Just two weeks after warning of the potential for an imminent 'Minsky Moment', Chinese central bank governor Zhou Xiaochuan has penned a lengthy article on The PBOC's website that warns ominously of latent risks accumulating, including some that are "hidden, complex, sudden, contagious and hazardous," even as the overall health of the financial system appears good.
The imminence of China's Minksy Moment is something we have discussed numerous times this year.
The three credit bubbles shown in the chart above are connected. Canada and Australia export raw materials to China and have been part of China’s excessive housing and infrastructure expansion over the last two decades. In turn, these countries have been significant recipients of capital inflows from Chinese real estate speculators that have contributed to Canadian and Australian housing bubbles. In all three countries, domestic credit-to-GDP expansion financed by banks has created asset bubbles in self-reinforcing but unsustainable fashion.
And then at the latest Communist Party Congress meeting in Beijing, the governor of the PBoC (People’s Bank of China) said the following;
“If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.”
Yet, stock markets shrugged off his warning... while the Chinese yield curve has now been inverted for 10 straight days - the longest period of inversion ever...
The nation should toughen regulation and let markets serve the real economy better, according to Zhou.
The government should also open up financial markets by relaxing capital controls and reducing restrictions on non-Chinese financial institutions that want to operate on the mainland, he wrote.
“High leverage is the ultimate origin of macro financial vulnerability," wrote Zhou, 69, who is widely expected to retire soon after a record 15-year tenure.
“In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly."
Zhou’s comments signal that policy makers remain committed to a campaign to reduce borrowing levels across the economy.
Concern that regulators may intensify the deleveraging drive after the twice-a-decade Communist Party Congress has helped push yields on 10-year government bonds to a three-year high.
Still, measures of credit continue to show expansion, with aggregate financing surging to a six-month high of 1.82 trillion yuan ($274 billion) in September. China’s corporate debt surged to 159 percent of the economy in 2016, compared with 104 percent 10 years ago, while overall borrowing climbed to 260 percent.
- China’s financial system faces domestic and overseas pressures; structural imbalance is a serious problem and regulations are frequently violated
- Some state-owned enterprises face severe debt risks, the problem of "zombie companies" is being solved slowly, and some local governments are adding leverage
- Financial institutions are not competitive and pricing of risk is weak; the financial system cannot soothe herd behaviors, asset bubbles and risks by itself
- Some high-risk activities are creating market bubbles under the cover of "financial innovation"
- More companies have been defaulting on bonds, and issuance has been slowing; credit risks are impacting the public’s and even foreigners’ confidence in China’s financial health
- Some Internet companies that claim to help people access finance are actually Ponzi schemes; and some regulators are too close to the firms and people they are supposed to oversee
- China’s financial regulation lags behind international standards and focuses too much on fostering certain industries; there’s a lack of clarity in what central and regional government should be responsible for, so some activities are not well regulated
- China should increase direct financing as well as expand the bond market; reduce intervention in the equity market and reform the initial public offering system; pursue yuan internationalization and capital account convertibility
- China should let the market play a decisive role in the allocation of financial resources, and reduce the distortion effect of any intervention
- China should improve coordination among financial regulators
Which all sounds very ominous and very positive in ending this facade..but just like the promises/threats ofprevious deleveragings - at the first sign of market jitters, the bankers will fold. As Kyle Bass recently concluded...
"...it’s the biggest bubble we have ever seen in the history of financial markets. $40 trillion of assets in a system with $2 trillion in equity."
Aside from China's credit bubble, the simmering conflict in North Korea and tensions between the US and China related to the latter's insistence on building in the Spratly Islands also threaten China's economy, as well as global risk assets.
“We’re now in a bubble of epic proportions for Chinese credit...everything seems to be bubbling to the top and reaching a boiling point almost concurrently."
To be sure, there are a lot of powerful interests around the world that would suffer if China’s economy collapsed. But despite this, because he believes in the position, Bass is going to stay on his side of the trade – even as other longtime China bears like Mark Hart announced this week that he was abandoning a seven-year long bet on a massive yuan devaluation.
“People so want for everything to be okay. Nobody in their right mind wants us to be right because if I’m right were going to see a global growth slowdown you think about the concentric circles of how it affects each participant.
The economy may really slow down and we might have additional problems…so I’m going to keep investing the way I am and hope it all works out.”