery campaign of politicans to enable the grand scheme to continue and add the state security teeth to it to enforce it. The consumer is being squeezed and will reach the breaking point with one more engineered collapse. Then TPTB PR campaign will unleash the Debt Finance WMD to "protect" the masses from their wealth destruction (caused by TPTB) by herding the sheeple into new Govt Backed Debt Instruments (ala MyRA on steroids + Reverse Mortgage) to replace their devestated mortgages, 401k's and IRA's. And the sheeple will rejoice at being "saved" by the govt. The final solution of wealth transfer from the masses to the elites. That's why I call it the New Feudal World Order.

Seer's picture

Two words: Confidence; velocity

At some point the confidence is going to get to the point where TPTB will feel it start to turn on them.  At that point they'll go all in and start dropping money out of the helicopters (velocity) in an attempt to try and pull people back into the "system."  Might also be a way for them to distance themselves from the eventual chaos: like tossing meat to hungry dogs in order to make a get-away: of course, there's no real meat in the "meat," in which case the smoke clears and folks resort to their upheaval.

SMG's picture

No that would be the SDR or it's equivalent for the new temporary reserve currency.  The future reserve currency will be an asset based cryptocurrency.  Just saying.

Soul Glow's picture

The dollar will hold swap as long as it can still short gold during asian trading hours.  After that it is the SDR.

blueRidgeBoy's picture

you're assuming we'll have electricity and interweb

bunzbunzbunz's picture

I have a stationary bicycle, an alternator, a power inverter, and a router with DD-WRT. The internet is unstoppable. It may be text based rather than media based, but it will always be there for the educated.

Seer's picture

Got food?

(ever have electronic stuff fail on you?)

"Education" is subjective.  Hicks in the sticks might not be able to perform "educated" tricks for the techs, but they can probably survive in the REAL world.

If things get really bad the Internet is going to be locked down tighter than an evangelical's daughter.  You'll have to be working for "Someone" in order to use it...

Mitzibitzi's picture

So, I'm guessing you've wasted your life accumulating fiat? Had you been something other than a greedy cunt, you'd have learned how to build a plethora of electrical generators from scratch, how to nail net hardware together to make it function, and how not to be a whiny bitch in the process.

Your standard of living IS GOING TO DROP; deal with it!

Your options.. and there are only two, so deal with this now and move on... are:

We nail every sociopath on Earth to the nearest fucking post! Good luck cathicing them all, the smarter ones don't advertise!

Or.. we carry on with the 'do fuck all' that is the current plan and they win! Probably forever. Keep the population stoopid enough and you can feed them any line of bullshit and they'll believe it!

Volaille de Bresse's picture

"And some people wonder why the Chinese are buying real estate in the US hand over fist"


It's because the popualtion of China think the US are cool and friendly. They have Starbucks Nike Apple and Hollywood movies in mind.

Otoh the Chinese politburo WANT to destroy the US as they think you're a bunch of arrogant upstarts and usurpators who've been around for 2 centuries only (that's 2 weeks by Chinese standards = nothing in their eyes). 


That's where the dichotomy lies but makes no mistake you'll feel their breath down your neck soon and you'll feel a stinging pain below the belt soon after. 

I don't htink they'll engage into a full-blown frontal war with the US but they'll push you to the brink till you self-destruct. One possibility is "hey USA let's play a game of I'll show mine and you'll show yours : we have XXXX 1000's tonnes of solid gold in our vaults. What about you?". 

Within 6 weeks the US will crumble... or wiil attack China. 

Raging Debate's picture

Volaille - I am buying real estate too. I would buy some in China in about oh, about a year if I could afford it. Nothing else worthy of investing and the gains are small for long-term investments.

The Chinese investors that can afford to buy here in America, strongly influence there government (one and the same) are going to make us pay and hurt there own investment? We're going to attack China and hurt our multi-trillion dollar investment?

Sorry man but the most arrogant people are the French who haven't contributed dick globally since the Renessaince. I would say the US will do better with a bit of humility and respect but we see how your opinions make others react.

