The Complete Idiot's Guide To The Biggest Risks In China

With both commodities and Chinese stocks suffering sharp overnight drops, it is hardly surprising that today trading desks have quietly been sending out boxes full of xanax their best under-25 clients (those veterans who have seen one, maybe even two 1% market crashes), along with reports explaining just what China is and why it matters to the new generation of, well, traders. One such analysis, clearly geared to the Ritalin generation complete with 3 second attention spans, comes from Deutsche Bank which in a few hundred words seeks to explain the key risks threatening the world's most complex centrally-planned economy, and ground zero of the next financial crash.

Which, one day after our summary take on why the Chinese commodity, economic and financial crash is only just starting (as those who traded overnight may have noticed), is probably a good place to reiterate some of the more salient points.

As Deutsche Bank's Zhiwei Zhang writes in "Risks to watch in the next six months", the key thing to keep in mind about China now that the 19th Party Congress is in the rear-view mirror, is that the government is likely to tolerate slower growth in 2018. Han Wenxiu, the deputy head of the Research Office of the State Council, said that GDP growth at 6.3% in 2018-2020 would be sufficient to achieve the Party's 2020 growth target. And while this is a positive message for the long term, it indicates growth will likely slow in 2018. And, as DB warns, recent economic data suggest the economic cycle has indeed cooled down.

For all those seeking key Chinese inflection points, here are the three big red flags involving China's economy:

  • For the first time since Q4 2004, fixed asset investment (FAI) growth turned negative in real terms in Q3 this year.

  • Growth of property sales for the nation turned negative as well in October, the first time since 2015.

  • The property market boom in Tier 3 cities is also losing momentum.

We hope not to have lost by now all the Millennial traders who started reading this post. To those who persevered, here - in addition to the risks facing the economy - are the other two main risks facing China's investors: (rising) inflation and (rising) interest rates.

The details:

Inflation. The benign headline CPI masks an important underlying trend. Nonfood inflation has been rising steadily – it reached 2.4% in Oct, an unusually high level compared to the historical average of 1.3%. This is largely driven by services prices, such as healthcare(7.2% yoy), education(2.8%), and domestic services(4.3%). Headline CPI inflation is expected to reach 3.1% by February 2018, with DB's baseline is that inflation will moderate in H2 2018, but watch out for the risk scenario that it will stay above 3% through the rest of 2018.

If inflation becomes persistently high, the central bank's hands will be tied, making any monetary loosening more unlikely, if not further tightening.

Interest rates. Interest rates are climbing around the globe, but more so in China than in the US.

Clearly it is not because of demand in the real economy, judging by weaker investment. One likely explanation is that financial deleveraging has caused NBFIs to reduce their (often leveraged) exposure to longer maturity assets. Inflation expectation may also play a role. If these are true, interest rates may face persistent upward pressure. This will in turn suppress borrowing: for example, LGFVs issue less bonds during periods of rising interest rates.

And while Deutsche's veteran Chinese analysts have some soothing words for the world's 25-year-old traders who have yet to see a bear market, and promise that nothing will break in China, we would disagree because as we have said for the past 3 years, the next global crisis will start in China, and with Xi's role cemented for the next 5 years (if not for life) the smart thing would be to have the Chinese economic hiccup (because recession is clearly a taboo under central planning) as soon as possible, so the economy can recover by 2022. Judging by the tremors in the past few days, he may agree.


buzzsaw99 Wed, 11/15/2017 - 20:24 Permalink

zh today:because as we have said for the past 3 years, the next global crisis will start in China...zh ten years from now:because as we have said for the past 13 years, the next global crisis will start in China...

Crazy Or Not Wed, 11/15/2017 - 20:27 Permalink

However much ZH wants China to implode does not necessarily make it happen.Where does your Quant come from (Hint he's got a H-1B visa)?Publish this story again in January, lets see how the chess board is then.

roddy6667 Wed, 11/15/2017 - 20:29 Permalink

This is trading. Trading is gambling. almost nobodt wins in the long run. It is not investment. It is no different than Vegas. At least in Vegas half naked women bring you drinks while you are losing money using your "system".The writer uses a lot of charts and data to hide the fact that he is no different than the guy furtively calling his bookie with a bet on today's game.Old whore in a new dress.

Anonymous_Bene… Wed, 11/15/2017 - 20:33 Permalink

China's main risk of implosion is the explosion in at-home manufacturing in the US and the rest of the world.Any person with half a brain, some loose pocket change and access to the internet (to get the know-how) can build their own manufacturing bots...take me, for example.There really is no need to keep subsidizing the Chinamen.

CNONC Anonymous_Bene… Wed, 11/15/2017 - 21:13 Permalink

I agree to a significant extent.  Proper industrial processes with insurable and safe designs, and the accuracy to produce undifferentiated product are not exactly pocket change, but there are hundreds of niches in the supply chain where you can supply a specialized product, a new product, or a new, cheaper process for production.  If you talk to people in lots of industries and understand the things which limit their productivity or add costs, you can find these niches and exploit them.  Your new machine or product will be obsolete or commoditized by the big boys in two years, but if you follow the rules and design a machine which meets modern standards (NFPA and UL are your best friends . . . as long as you pay) the big boys will just buy you out instead of trying to put you out of business.  Free example.  I have been selling body shops aluminum repair equipment (resistance welders, sanding stations etc.) for a couple of years based on the expectation that the F150, being the most common vehicle on the road, will require body shops to have it.  One of my clients, who focuses on higher end vehicles in an urban area, believes that aluminum is a dead end.  He wants me to help him develop an affordable carbon fiber curing system.  I think I see an opportunity.  I'll race you.

In reply to by Anonymous_Bene…

Dragon HAwk Wed, 11/15/2017 - 20:37 Permalink

Got a Buddy who is always saying at CMas. The Rate of Growth Has declined.  Means it's still going up but not as fast, alot different that Sales Have Declined.but the Press always make it sound like doomsday.

GreatUncle Dragon HAwk Thu, 11/16/2017 - 06:13 Permalink

It has to support the debt through Keynes inflate/deflate game.Now they ramped up the rate far higher than the 2% they modelled.This new rate requires an even higher rate of inflate / deflate to support the concept.Try 5% and why every 10 years items double in value, their measure of growth.For 10 years now they have been struggling to even hit the 2% and unfunded liabilities will have been growing at the old rate.The current interest rate rises are now an attempt to lift the paltry growth nearer to the desired 5%.NOT A CHANCE the economy is already in contraction.

In reply to by Dragon HAwk

ThuleNord Wed, 11/15/2017 - 21:22 Permalink

Millennial investors don’t persevere because of all your damn advertising. At least attempt to appear more interested in presenting data than you do for whoring out your space. What a joke

DaBears Wed, 11/15/2017 - 21:31 Permalink

China will be fine as long useless eaters and non-slave peasants starve to death behind their Great firewall. They could be in an depression and still claim "6.5% GDP GROWTH". What happens behind the great firewall stays behind the firewall.

Let it Go Wed, 11/15/2017 - 23:38 Permalink

One risk nobody talks about is America turning more to buying from Mexico and Canada. A very strong strategic dimension exists for NAFTA and when President Reagan fathered and endorsed the concept decades ago he envisioned a powerful regional trade bloc would be vital as Europe and East Asia created their own regional economically self-sufficient trade arrangements. More below on why America first and North America first is a good strategy. http://NAFTA, Let US Favor "Regional Trade" Over Global Trade.html