CHINA: Countdown to Crisis?
YES OR NO?
Every major corner of the world’s economies is sitting on a knife’s edge of one type or another; the question becomes who falls first triggering the next leg down in the Global Economies and ongoing depression. All are in debt spirals as deficits and debt compound at a high rate, while the growth to service them is but an illusion of official account measures, public sector growth and understated inflation.
Waves of insolvency are just waiting to strike as elites, academics, government servants and banksters worldwide cling to the dying Consumption, asset-backed economic model created at Bretton Woods II. Before that time, the developed world created wealth the old fashioned way: they produced more than they consumed creating savings for allocation to productive enterprises, also known as capitalism. Now growth is measured in how much you can consume creating a top line while ignoring the amount you borrowed from future income to do so.
"Men, it has been well said, think in herds. It will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."
- Charles Mackay, Scottish journalist, circa 1841
VERY FEW realized at that time that CLOSET socialists in developed world capitals, elites, and the banksters that owned them had fully captured the printing presses and fractional banking systems which had just been UNCHAINED from any form of REAL reserves. And, that going forward, the economic model would be the consumption of wealth rather than the production of it.
People had semi-sound money and the ability to save money, which held its purchasing power in a far superior manner than the IOUs called money today. Capitalism created the greatest piles of wealth and broad, rising middle classes in recorded history. Money now is nothing more than a confiscation device used by the powers that be to rob their constituents of the fruits of their stored labor.
Henceforth, consumption reported as growth fueled by borrowing from the future became the model. A borrowing spree began which has now morphed in a government policy to borrow money with NO INTENTION of ever paying it back while telling the world it is RISK-FREE when, in reality, mathematically, it is ALREADY worthless and the world is just waiting for people to WAKE UP.
This model of debt/leverage masquerading as growth, welfare states using the printing press to feed the people as economies collapse under socialists policies, and continuous currency debasement (theft of the stored capital in the savings of the private sector) are to fool the people and useful idiots everywhere.
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
- Ludwig von Mises
Every developed economy and many emerging economies sit directly in the crosshairs of this simple statement. The debt orgy continues and shows no sign of abatement as the BIS recently published a paper outlining that over $30 Trillion dollars of debt has been issued since the Global financial lows in 2008. What is $30 trillion in terms you and I can possibly understand? 30 million million.
Look at how much of the borrowing is CROSS BORDER holdings. The world’s financial systems are inextricably entangled. People think the Ukraine conflict is a conventional war; in my mind it is a financial conflict as Russia holds Hundreds of BILLIONS of loans from Western Banks as does the Ukraine - one misstep by the US and it’s kerblooey for Euro area banks who are in way too deep. The IMF loan to Ukraine was rushed into place to prevent this explosion from happening.
Trapped in debt orgies of their own, China and Japan must import inflation and export deflation to the world. It is “INFLATE or DIE” to keep their debt piles from imploding. This is the order of the day throughout the world. Europe particularly is affected by the deflation as capital flows from China and Japan and lands on the continent. The fun will really start when the flows REVERSE (back to China and Japan), as they ultimately WILL….
China has decided to try and walk back from the edge of a Minsky moment and engineer a soft landing while Japan careens headlong into it. The task for China is enormous as HALF ($15 Trillion, or $15 million million) of the world’s credit creation mentioned previously emanates from the Chinese economy.
Much of the credit creation went into real estate development and lending:
Floor space per capital is now 30 square meters, surpassing the level that preceded the level in japan just before the property collapse in 1988. Much of the lending is also threatened by rehypothication as developers have borrowed from many using the same collateral. So titles are BLURRED!
Looked at more broadly, corporate debt has been the principle destination for the credit creation and profits have barely budged or declined due to Yuan appreciation.
