At the end of November, we showed a troubling observation for China - and global - macro watchers from Axiom's Gordon Johnson: for the first time ever, record Chinese credit creation had failed to stimulate the economy, and in fact the exact opposite appeared to be unfolding – economic growth is slowing across a number of data points despite massive new credit injected into the economy over the past year.
In economic terms, this meant that China's credit impulse had hit rock bottom, and was perhaps at its lowest level ever, something UBS hinted at over the summer when it showed that no matter how much credit China creates, it can no longer keep the first derivative, i.e. impulse, surging at is had in the past despite record amounts of nominal debt created. Quite the contrary.
And while one can debate the definition of credit impulse, and its impact on the global economy, one thing is clear: China's credit creation - the growth dynamo of the entire world - is rapidly slowing. We got the latest confirmation of this earlier this week, before last night's battery of economic data which painted a very mixed picture of the Chinese economy, with retail sales missing, while IP and CapEx barely met expectations...
... when the PBOC reported November new loans of Rmb1.12Trillion and Total Social Financial of Rmb1.6Trillion. While on the surface both numbers appeared solid, beating consensus, a careful read between the lines showed some very troubling details which confirmed that not only was November not the upward "turning point" for monetary policy some expected it to be, worse, China's credit slowdown was accelerating.
For one, adjusting for municipal bonds and equity raising, as Deutsche Bank did, showed that system credit growth slowed further to 14.4% yoy from 14.9% the prior month.
Putting this number in context means that adjusted credit growth (including municipal bonds) of 14.4% yoy this month was the slowest in the past 27 months. In fact, the last time Chinese credit was growing this slow, global markets were about to get rocked and only the Shanghai Accord of 2016 prevented a global bear market.
Looking at the breakdown, loan growth accelerated to 13.3% yoy (vs. 13.0% in Oct), while shadow banking and corporate bond financing remained muted. Shadow banking components (entrusted loans, trust loans and undiscounted bills) made up only 11% of Nov TSF versus 22% in 1H17. This suggests that following a series of tightening rules, banks are bringing off-BS shadow banking into on-BS. What is notable, is that de-levering shadow credit, cutting off financing layers and bringing debt creation into the "open", M2 growth actually rebounded from a historical low of 8.8% yoy in Oct to 9.1% yoy. The M2/GDP ratio stayed flattish mom at 207% versus a record high of 210% in March.
The slowdown in credit creation wasn't only at the aggregate level: looking at banks’ balance sheets, asset growth dropped below 10% yoy for the first time ever...
... dragged by shrinkage in interbank funding.
Looking at the recipients, short-term household loans almost doubled last month from a year ago as regulators clamp down on other opaque forms of borrowing to tame shadow banking sector risks. According to Reuters, new short-term household lending, which includes credit card debt and car loans, rose more than 80 percent to 202.8 billion yuan ($30.65 billion) in November from a year ago, and nearly trebled from the previous month.
Recently China has been cracking down on risks to the financial system due to excessive leverage, and has recently zeroed in on fast-growing, loosely-regulated micro-lenders that make unsecured cash loans. The crackdown on micro-lenders followed warnings from the authorities on rising household debt, which includes mortgages and consumer loans.
As Reuters adds, the jump in demand for bank short-term household loans also comes against a backdrop of Beijing trying to temper speculation in the property market by tightening the loan-to-value ratios for mortgage loans in some cities. As a result, the tighter mortgage rules have led to the widespread ‘re-purposing’ of short-term household loans for the deposit a homebuyer has to make to get mortgage, say analysts and people familiar with the matter.
“Short-term lending growth really starts to pick up just as property (purchase) controls start to weigh on long-term lending growth,” said Julian Evans-Pritchard, an economist at Capital Economics. The surge in such loans suggests that “households are finding ways around some of those mortgage restrictions using short-term credit,” he added.
Short-term household credit has also become more accessible, with Chinese lenders swapping struggling corporate borrowers for more promising retail borrowers as this allegedly carries relatively lower risk to their balance sheet and asset quality. “It’s hard to bring it down because it’s convenient for banks ... it’s cheap in terms of capital and in terms of provision,” said Alicia García Herrero, chief economist for Asia Pacific at Natixis.
Ultimately, local banks face a choice: continue with shadow lending, or hand out money to households. Having done the former for years, China's financial system is now shifting to the latter.
“Of course, it could create problems down the road because there’s too much concentration on the mortgage loan,” she noted. “We’re not there yet because this (household loans) is only 30-plus percent of Chinese banks’ loan books.”
The surge in question in short-term retail loans - at the expense of traditional, long-term loans - is shown in the charts below. Putting in context, Chinese household debt-to-GDP rose to 47% in the second quarter of this year from 39% in the same period two years ago, according to the Bank for International Settlements.
Household loans as a proportion of overall China bank lending is expected to grow by a quarter this year, versus 7 percent growth for corporate loans, according to a Natixis report. The bad loan ratio of household debt is significantly lower than it is for businesses.
Separately, and as discussed on many occasions in the past, China has launched probes into consumer loans that are being misused for home purchases, warning they can’t be used to “fuel property bubbles”, a senior banking official said in September.
Essentially, what China is doing, is now that it has filled up the shadow conduits with debt to the point where they pose a systemic risk, Beijing is hoping to flood the world's largest population with debt as the last recourse to keep the debt game going for a few more years; the good news is that one decade after the US great financial crisis which was catalyzed by record household and consumer debt, we know how it all ends.
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Yet going back to the beginning, the biggest irony in all this is that China's quiet attempt to redirect credit formation while injecting massive amounts of loans is still not enough, as the following chart of China's credit impulse vs home prices shows.
In the end, whether China's deleveraging is premeditated or accidental doesn't matter: a few more month of China's credit impulse collapsing and it will be too late to prevent a hard landing, first in China where real estate was, is and will be the most popular and important asset, and then the rest of the world. As we explained in "Why The Fate Of The World Economy Is In The Hands Of China's Housing Bubble", to understand what the world economy will do in 6-9 months you only have to follow China's debt creation and housing market today.
And right now, both of those are headed straight down, and the worst is yet to come: as Deutsche Bank sumamrizes in its latest snapshot of China's banking system, "we are likely at most halfway through the financial deleveraging process. New regulations on asset management and liquidity risks will be phased in and more rules will probably follow."
Which means even less credit creation, even faster slide in property prices, and even greater global credit deflation which is coming just as the world's central banks are poised to tighten financial conditions expecting a deluge of inflation. The result will be another economic crash in the coming year.