China, Real Reform Or Just Spinning Its Wheels?

China Continues Expanding Liquidity

Recently China has been on a tear to add liquidity to its flagging financial system. Liquidity should by all rights stem its economic descent, however, China's central bank is in the unenviable position of filling a leaky bucket. While they have made every effort to plug the leaks and halt the flow of money across its borders it is finding just how porous the financial dikes around modern day economies has become. We have witnessed massive monthly outflows of wealth and capital that have continued to flee China even after efforts to plug the fractures and cracks. Cross-border money flows is a strong and important force that disrupts markets and effects the ability of central banks to isolate and control problems within their borders.

Chinese Money Is Distorting Markets

Well documented is how money flowing out of China has affected housing prices in Vancouver and driven them into bubble territory. It is estimated that $700 billion to $1 trillion have fled China last year. This sum is more than the entire economy of Switzerland. China now claims the cross-border capital flows are expected to stabilize in the fourth quarter and major capital flight is unlikely because the country's economic fundamentals are strong. On Friday the nation's foreign exchange regulator claimed. Official data released on Wednesday showed overall economic growth at 6.7 percent, with some signs of strength  appearing in the industrial sectors.

More important to many China watchers than what is said or government numbers is that on Friday, the People's Bank of China (PBoC) set the central parity rate at 6.7558 hitting a six-year low. They claim depreciation of the yuan is natural in light of the recent strengthening of the U.S. dollar, noting that the dollar index, which is the trade-weighted value of the dollar against a basket of major currencies, rose by 2.99 percent since the beginning of the month. The dollar has strengthened mainly due to the rising expectation of an interest rate hike by the United States Federal Reserve by year's end.

All in all the events unfolding are directly responsible and feeding into several trends. One noticeable trend is that Chinese companies are expanding investment in overseas acquisitions, this is a way to move money out of the country while not upsetting the apple-cart. Also, China has embarked on an unprecedented spending spree, rebuilding the infrastructure both in China and across the world. Another area where money continues to flow is into housing. New home prices in 63 out of 70 cities that the National Bureau of Statistics monitors gained in September. This has raised enough concern to caused the central bank, the China Banking Regulatory Commission and other bodies to draft new rules barring developers, peer-to-peer networks, and other non-banks from offering down-payment loans to people buying houses.

By the end of September, financial institutions in China had lent 25.33 trillion yuan ($3.74 trillion) to the property sector, up 25.2 percent year on year, according to a report from the People's Bank of China. It is important to note housing prices are again on the rise in China as if they were not high enough. Indications that China’s hundreds of P2P lenders allowing home buyers to seek down-payment loans online are a sign of shadow-banking leverage creeping into China’s housing market and similar to what drove the margin financing that fueled last year’s stock market bubble. Concerns of a damaging housing crisis like the 2008 subprime mortgage crisis in the U.S. are very real.

Chinese Ghost Town built in Angola, Africa

The so-called re-balancing of the Chinese economy is multi-pronged and not free of risk. As they try to diversify away from exports toward a consumer economy and shift from domestic investment toward international investment we may see inexperience and greed take a backseat to good sense. Much of this is taking place at an astonishing speed. Not only is China building infrastructure projects for near neighbors such as a mega-pipeline project in Russia for natural gas and making plans to help refurbish Europe’s aging infrastructure. They are also doing work in nations throughout Latin America and Africa. Like the Chinese ghost town built on the outskirts of Angola's capital city, in the end, many of these may turn out to be nothing more than glorious bridges to nowhere.

The Bank for International Settlements says much of the capital outflow from China has been to pay down dollar debt and is largely benign and indicated foreign reserve depletion has subsided. Still, a debate rages on as to whether the Chinese economy really bottomed in mid-2015 and has been slowly recovering. It remains clear even with the banks already holding a lot of bad debt we are again seeing credit growing at unhealthy double-digit rates. The Communist Party may have put off the day of reckoning by pulling the levers of stimulus but when that moment comes it will be even harder to deal with as  trade tensions continue to grow.


Footnote;  As always comments are welcomed and please feel free to scan the archives for other article that may interest you. Above I mentioned an earlier post that explored the rather strange customs and how houses are sold in China, the link to that post can be found below.
http://brucewilds.blogspot.com/2017/10/china-housing-market-customs-bizarre-to.html