"It's Coming To A Head In 2016" - Why Bank of America Thinks The Probability Of A Chinese Crisis Is 100%

Tyler Durden's picture

Some sobering words about China's imminent crisis, not from your friendly neighborhood doom and gloom village drunk, but from BofA's China strategist David Cui.

Excerpted from "2016 Year-Ahead: what may trigger financial instability", a must-read report for anyone interested in learning how China's epic stock market experiment ends.

A case for financial instability

It’s widely accepted that the best leading indicator of financial instability is rapid debt to GDP growth over a period of several years as it’s a strong sign of significant malinvestment. Based on Bank of International Settlement’s (BIS) private debt data and the financial instability episodes identified in "This time is different", a book by Reinhart & Rogoff, we estimate that once a country grows its private debt to GDP ratio by over 40% within a period of four years, there is a 90% chance that it may run into financial system trouble (Table 1). The disturbance can be in the form of banking sector re-cap (with or without a credit crunch), sharp currency devaluation, high inflation, sovereign debt default or a combination of a few of these (Table 2).


As Chart 1 demonstrates, China’s private debt to GDP ratio rose by 75% between 2009 and 2014 (i.e., since the Rmb4tr stimulus), by far the highest in the world (we suspect a significant portion of the debt growth in HK went to China). At the peak speed, over four years from 2009 to 2012, the ratio in China rose by 49%.

Other than sovereign debt default, China has experienced all the other forms of financial instability since the open-door reform started in late 1970s, including a sharp currency devaluation in the early 1990s (Chart 3) and hyper-inflation in the late 1980s and early 1990s (Chart 4). China also needed to write-off bad debt and recap its banks every decade or so. Banking sector NPL reached some 40% in the late 1990s and early 2000s and the government had to strip off some 20% of GDP equivalent of bad debt from the banking system between 1999 and 2005.

When debt problem gets too severe, a country can only solve it by devaluation (via the export channel), inflation (to make local currency debt worth less in real terms), writeoff/re-cap or default. We judge that China’s debt situation has probably passed the point of no-return and it will be difficult to grow out of the problem, particularly if the growth continues to be driven by debt-fueled investment in a weak-demand environment. We consider the most likely forms of financial instability that China may experience will be  a combination of RMB devaluation, debt write-off and banking sector re-cap and possibly high inflation. Given the sizeable and unstable shadow banking sector in China and the potential of capital flight, we also think the risk of a credit crunch developing in China is high.

In our mind, the only uncertainty is timing and potential triggers of such instabilities.

Why 2016 can be a dangerous year

Since 2011, there had been a round of debate about the potential of hard landing and financial instability every year in the market. So far, the financial system has held up reasonably well, notwithstanding some periodic short term volatilities. Many view the absence of any severe disturbance as proof of the government’s ability to tame financial sector volatility and believe that the risk of this happening has diminished over time. We disagree. We believe that the government has maintained a superficial stability largely by debt-funded stimulus and an ever-greening of bad debts. These strengthened various implicit guarantees which have been generating destabilizing forces beneath the surface - a classic case of short term stability breeding long term instability. It’s our assessment that the longer this practice drags on, the higher the risk of financial system instability, and the more painful the ultimate fall-out will be.

Whether the government intended for it or not, we summarize that investors and other market participants have been counting on five government guarantees over the years: 1) the government will prevent a sharp slowdown in GDP growth by running pro-growth macro policies, including fiscal stimulus; 2) up until about two years ago, the government would always appreciate RMB vs. the USD, at least moderately a year; and since then, the government will not allow a sharp devaluation of RMB; 3) since about 2014, the government will always support the A-share market; 4) the government will not allow major debt default; and 5) the government will always hold up the property market because it’s so essential to the financial system and local government income.

In our view, so far these implicit guarantees have helped to maintain public confidence in the financial system or prevent investors from realizing the risks. However, as stated earlier, they are also creating powerful destabilizing forces. For example, the GDP growth guarantee means that the best strategy for many businesses over the past few years was to keep borrow and expand during any downturn, anticipating government stimulus; the RMB guarantee means that carry-trades designed to arbitrage interest rates and RMB appreciation became prevalent; the A-share market support prompted many investors to use leverage, counting on the government being the buyer of last resort; the no-default guarantee means many investors turned a blind eye to potential default risks (or simply not aware of them) and fund uneconomic projects; the property guarantee drove a significant portion of national savings into one of the most unproductive areas of the economy and the financial system has increasingly become a hostage to the property market via direct lending or through collaterals.

The problem with this stability-maintaining strategy is that many of the goals are conflicting so maintaining all of them are logically irreconcilable. For example, the government have tried to hold up growth by pumping money into the system – China’s M2 growth has been among the fastest in the world since the global financial crisis (so in our view, debating about whether China should QE or not is beside the point).