Now the property markets are beginning their tumble:
The Chinese have fully anticipated this and have instructed the major banks to pick up mortgage lending to individuals to cushion the fall. Other measures to follow in my opinion. They are trying to execute a controlled crash. They have made a decision to pop the bubble DELIBERATELY, allow defaults to instill market discipline and remove the moral hazard currently in place. Let’s pray for their success, no other central bank or government dares to walk this path. They are doing what Von Mises said in an attempt to avoid an extinctions event.
This is a face of the debt spirals we see throughout the world as developed world economies’ debt compounds ferociously and growth is a distant memory. The Chinese just did it in the private sector while the developed world have done it in the public sectors since 2008.
The corporate buildup of Infrastructure - industrial, energy, and state owned enterprises - is excess capacity that lays idle or underutilized. It is why the Yuan has suddenly weakened as China must become more globally competitive; what was a one way train in Yuan appreciation is now probably going to become a one way train lower to regain export competitiveness and profitability regardless of US POLITICAL CATERWAULING. The Chinese just need to say, “Do you want us to buy the treasuries or not?”… and they will privately…
Huge carry trades are in place to capture the appreciation of the YUAN and have enjoyed a one way bet for years. This is most likely OVER! The fireworks as these unwind should be full of excitement and BIG LOSSES as the GLOBAL specs get burned to a crisp. Some of those trades are operating at 50 or 100 to 1 leverage.
Fortunately, most of these loans DID NOT go for consumption so a good amount of value is recoverable. Very little of the credit creation is denominated in foreign currency and what is subject to capital controls, thus China’s mostly closed economy is not threatened by the tide of liquidity and hot money going out as many other emerging economies are.
Notice how much DEBT is Yuan denominated! Mostly ALL OF IT. The Chinese are painfully aware of the problem and DETERMINED to address it, trying as hard as they can to reduce the credit growth rate without triggering an implosion. A high wire act of historic proportions. They have forcefully dealt with bank runs by trucking in loads of cash and have used state run media support, while a financial firefighting team is clearly visible when questions or fears arise.
Author’s Note: In my opinion the greatest manmade disaster and OPPORTUNITY in history is unfolding in every corner of the world. Are you diversified or operating with EYES WIDE SHUT? Are you prepared to turn it into opportunity by properly diversifying your portfolio? Adding absolute return investments, which have the potential to thrive (up and down markets) regardless of what unfolds economically? Hedging the printing presses impact on your paper money? This is what I do for investors; help them diversify into investments, which are created to potentially thrive in the storm. For a personal consultation with me CLICK HERE !
Private sector wealth management trust products present the biggest challenges this year as many of their offerings mature this year presenting big challenges to avoid a LEHMAN moment to the Chinese banking system. Non-performing loans are skyrocketing as we can see fromthis chart from www.zerohedge.com:
Looks formidable, but in doing the math 593 billion Yuan is just $95 billion dollars, a drop in the bucket for a central government holding $4 trillion dollars ($4 million million or 4,000 billion) of foreign reserves. They can take hits 5 times this amount and not blink, and most of it will come from CTRL PRINT so virtually none is at risk. Although the rolls will be ferocious, the debt from sectors suffering from overcapacity is manageable. Check out this graph from GaveKal and ‘Over My Shoulder’ by John Mauldin:
Will some eggs be broken? Yes, as intended. Fortunately, for depositors, most of the banks are state-owned and the solution is just as close as the printing press, which they have no problem deploying. Can you say a bad bank for the second time in the last 18 years? They will not be allowed to fail…
Contrary to popular belief the cost of money is not as badly priced as most people believe in China, and contrary to the developed world there is a cost for money and it is mostly paid in full (another graph from Gavekal and Mauldin):
In conclusion: the Chinese BOOM is over but the bust talk is FAR overdone in my opinion. Chinese leaders acknowledge the mistake they have made with the credit bubbles and are determined to walk back from the precipice.
“If everyone in society is trying to get into the financing business, we may have entered a phase where a fever has started to affect our ability to think,” … “We must make up our minds to rectify interbank operations and all kinds of wealth management products.”