China and America have a good thing going but leadership ahpuld have started trade rebalancing or at least detente by 2005. It is the little guy that got hurt on both sides the last near decade by the imbalance.

Mitzibitzi's picture

You really don't understand the world, do you? EVERY greedy elite cunt wants to be some 'Doctor Evil' James Bond bad guy! All of them! What they'd do with the world once they got it is harder to understand, but hey;....

Seer's picture

"Otoh the Chinese politburo WANT to destroy the US"


TPTB all run in the same circles.  They know that they ALL depend on one another to keep this game going.  The Chinese version, just like all others, could give a fuck about anything other than maintaining power.

China is resource-poor compared to the US (Russia and Canada).  They've also heated up demand for imports that cannot be sustained.  Internally the pols there will have to battle with Madison Ave (mindset- Edward Bernays' psychology).  Look at all the younger people glued to iShit.  Game fucking over...

InflammatoryResponse's picture

Actually,  it is AWESOME that we're unloading property to the Chinese, it allows for all sorts of fund raising opportunities.


1) Foreign ownership license fee   a % of the value of the property to make sure said property is maintained etc.

2) Vacant house registration.  Any house occupied less than 50% of the time must register.  again a % of the value :)

3) Foreign owned rental license and maint.s tax.



  well you get the idea by now. :)

Seer's picture

And then there's the part in the story where the "locals" reappropriate all their domestic land held by foreign entities...

irishlink's picture

Not in just the USA also Canada and Ireland. Wealthy Chinese family bought Foto island park in west cork and also e top Dublin hotel on the cheap. They are also active in London. Sydney, Melbourne over the past number of years.

Johnny Cocknballs's picture

go ahead and short the yuan.  report back with your findings.

krispkritter's picture

Ah, so. You see a Chink in their economic armor?

akak's picture

1.3 billion of them, to be precise.

prains's picture

if you like your chink you can keep your chink

Troll Magnet's picture

Nobody likes chinks. Hell, chinks don't like chinks. Fuck'em!

GetZeeGold's picture



Clearly you are ESPN material.

Keyser's picture

Considering there are 5 times the number of 'chinks' in China compared to round-eyed devils in the US and the fact that their culture pre-dates western civilization by a few thousand years, one can only deduce that you are the pig in this story. 

akak's picture

At least we "foreign devils" (nice racism and xenophobia in that, by the way) do not routinely shit on every convenient sidewalk and roadside, unlike the uncouth and constantly spitting antlike hordes of Middle Kingdom fabled past (and present).

ILLILLILLI's picture

So...you haven't been to San Francisco lately, have you?

akak's picture

No, I  haven't --- I don't seem to have any trouble finding men willing to shove their arms elbow-deep up my tortured rectum whle tugging on the clamps on my nipples much closer to home.

prains's picture

phunny that you think population size and longevity are the TWO requirements for a civilization to be GREAT . That they are the foulest, most corrupt, shit eating, floating shaved pig civilization to ever soil the earth has somehow been LOST to yu. LOFUCKING LLLLLLLLLLL

FEDbuster's picture

and F. Sawyer is gone for his comments regarding the tribe?

Guess the Chinese Defense League doesn't monitor ZH?

prains's picture

they're too busy milking their country of funds for the eventual escape

Seer's picture

"Considering there are 5 times the number of 'chinks' in China compared to round-eyed devils in the US"

Given the realities of resource depletion I wouldn't necessarily claim this as an advantage.

If one were to view the defensive capabilities of both countries I'd have to give the clear nod to the US, as it has less land boundaries to defend, and all along those boundaries are "friendlies."

The US can withdraw, as it has a substantial amount of resources to draw down, likely over a much longer period that China can (with its huge population).  And as much as I hate to say it, I think that the US govt actually has more ability to control its citizens than does China: useful for establishing quotas.

"their culture pre-dates western civilization by a few thousand years"

All fine and well for preserving culture.  Preservation and expansion are two different things...  Also, I'd hardly call China's population homogenous (see: Tibet).