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"What Could Go Wrong" - China's "Worst Case Negative Loop"

Tyler Durden's picture




 

Yesterday, as we reported, in a surprisingly scathing report, Goldman announced that it was now positioning for an "imminent" two year real estate property downturn, which has significant probability of becoming a hard landing as many others, most notably Barclays in recent days, have pointed out. Which is perhaps why Goldman was one of the few banks this morning to trash last night's "better than expected" HSBC manufacturing PMI report, as a softish landing is now clearly Goldman's base case.

But under what conditions could the soft landing scenario become a hard landing? In other words, what could go wrong?

Here is Goldman's answer:

We are concerned about policy uncertainties, and the possibility that potential policy changes could be too little or too late. In particular, we believe potential policy missteps could lead to a self-fulfilling bear-case scenario, i.e. further property market weakness, which could in turn lead to weak corporate earnings, rising unemployment, forex outflow, lower GDP and bank asset quality risks.

We believe the two policies discussed below are critical in preventing a prolonged property market slowdown while not increasing the property over-investment risks:

  • Lower the minimum down-payment ratio for property upgrades, e.g. to 50% from the current 60% (nationwide) and 70% (in some big cities).

We note that during the housing reform in 2001 when many government and SOE employees obtained subsidized houses from the government at much reduced prices, China house-ownership within urban areas already reached c. 80%, according to the Ministry of Housing.

As such, property demand has been mainly driven by households improving their living standard, or upgrading need. In 2011, to control housing prices, China adopted a mortgage policy that imposed minimum 60% downpayment ratios for second home purchases. Second home purchase is defined as: 1) a family that already has a flat; or 2) a family that historically already borrowed a mortgage (even though the family already paid off the mortgage and no longer owns the flat).

We believe such a high down payment for second homes effectively significantly hurt property upgrade needs, which is the main demand for property markets, rather than the first home purchase.

As such, we believe lower downpayment ratios for second home purchases will be fundamentally positive for increased property demand, while not increasing property bubble risks as China still prohibits the purchase of third homes.

  • Lower the funding costs for mortgage and corporate sectors, by RRR cut, removal of loan/deposit ratios, etc., per our earlier discussion.

That said, we are not sure whether these policies will be changed, and when.

In the bear case, if China fails to address the above-mentioned policy mix, we believe worse-than-expected mortgage rate rise could lead to a more severe property downturn, a FAI/GDP slowdown, and corporate earnings weakness, and in turn, could lead to higher unemployment, forex outflow, and more GDP/property/banks’ asset quality downside risks.

We define our base case assumptions for bank earnings estimates below:

  • China selectively eases mortgage policies for property upgrade needs in certain areas in 4Q14 (on May 12, 2014, PBOC held a meeting with banks to encourage mortgage offering);
  • No RRR cut. China banks’ funding costs continue to rise, which retain relatively high corporate/mortgage funding costs.

* * *

A simple way of grasping the above is with this useful diagram which summarizes the negative loop that China's economy (which essentially means housing market which as SocGen recently explained is indirectly responsible for 80% of local GDP) could fall into should the government not promptly move to address the emerging dangerous situation, i.e., resume aggressive easing.

So is China taking this warning seriously? Why yes: as the WSJ reported today, China's central bank is set to inject the most cash this week into the financial system since late January to help meet rising demand from companies and to boost the sluggish economy.

The People's Bank of China will pump a net 120 billion yuan ($19.2 billion) into the interbank market this week, said traders participating in the operation Thursday. That's the most since the last week of January.

 

"It's to a certain extent a form of monetary policy easing as looser funding conditions will definitely facilitate the ongoing economic recovery," said Steve Wang, research director at Reorient Financial Markets Limited.

Keep in mind that this is happening as China is also easing at the fiscal and macro level, having pushed the Yuan to its lowest official fixing since September, a move which in itself has largely offset the concerns about liquidity following the ongoing credit drought. However, the favorable impact of FX may be passing:

Despite the supply of funds, it wasn't enough to cool rising stress in the financial system. A seven-day benchmark cost of short-term loans among banks rose to 3.43% Thursday, from 3.39% Wednesday.... China's central bank and financial institutions bought a net 116.92 billion yuan ($18.8 billion) of foreign currency in April, compared with a net purchase of 189.20 billion yuan in March.

Yet on the surface, it appears that China's liquidity injection is merely being implemented to sooth the memory of last year's near collapse of the nation's money market when the 7-day repo rate briefly exploded as high as 25%.

"This week's large injection is also aimed at stabilizing sentiment in the market, because obviously the authorities don't want the cash crunch to repeat itself," said Mr. Wang. "To achieve stable economic growth, you need to stablize people's mood first," he added.