Moreover, if we properly account for local government borrowing, the government as a whole has probably been running fiscal deficit close to 10% of GDP a year over the past few years. With this type of macro policies, it’s difficult to see how RMB can stay stable and how debt growth can be controlled. Another example is that to hold up the A-share market, the government has borrowed from the PBoC and commercial banks. This may crowd out private lending and hurt growth, or accelerate money growth and hurt the RMB.

It seems to us that the government’s policy options are rapidly narrowing – one only needs to look at how difficult it has been for the government to hold up GDP growth since mid-2014. A slow-down in economic growth is typically a prelude to financial sector instability. Putting it all together, it seems to us that many of these conflicts may come to a head in 2016.

* * *

There is much more in the full report, but here is the reco summary:

We expect the key market theme in 2016 to be financial system instability as a few destabilizing forces seem to be coming to a head. We forecast HSCEI to decline by about 7% to around 9,000 (range for the year: 7,400-12,800), and SHCOMP, by about 27% to around 2,600 (range: 2,200-4,000), by 2016 YE. Our year-end targets had not factored in a credit crunch scenario because the timing of which is difficult to predict. Should it occur, we expect the indices to end below the low bounds, possibly substantially so.

Just remember: if the Chinese government catches you selling, arrest, or far worse, awaits.

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Haole's picture

The Chinese PPT is going to have a fake Islands built on top of them unless they can purr labbits out of their flicking hats...

NoDebt's picture

Replace 'China' with 'US' and the story still reads the same.  Pot, kettle.  Kettle, pot.  Why don't you two get acquainted.

I already know how much of this debt is heading for severe impairment across the entire globe.  ALL. OF. IT.  And not a penny less.


Panafrican Funktron Robot's picture

Indeed.  It's funny how few people realize that we fit the functional definition of bankruptcy.  


That said, it's really all about the extent to which the central banks are willing to devalue their respective currencies.  I get the feeling that when push comes to shove, it'll just end up being more devaluation.  

junction's picture

Maybe this Bank of America analyst can advise China to do what his bank did, have the FDIC insure China's overvalued securities.  Right now, the FDIC is the insurer for the $22 trillion worth of derivatives Bank of America holds.  Those derivatives finance the jet set lives of the 0.01%, paying for the Gulfstream jets, the five star vacations to far off lands, the twenty something whores, the fine art (some of which is fake, but who cares?) and the townhouses.  As Bank of America knows, its good to have friends in high places to lend you money.

blue51's picture

Haha! How can you short, the FDIC?

Paveway IV's picture

By being long phyz + unfortunate boating accidents + S&W. The FDIC insures electronic bits that represent representations of proxies for fiat debt backed by other fiat debt. The clownbux ponzi is comin' off the rails pretty damn soon and China is why. Everyone always wishes they got off at the last stop just before the big accident - don't be that guy.

OzFan's picture


A succinct summary of these elitist pig bankers.


OldPhart's picture

Ah so...

As China collapses, so will gold, silver, patinum and fmj lead.

Screw teh markets and screw China...................proceed, fastly (as my DI implored))

asteroids's picture

Let's say for example China defaults on all its debt. Tells the West to go "fuck off".  They will still have all that gold and silver in their vaults.

kliguy38's picture

It seems there is a race between the big banks to warn the yokels that hell is comin'.......guess they can then say "we told ya so" and "we saw it comin' but ya wouldn't listen this time"

Never One Roach's picture

Moar disasters and moar crises...all created by the CBs yet the little peeples usually suffer.



Bossman1967's picture

The only reason our markets didnt crash today is these asshole put 100 billion on the US debt today 19,935,235,000 un fucking bellievable how in the fuck will you pay this back America I live here and I refuse anymore......

RiverRoad's picture

If they're talking the market down it can only mean one thing:  they want to buy.

So you make the muppets sell to you.

Soul Glow's picture

Let's see, they just spent $20b to ramp the market 3%.  Yep, there's probably a crisis.

FreedomGuy's picture

Bank of America happens to have particular expertise in financial meltdowns. I would listen.

Goldilocks's picture

Flo Rida ft. Sage The Gemini- Goin Down For Real (UNRELEASED) (FULL VERSION) *DOWNLOAD LINK*
http://www.youtube.com/watch?v=h6ml72lR-bA (3:07)

algol_dog's picture

Traders with hands on their heads.

Soul Glow's picture

And deer in headlights with hooves on their heads.

Pabloallen's picture



Fish Gone Bad's picture

The pic reminds me of shopping for candy at Christmas time.  8-10 women were in front of me, sampling everything they could and still not capable of making up their minds. Took forever to get through Laymons with a box of prewrapped candy.

YHC-FTSE's picture

They've been on crisis mode since May last year. BofA just noticed?

