China Economic Update!

The Infamous China Ghost City Of Ordos

Occasionally the world has witnessed an unusual alignment of interest that usher in a strong period of growth for a country that is not easily replicated.  Years ago Gordon Chang, author of "The Coming Collapse of China," said China may only be growing 2 or 3 percent and if you strip out all the construction going into ghost cities and "high-speed rail lines to nowhere," the economy may not be growing at all. At the time China claimed it had a 7.7 percent growth for the first quarter, Chang clarified his view by adding "But when you look at electricity, by far the most reliable economic indicator of Chinese economic activity, that grew 2.9 percent in Q1. When you consider that the growth of GDP is historically 85 percent of the growth of electricity, you're talking 2.5 percent (growth)." Again recently short seller Jim Chanos said about China, "It’s worse than you think. Whatever you might think, it’s worse,"

It is becoming clear that China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. To say the economy of China is shaky understates the situation. The type  of growth we have witnessed in China during the last several decades has been extraordinary and was driven by several "one time factors" that have played out. It is important to understand many of the loans used to finance the construction of ghost cities, unused airports, idle train lines, and other failed endeavors may never get repaid. Instead, banks continue to roll over these loans time after time. It should also be noted that many of these loans have been made to state-owned companies and local governments. It has become abundantly clear that China’s credit quality started to deteriorate in late 2011 as borrowers took on more debt to serve their obligations amid a slowing economy and weaker income.

This has caused a rapid rise in the ratio of credit to gross domestic product. That measure has moved from 120% in 2007 to around 180% at the end of 2012. Such a sharp shift raises concerns about the misallocation of credit on a grand scale, and a build-up of bad assets in the banking sector. Interest owed by borrowers rose to an estimated 12.5 percent of China’s economy from 7 percent in 2008, Fitch Ratings estimated in September. By the end of 2017, it may climb to as much as 22 percent and “ultimately overwhelm borrowers.” Meanwhile, China’s total credit will be pushed to almost 250 percent of gross domestic product by then, more than double the 120 percent figure of 2007. An estimate by the Goldman Sachs Group Inc indicated the nation might face credit losses as much as $3 trillion as defaults ensue from the expansion of the past four years, particularly by non-bank lenders, this far exceeds amounts seen in prior credit crises. This is not just about writing off a few bad loans.

Many strong and strange currents run through the Chinese financial system, these include, but are not limited to things like an artificial housing market propelled along by a lack of sound investment options and a massive shadow banking system driven by the low interest on savings offered by state controlled banks. It is pure insanity and a bit naive to think that China's economic system developed over only a few decades both anchored, helped along, built, and mentored by Americas too big to fail banks is ready for prime-time. Instead what is before them is a sea of bad debt fueled by political corruption and a major stimulus response following the 2008 meltdown that has misallocated funds and created massive overcapacity. Remember four big state-owned commercial banks and other, mainly state-controlled banks, account for the bulk of all official lending in China and their customers tend to be state-owned firms, other borrowers are forced to go elsewhere.

No one really knows how big the largely unregulated informal lending is, but it has grown rapidly in China during the last five years. Companies and local governments who cannot get loans from state-controlled banks have been on a borrowing binge from these unofficial sources. Shadow bank loans can come across to Americans as some kind of "loan shark" operation because they charge as much as 24-30% in interest and can be for as short a period of time as just three to five days if someone is desperate for cash. The shadow banking sector is so large that concerns exist about contagion and a domino series of defaults that might rack the economy if savers who have put their saving into it lose money. One of China's most notorious shadow bankers is currently in jail serving a life sentence but this does not help those who loaned this person money because of the high rates he paid. The "investors" become victims and often lose everything they have saved to retire on when a shadow bank goes bust.

China’s biggest banks have taken a big hit and have tripled the amount of bad loans they wrote off in the first half of this year cleaning up their books ahead of what appears may be a fresh wave of defaults. Industrial & Commercial Bank of China Ltd. and its four largest competitors expunged 22.1 billion yuan of debt that couldn’t be collected through June, up from 7.65 billion yuan a year earlier. “In the next three to four years, industries with excess capacity will be the main source of credit loss for banks and their nonperforming loans as China cleans up the legacy,” said Liao Qiang, a Beijing-based director at Standard & Poor’s. “The speed of the process will depend on the government’s determination and whether they are willing to incur short-term pain for long-term gain.”