In other words, once this temporary liquidity injection passes, the storm clouds over China's "negative loop" may promptly gather once again...

 

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Thu, 05/22/2014 - 12:51 | 4785244 Chewybunny
Chewybunny's picture

Enjoy the Yuan, Putin. 

Thu, 05/22/2014 - 13:02 | 4785282 El Oregonian
El Oregonian's picture

What could go wrong? Well, for starters they've aborted most of their female babies in the past and now those young chinese men are coming to take your daughters as concubines and slaves.

Guard your daughters.

Thu, 05/22/2014 - 14:00 | 4785488 TrustWho
TrustWho's picture

Oregon,...Agree, I have been saying for decades that the Chinese one child (mostly male) policy will force China to go to war to control their citizens (males). I use to know the numbers, but the Chinese must have 30 million unmarried boys of fighting age (16 - 40 years old). Vietnam better be getting ready to protect their females. Funny, males have been fighting for women like the dominant male herd animal we are since the beginning of human civilization. Genghis Khan was best to date. 

Thu, 05/22/2014 - 15:33 | 4785968 Son of Loki
Son of Loki's picture

Australia's going to feel some pain as China's GDP slows to only 6-7% and the demand for coal, iron, etc tumbles. Those truck drivers [remember, the ones how make more then Australia's heart surgeons ZH wrote about] better save every penny. I read the median house price in Australia is still a whopping $653,000 !!

Even air fares to Down Under are over 300% what they used to be.

Crazy.

Thu, 05/22/2014 - 16:51 | 4786318 Rantabulous
Rantabulous's picture

I am in Aust. I feel like I have been taking 'crazy pills' when I talk to people here.

 

A conversation with a friend who is on a solid middle class income - completing his PhD - a generally smart and nice guy. Talking about the local housing market and how it has "lost some energy", due to 'uncertainty with the new federal government'.

I feel like I need to know the lines from a script to reply to him, but I don't know what they are. Our world view is so far apart.

Another friend of mine (a PhD and solid income) actually said the words to me about 12 months ago, "I think I should get in and buy a house because the prices are only going up." As his money was on the line and as he is a friend I decided I should tell him what I really thought of that idea and why. He held off and now prices have "flattened" where he lives and he is now seeing the world differently.

Fri, 05/23/2014 - 02:14 | 4787564 BrosephStiglitz
BrosephStiglitz's picture

Bleh.  Cry me a river.  Australia still had one, or two thriving industries while the rest of the world was in a tailspin.  All this is going to be is a reversion back to the mean for them.  

Pretty much where everyone else has been for the last 6 years. 

Thu, 05/22/2014 - 13:05 | 4785289 dryam
dryam's picture

China knows there is a coming reset of the global financial/monetary system. They will work out their internal issues. The main thing they are interested in is positioning themselves for a world where real assets matter much more so than "money/credit", whatever that means anymore.

Thu, 05/22/2014 - 13:44 | 4785432 i_call_you_my_base
i_call_you_my_base's picture

"They will work out their internal issues."

I don't know how you can so flippantly say these words. There are a billion people in China, 1/5 of the worlds population. Their pollution is unreal, they struggle for water, energy, they have a gigantic lower class, etc. And the bubbles they've blown are very large. I'm not saying they can't "work out their issues", but it's not going to be easy at all.

Thu, 05/22/2014 - 13:50 | 4785458 dryam
dryam's picture

It's not going to be "easy" for anyone. This world is moving back to basics. That process is extremely painful all the way around, but will be more painful in developed countries. China has a lot they have to work through, but everything is relative.

Thu, 05/22/2014 - 12:53 | 4785256 _ConanTheLibert...
_ConanTheLibertarian_'s picture

Housing market is already imploding. They can't do anything to stop it. Hehe.

Thu, 05/22/2014 - 13:01 | 4785278 gdogus erectus
gdogus erectus's picture

Uhh, wait- 50% down? We need to give them some lessons on leverage.

Thu, 05/22/2014 - 13:10 | 4785307 All is chosen
All is chosen's picture

If only we knew which currency the people of Inner-Earth, or the moon use, we could adopt that. They would welcome us....wouldn't they?

Thu, 05/22/2014 - 13:59 | 4785418 kurt
kurt's picture

Think of this report as a very specialized fishing lure. If acted on, the vampire squid has already gamed the outcomes and has pre-positioned itself to take advantage of predicted results, and the secondary waves of consequences, each presenting as an opportunity to latch on with its hooked tentacles while ripping out the guts with its ravenous beak, gulping meaty chunks and sucking salty hot blood.