Consuelo's picture



China has been on a glide path to a 'hard landing' since 2008 according to the overwhelming majority in the financial media.   Guess that plane they're flying has a lot of FX reserve 'fuel' to keep it well in the air, no...?

Arnold's picture

They can keep it popin' longer than you can stay solvent.

Dark Daze's picture
Dark Daze (not verified) Jan 4, 2016 10:15 PM

This is laughable. If China defaults, who do you think gets hurt the most? Ans: USA

joego1's picture

Moar dead pigs.

yrad's picture

My guess is the Chinese Market can stay irrational longer than I could stay solvent.

CB's are the financial NSA. Good luck "winning"

Truth Eater's picture

Government thinks it can work more efficiently than the markets.  Psychopaths who insist on being in charge deserve to get strung up when it crashes down.


Today in China- you lucky winner.  You buy stock.  You own for life.  you lucky.  What?  You want sell?  No sell.  You buy you keep. You lucky.

surf@jm's picture

Well, you will have to go down to the Caymans to string them up.......

Because, all those Psycopaths will not be hanging around to see the aftermath.....

FrankieGoesToHollywood's picture

Chinese traders are selling at the risk of execution by the government. You know it is more serious than the selloff indicates!

Farmer Joe in Brooklyn's picture

China defaults on all debts, pegs yuan to gold, announces total gold holdings of 5+k tons, and challenges US to a gold audit.

US hits the nuke button. 

Consuelo's picture

"5k+ tons"...


The U.S. would pray for such a revelation.   Perhaps more like 15k tons - at the bare minimum.    If and when the Chinese decide to reveal their actual physical gold holdings...?   Remember what we were taught as children about drawing a weapon towards an opponent...?

803Mastiff's picture

Year of the Fook'd

JenkinsLane's picture

Very good summary but price target of 2600 for $SSEC is just the SMA 200 on the weekly chart, which is equivalent to the SMA 50 on the monthly chart. 

surf@jm's picture

Paul Krugman Obamanomics........

Or, if you prefer.......Adventures in turning capitalism into socialism.....

Dragon HAwk's picture

Yeah Big Banks warning us Shit is Going to Hit The fan... what's up with that

sschu's picture

Now that this is being published publically means BOA and the other banksters have staked out their positions to maximize their winnings.

Someone will lose and as the saying goes, if you do not know who it will be, it is probably you.


Kirk2NCC1701's picture

We now live in interesting times.

omi's picture

Just more price propaganda. We'll save our shittiest situation by making noise that someone else is in somewhat crappy situation. Pathetic.

Janet Shalom Bernanke's picture

China's central bank injected 130 billion yuan ($19.9 billion) in short-term funds into the country's financial system, according to a statement, in an effort to help calm jittery investors after Monday's sharp stock selloff.

The People's Bank of China offered the funds in the form of what are known as seven-day reverse repos on Tuesday at an interest rate of 2.25%, according to the statement.

Which domino will fall first?  China?  Europe?  U.S.?


Kirk2NCC1701's picture

KSA.  One can hope.

Wahhabi scum.

fatlibertarian's picture

They just paper over everything so much now that we may never get a collapse, just a zombie economy.

laomei's picture

have already pulled out entirely from china.  all investments, all assets, all funds and have been short the currency and the market.  

Jack Oliver's picture

With China building infrastructure (including ISLANDS) with their US dollar holdings - the US is actually financing its own demise !

Chris P's picture

1) the government will prevent a sharp slowdown in GDP growth by running pro-growth macro policies, including fiscal stimulus; 2) up until about two years ago, the government would always appreciate RMB vs. the USD, at least moderately a year; and since then, the government will not allow a sharp devaluation of RMB; 3) since about 2014, the government will always support the A-share market; 4) the government will not allow major debt default; and 5) the government will always hold up the property market because it’s so essential to the financial system and local government income

Sounds very familiar. Who started first us or them???

InsanityIsWinning's picture

China is starting to look like Japan circa 1989.  Everyone thought the Japs would take over the world then but when they crashed and burned it didn't have a worldwide impact. China is big enough to bring down everyone's house. . .  

I AM SULLY's picture
I AM SULLY (not verified) InsanityIsWinning Jan 5, 2016 8:44 AM

Beware: for even QUESTIONING the "China will Rule the World" Meme you get violently attacked. My view - nobody will be in charge ... whether this is before or after a nuclear war is the only variable.

I AM SULLY's picture
I AM SULLY (not verified) Jan 5, 2016 8:21 AM

I saw this 20 years ago in grad school - right at the time Murica, under Clinton, was congratulating itself over "broadening trade" with China. Me - I read the Davies paper, and I looked at that sick relationship, and saw an expiration date written in blood.

(China will be 2 or more countries in 10 years)

And yes - the situation for the  USA is not much better (just better pop/farmland ratio).

(food is important)

(wait and see)