Sunday, July 30, 2017

China's Financial Missteps Continue

What Happens In China Does Not Stay In China!

The financial missteps in China have continued and it will only be when their economy falters that we will learn to what extent or hear more stories about how they have masked their problems. China recently began touting what is seen as a buoyant economic expansion as evidence it is putting its financial house back in order. The country's gross domestic product grew 6.9% in the second quarter, according to government data recently released, the same figure as the previous quarter and marginally higher than most forecasts. The latest numbers position the economy above Beijing's stated growth target for 2017. While the numbers from China show an uptick in growth from the 6.7% it recorded last year it will be difficult to sustain this in the months to come if the government begins to focus on reining in the country's rapidly ballooning debt.

China is no small underdeveloped backwater with an insignificant economy and it is important to remember that "what happens in China does not stay in China." While we tend to be fixated on the four central banks that make up the worlds major reserve currencies because of its size and how it is connected to other major players we should remember that China policy packs a major wallop.  Growth in China has been fueled by its government expanding the money supply and debt, that is distorting markets across the world. This extends to things like causing housing prices to soar in many parts of Canada. This is why it is so baffling that many economists have chosen to ignore or given a pass to the ramifications of China's policies as they affect the big picture.

Finding A More Recent Chart Proved Difficult
It is difficult to ignore the Chinese economy has "been very reliant" on government stimulus, rapid credit growth and the flow of newly created money from a loose monetary policy. One thing we are seeing is that China will do anything to move its products, this is again apparent in the fact the prices of its exports are again falling. This means producers in the U.S. and elsewhere are unable to pass through any input cost increases because China is once again busy exporting its own brand of deflation across the world by keeping the cost of consumer goods in check. Again this feeds into the debate about globalization and is a solid endorsement of the movement by China which has benefited greatly from the shifting of jobs into the country from higher cost producers.

Getting a handle on the true strength of China's economy is complicated by the Chinese government recently announcing it would change the way it calculated economic growth for the first time in 15 years, adding healthcare, tourism and the "new economy" to the overall figure. It was not immediately clear whether those additions had an impact on growth or to what extent. The latest growth numbers will likely reinforce skepticism among analysts about the reliability of official statistics. Because of doubt surrounding the accuracy of these numbers, many economists continue to use measures such as electricity output and freight shipments to get an indication of China's true economic strength.

At the end of May, for the first time since 1989 credit rating agency Moody's downgraded China warning that the country's financial health is suffering from rising debt and slowing economic growth. This follows the International Monetary Fund's pushing Beijing last year to "urgently address" the issue. This problem has been years in the making when growth in the West collapsed following the global financial crisis of 2008, China's local governments and state-owned companies borrowed heavily to build cities and roads, invest in businesses and bolster financial markets. The spending spree resulted in a domestic debt hangover, particularly among some of the country's bloated and inefficient state-owned companies.

One thing China has not done is to prove it can reduce debt without harming growth, in fact, doubt has increased considering the property market’s outsized role in the economy, jittery consumers and signs that significant deleveraging hasn’t begun. A major reason this message is being ignored and we do not see enough focus on money and wealth continuing to flee China is because it is old news. Following a slew of stories at the end of 2015 and during 2016, lazy and inept financial writers choose instead to focus on easy to write and unimportant clickbait such as toys of the ultra rich and who is the worlds richest man.

A bit of light was recently shed of how money was continuing to leave the China when Beijing's attention shifted to the biggest conglomerate of them all, billionaire Wang Jianlin’s Dalian Wanda Group. The WSJ and Bloomberg reported the company was being "punished" by Beijing and would see its funding cut off after China "concluded the conglomerate breached restrictions for overseas investments."  Known as China's "Gray Rhinos," several large conglomerates with global reach have long prospered on credit financed by Chinese state-controlled banks, however, with stabilizing the yuan a top priority Chinese companies won’t find it as easy to acquire assets overseas going forward.

In all reality, Chinese companies have been using this as a way to move money offshore and adding to the flight of capital out of China. This has continued at a pace far worse than Beijing wants to admit and this "foreign merger party" and an orgy of high-priced foreign acquisitions is partly responsible for fueling higher stock markets across the world. The abrupt end of credit flowing to such companies should be viewed as a dramatic shift in policy considering that for years Beijing had been encouraging Chinese companies to scour the globe for deals. This dramatic reversal in policy is reining in some of its highest-profile private entrepreneurs in what officials say is growing unease with their high leverage and growing influence.

Several articles appearing on the financial blog Zero Hedge have delved into the corporate leverage that emerged as a result of China's unprecedented offshore M&A spree that emerged in 2015 and raged through most of 2016. It seems the stocks of the "famous four" Chinese conglomerates plunged after China officially launched a crackdown on foreign acquisitions amid concerns of "systemic risk" that were described as having the potential to become a "reverse rollup from hell" sending the loan to value of billions in loans collateralized by the company's shares to where they unleashed a catastrophic margin call upon the company's lenders.

 The bottom-line is that in a world where main stream media pumps out stories about how all is fine and markets are soaring warnings such as "Chinese billionaire warns of 'biggest bubble in history" continue to go unheeded. Many people still claim that China has plenty of ammo left and could even afford to bail out its troubled banks even as Moody's downgrade leaves China with the same rating as Japan, which has a far bigger government debt load. Some people feel massive systemic defaults are far less likely when the bulk of the debt is owed by a public sector with a strong balance sheet, which they see as being the case with China, however, remember China is far from transparent and the risk remains out of sight. The simple fact that we have become complacent over our concern and that it has yet to develop into a catastrophe doesn't mean it is no longer a danger or valid.


  1. A similar trend of debt growth has been present also in Japan, but these two economies seem to belong to a different planet, because of their extreme propensity to save money instead of consuming it. Therefore their enormous internal debt is just an expression of their aggregated savings.

  2. Hello Bruce.

    You might remember me posting in the past. The barely sane real estate guy. We have had massive building projects in town. Lack of planing means now they are tearing up the streets because the water and sewer lines are too small. I thought all these new places being available would wipe me out, but something weird is happening. I have more tenants and higher rents than ever before. The only thing I can figure is all this new stuff is so expensive, and our rents, even after jacking them up this year, are lower than most. But then I check my rents against Zillow, and looking at other complex's rates, my rents aren't that low. One thing I've noticed is students hate living in those MUDs. Noise, vomit in the hall, and people doing the wild thing where ever they please. Anyway, pleasantly surprised what happen, hope it keeps up.

    Charles Tanger esq

  3. And a good hello to you chazz!

    Thanks for your interesting comment. While things are also in flux here I have yet to see rents moving up but higher overall cost indicate that it is only a matter of time. The issue remains the numbers for all this new building simply do not work and sooner or later when higher interest rates arrive many speculators will be in a world of hurt and loans will not even be available to many. Below are five posts I have written about real estate in my area. Stay well!