Thu, 05/22/2014 - 13:51 | 4785460 kchrisc
kchrisc's picture

China is going to have problems, but they have a manufacturing base, gold/wealth, is respected in the world, and are completely sovereign.

The DC US has no manufacturing base, no gold/wealth, is detested in the world, and has almost no sovereignty left.

Thu, 05/22/2014 - 14:42 | 4785665 Secunda
Secunda's picture

Explain the no sovereignty remark? WTF do you mean?

Contrary to your assertion the US is not detested in the world. Most respondents to a recent Pew survey did not 'detest' the US. If you want to see people being detested try Vietnam's recent riots against the Chinese. When Iraq wanted US troops out we left after an agreement with a sovereign Iraq could not be reached. The US still has a manufacturing base and still exports goods that people around the world want (finished Petroleum products, medicants, cars, industrial equipment, food, more).Do not base your conclusion on propaganda.

Despite the wars, the NSA scandals, the growing disparity between rich and poor the US airs its dirty laundry for its citizens to debate and argue and act on. We aren't always pretty as we make our country work but it works, sometimes well, sometimes not.

People around the world get indignant at the US when they think we act too unilaterally but mainly because they trust the US to live up to our ideals and act better. When they think we have gone too far they feel (rightly so) that we have violated that trust.

Judging from your statement sounds like you'd trust Russia, China, Iran over the US?

You're welcome to it.

Thu, 05/22/2014 - 15:07 | 4785801 kchrisc
kchrisc's picture

I did not down-arrow you. I don't agree with your comment, but it is very well thought out and articulated. Additionally, I don't trust Russia, China...more. I am only commenting on what is coming this way, the way of the American people.

As for no sovereignty:

As revealed during the Bundy Ranch treason by the DC US, the pols and crats are basically trading/selling off the American country to foreigners. This benefits them directly, and personally, and they also hope to keep the DC US operating at least one more year and therefore keeping them in power that much longer.

The DC US' sovereignty is also vaporous if one considers how they must kowtow to foreign powers or risk the dumping of the Petro$. The ongoing Ukrainian "cookie coup" "sanctions" illustrates this well.

Additionally, as many have noted here at ZH, Israel and the zionists pretty much wag the dog that is the DC US.

That's what I mean.

Thu, 05/22/2014 - 15:38 | 4786003 kurt
kurt's picture

A Pew survey of WHO? Why should I trust an ultra-conservative NGO? Besides, when Hitlery was Sec she granted, legally "sovereignty" over land on American soil to China as surety against US default or monetary collapse: she needed them to keep buying Treasuries.

The wars, NSA, murder of the middle class, are all much worse than "scandals... dirty laundry". Add to that the Anti-Constitutionalists and "Unitary" fascists, I'd say there are darker, much darker, things afoot.

You use the word "indignant" and "feel" in your soft soap sell of our ABSOLUTELY insane foreign policies. Then you pull out the "you'd trust Russia...." 

You know what THAT sounds like? "America, Love it or Leave it."  Asshole.

Thu, 05/22/2014 - 18:30 | 4786692 Bazza McKenzie
Bazza McKenzie's picture

You ignore the trajectory the US is on.  It is much less free than it was.  It has much less manufacturing capacity than once it had.  In real terms, the majority of the population have a lower standard of living than once was enjoyed by a comparable group of the population.  It is far less united than once it was.  Wealth is increasingly concentrated in the hands of a small, self-reinforcing elite.

Many other countries in the world are on the opposite trajectory.

Do not base your conclusions on propaganda.

Thu, 05/22/2014 - 14:06 | 4785518 orangegeek
orangegeek's picture

China has been in the tank for well over a year.  Stick a fork in them.  They're done.

 

If Yellen stops giving away conditional free money (condition is that they buy all this shit stock they can find - the weaker the stock, the better the buy) to the banks/hedges we may roll over.

Thu, 05/22/2014 - 15:13 | 4785851 pashley1411
pashley1411's picture

Saying that China is a dynamic, productive economy, is like saying Detroit was a dynamic, productive economy.    The dynamic and productive populations are capable of getting the hell out.  

 

Thu, 05/22/2014 - 15:46 | 4785905 Seeing Red
Seeing Red's picture

That is a POSITIVE (self-reinforcing) feedback loop -- with a negative outcome.  Negative feedback promotes stability.

Thu, 05/22/2014 - 20:45 | 4787033 intric8
intric8's picture

Goldmans patriotic duty- start downgrading china left and right. Wonder what that sociopath jp morgan has cooking

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