Policy makers in Beijing have said they would elevate the role of markets in the nation’s economy and China’s top banking regulator has urged lenders to “seek channels to clean up bad loans by industries with overcapacity to prevent new risks from brewing” and deal with the issue. Overcapacity is a big problem, a third of the country’s 1,600 shipyards may shut down within five years amid a global vessel glut, said the secretary general of the China Association of the National Shipbuilding Industry, said in July. Ji Fenghua, chairman of Nantong Mingde Heavy Industry Group Co., another struggling “Shipping Valley” thinks this is an an understatement, he said “I won’t be surprised if half of the shipbuilders fail, given the excess capacity,” In July 2012 hundreds of his workers who hadn’t been paid in three months besieged his office building.

Many capital-and-labor-intensive industries that have relied on bank loans and policy support for their past success are now in deep trouble. Support for the solar industry since late 2008 has resulted in at least one factory producing sun-powered products in half of China’s 600 cities, according to the China Renewable Energy Society in Beijing. China Development Bank, the world’s largest policy lender, alone lent more than 50 billion yuan to solar-panel makers as of August 2012, data from the China Banking Association showed. China accounts for seven of every 10 solar panels produced worldwide. If they ran at full speed, the factories could produce 10 times more than in 2008, according to data compiled by Bloomberg. This overcapacity has driven down prices to about 84 cents a watt, compared with $2 at the end of 2010, but falling prices have forced dozens of producers into bankruptcy. One local bank now reports a 33 percent nonperforming-loan ratio for the solar-panel industry, compared with 2 percent at the beginning of the year.

The real situation is much worse than the data shows because it will take at least a year or longer for many of the non-preforming loans to be recognized by the banks. This overcapacity is seen in other industries such as steel and cement, which are also facing a serious glut. China’s economic planners have sought to rein in the steel industry since at least 2004, when work on a 10.6 billion yuan project in Jiangsu was halted. Even so, the steel association shows annual capacity has risen to 970 million metric tons. China now produces seven times more than No. 2 Japan. About 10 million tons of aluminum production capacity is being built at a time when the industry incurred combined losses of 670 million yuan in the first half, with some producers in central and eastern China facing severe losses.

Because of this more than 1,400 companies in 19 industries including steel, and cement have been told to cut excess production capacity this year. This is an indication that the government is serious in pursuing pledges to fix fundamental issues in the economy, but as they move in this direction the financial pain will be brutal. China’s lending spree has created a debt burden similar in magnitude to the one that pushed Asian nations into crisis in the late 1990s. As companies loaded up on debt, the efficiency of credit use has deteriorated. Since 2009, for every yuan of credit issued, China’s GDP grew by an average 0.4 yuan, while the pre-2009 average was 0.8 yuan. This means printing and loaning more money has not resulted in the same amount of growth that it did in the past. It is now becoming clear the 2008 stimulus was not the correct answer to move China forward, but instead it only exacerbated an industrial glut that has been in existence since 2003.

To those who doubt just how massive the problems are they only need look to the newly constructed city of Ordos in Inner Mongolia. Most of the new town buildings are empty or unfinished. Ordos is a spectacular example of a new Chinese phenomenon, that now exist in many cities, unsold condos, unleased shops, and building after building of empty office space. In March of 2012 the BBC ran a story about the city of  Ordos, that suggested the great Chinese building boom, which did so much to fuel the country's astonishing economic growth was coming to an end and was a bubble about to burst. This ghost city is by most accounts devoid of people and construction of the half finished project is at a halt. Western financial experts who fear a bursting of the Chinese real estate bubble point out that the Chinese economy still remains more dependent on home building than the United States economy was, before the sub-prime lending bubble burst in 2007.



  Footnote; Please feel free to explore the blog archives and as always you comments are encouraged. For more on China see any of the post below,
              http://brucewilds.blogspot.com/2014/03/china-and-great-credit-trap.html
              http://brucewilds.blogspot.com/2013/11/china-land-of-overcapacity-and-debt.html
              http://brucewilds.blogspot.com/2013/04/china-and-corruption.html
              http://brucewilds.blogspot.com/2013/02/china-bubble-yes-it-is.html
              http://brucewilds.blogspot.com/2012/09/china-made-by-america.html