- President Xi Jinping
They have done a good job in my opinion by cutting credit growth from 35% year over year at the peak of credit expansion to 12-14 % you today, a monster reduction already. The clean ups will be messy as financial mishaps occur and malinvestments fall to their demise, but moral hazard will recede which is the GOAL. Chinese leaders have repeatedly talked about slower economic growth and are tightening their grips on credit growth. They are prepared to fight the fires as they emerge.
The Chinese leaders are also opening capital accounts, beginning interest and exchange rate liberalization, attacking pollution, reforming state owned enterprises, banking reform and job creation to name a few. If only the developed world would tackle their problems which have been unaddressed since the 2008 crisis.
People underestimate the level of BRAINS in the communist party upper echelons; most were identified at an early age, have been GROOMED since an early age and have attended the finest schools in the world. They are not the political ignoramuses you see in the developed world. Do not underestimate their bona fides or the powers they wield in a one party state to address systemic weaknesses. Those five and ten year plenums are serious long-term planning as well as political slugfests, but when they are over everybody has a GAME PLAN.
The anti-corruption campaign and war on political patronage is upsetting a great deal of apple carts as bribery in the form of red letters is a common part of doing business in China today. It’s all who you know and how much you pay for success to modern day POLITICAL Mandarins. Now the corporate sector doesn’t know who to pay as they are connected and who not to pay so they don’t get caught in the dragnet. Some are above the law and some are not becoming subject to it.
Yes, the residential real estate markets have commenced their slides from bubblicious levels, but the fact remains the buildings are there as is the recoverable value. Anyone who has been to China (I have and my wife is mainland Chinese) KNOWS there are plenty of people looking for better places to live and to move. The Chinese government is not BLIND, they see the ghost cities and have prepared for it. You can count on it.
Now affordability will loom making the inventory attractive, we are just waiting for Mother Nature to do her stuff and strong hands to surface, and they will. I believe they will soon they start broadening the Foreign direct investment rules to allow more strong hands to enter the country and buy the malinvestments that were not taken down by domestic vultures. Capital flows will become much more TWO WAY: IN AND OUT as they increasingly join the international financial community as they should being the world’s second largest economy. Expect them to exercise their military and financial clout with regularity.
Globally, the slowing China will no longer PULL economies forward as they have done for almost 5 years. This will put the Fed, BOE and Bank of Japan back into the HOT SEAT to provide the next round of money printing to FILL THE GAP. Much of whole world is operating in the function equivalent of insolvency; the kabuki dance to the destination Von Mises outlines at the beginning of this letter is unfolding as predicted. I am in no hurry to get there… Are you?
Everybody UNDERESTIMATES the Chinese (which they love), but in the end the Chinese will deal with the banking and lending crisis as they have done numerous times in the last 20 years: THEY WILL PRINT THE MONEY to DEFUSE the crisis and let the Chinese people take the INFLATIONARY HIT. For the People’s Bank of China and the communist party, money is free. They will print whatever is necessary and use the media and force to control confidence and fear to the chagrin of the china bears. They are moving into the modern world as fast as possible based on the enormous tasks they have embraced. So, no more booms but probably not a bust.
Don’t miss the next edition of TedBits subscriptions are free at CLICK HERE . We will be covering the deflation in Europe and the insanity gripping sovereign bond markets.
Author’s Note: In my opinion the greatest manmade disaster and OPPORTUNITY in history is unfolding in every corner of the world. Are you diversified or operating with EYES WIDE SHUT? Are you prepared to turn it into opportunity by properly diversifying your portfolio? Adding absolute return investments, which have the potential to thrive (up and down markets) regardless of what unfolds economically? Hedging the printing presses impact on your paper money? This is what I do for investors; help them diversify into investments, which are created to potentially thrive in the storm. For a personal consultation with me CLICK HERE !
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