'When the Chinese responded to the 2008-2009 crisis by engaging in a massive stimulus program, I said that they were creating a Michael Jackson economy, one that was kept going by artificial means, to the detriment of its long term health..'<blockquote>'The surge in credit is being extended in large part through extremely fragile and opaque shadow banking channels, but the risk is ending up on bank balance sheets.
To engage in regulatory arbitrage of capital rules, banks are disguising loans as “investments” in trust companies and other non-bank intermediaries, who then turn around and lend to corporate borrowers. Just call a loan a “receivable” and voila, no nasty non performing loan problems.
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When the Chinese responded to the 2008-2009 crisis by engaging in a massive stimulus program, I said that they were creating a Michael Jackson economy, one that was kept going by artificial means, to the detriment of its long term health. The most recent economic slowdown has engendered a similar response. Its scale is not quite as massive as 2008-2009, but it’s just begun. Furthermore, the earlier stimulus utilized a good portion of the nation’s debt capacity, and even though smaller, the current stimulus risks exhausting that capacity and raising the risk of a banking or financial crisis. It is clear, moreover, each yuan of stimulus today generates a smaller increase in (officially measured) output. Thus, in my view, the current stimulus will only provide a temporary boost to the economy, and indeed, will only aggravate the deep underlying distortions that resulted from past attempts to control the economy. This will make the ultimate reckoning even more painful.'
- Streetwise Professor,
Rounding Up the Usual Suspects, With Chinese Characteristics, April 29, 2016</blockquote>
'China has an historic Credit problem. It as well suffers from an unfolding “money” fiasco of epic proportions..'<blockquote>'April 25 – Financial Times (Jennifer Hughes): “Stand easy — or easier, at least. Ten basis points might not be the biggest one-day change for borrowing costs in China’s vast $7tn bond markets, but it was enough on Monday to push the country’s closely watched onshore repo rate back from an eight-month high. That offers a little breathing space for investors to ponder what next for the rising tensions in onshore bond markets. One point to look at is their own leverage as well as their fears for companies… Amid all the furore about the pain of rising rates, one so-far overlooked factor is that investors, as well as companies, appear precariously balanced. The market for pledge-style repos — short-term, bond-backed loans — is currently bigger than the stock of outstanding debt, according to Wind Info. A sharp worsening in market sentiment could force those borrowers into fire sales if their loans are called or cannot be rolled over.”
I recall an early-1998 Financial Times article highlighting the explosive growth in Russian ruble and bond derivatives. Not only had the “insurance” market for risk protection grown phenomenally, Russian banks had become become major operators in what had evolved into a major speculative Bubble in Russian debt exposures. That was never going to end well.
There was ample evidence suggesting Russia was a house of cards. Yet underpinning this Bubble was the market perception that the West would not allow a Russian collapse. With such faith and the accompanying explosion in speculative trading, leverage and a resulting massive derivatives overhang, any break in confidence was to ensure illiquidity, panic and a devastating bust. Just such an outcome unfolded in August/September 1998.
“The market for pledge-style repos — short-term, bond-backed loans — is currently bigger than the stock of outstanding debt” (from FT above). With this undramatic sentence exists the potential for a rather dramatic global financial crisis. And, to be sure, seemingly the entire world has operated under the assumption that Chinese officials (and global policymakers in general) have zero tolerance for crisis – let alone a collapse. So Credit, speculation and leverage have been accommodated – and they combined to run absolute roughshod.
Jennifer Hughes’ FT article (noted above) included a chart worthy of color printing and thumbtacking to the wall: “China’s Use of Bonds as Loan Collateral Rises Sharply”. The pink line shows “Onshore Market Bonds” having almost doubled since mid-2011 to about 40 TN rmb ($6.17 TN). The Red Line – “Pledge-Style Repos” – has ballooned four-fold since just early 2014 to surpass 40 TN rmb. So basically, in this popular market for inter-bank borrowings, borrowing banks have pledged bond positions larger than the entire market as collateral for their (perceived safe) short-term borrowing needs.
China has an historic Credit problem. It as well suffers from an unfolding “money” fiasco of epic proportions. My analytical framework attempts to differentiate the two, as each comes with its own set of (related) issues. A Credit Bubble is a self-reinforcing but inevitably unsustainable expansion of debt. Money (the contemporary variety) is a financial claim perceived as a safe and liquid “store of nominal value.” Importantly, systemic risk expands exponentially when risky borrowings are financed by an expansion of “money-like” instruments/financial claims. This typically occurs late (“terminal phase”) in the Credit Bubble Cycle.
During the U.S.’s mortgage finance Bubble period, “Wall Street Alchemy” worked to transform increasingly risky mortgage debt into perceived safe “AAA” securities and instruments. And so long as the rapid expansion of mortgage Credit propelled home prices and economic activity, the Fallacy of Moneyness prevailed. But at some point Bubble risk intermediation processes invariably turn perilous. The disconnect becomes increasingly untenable: enormous risk has accumulated – and continues to swell – backed by a rapid expansion of perceived safe “money.” After months of festering Credit deterioration, it was the breakdown in confidence in the repo market that precipitated the devastating 2008 financial crisis.
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With various Bubbles either already faltering or indicating acute fragility, confidence in China’s “repo” finance has turned quite vulnerable. And as goes the Chinese “repo” market so goes China’s asset Bubbles, Credit Bubble and economic Bubble, with ominous portents for global markets and the overall global economy.'
- Doug Noland,
The Red Line, April 30, 2016</blockquote>
Context<Blockquote>
'..economic policies that focus on nothing but debt expansion and financial-market distortion..''..credit booms tend to undermine productivity growth..'James Grant: The United States of Insolvency, April 30, 2016</blockquote>