May 6 – May 12, 2016

China’s coming debt bust.

It’s a short one this week – traveling with the family.  Enjoy!

Headlines

Briefs

  • Adding to this week’s feature is Ben Bennett’s piece in the Financial Times basically saying that by pushing out the problem (China’s growing debt imbalance), it will only make the remedy worse.
    • “Estimating the amount of debt that needs to be written off by China is not an exact science. It boils down to how much excess capacity has been built with little chance of making an economic return. Julien Garran at MacroStrategy estimates there has been around $8tn of excess fixed capital formation in China since 2008, which, assuming that 60% turn into non-performing loans and a 40% recovery rate, suggests losses of $3tn. This is about 30% of Chinese GDP. Autonomous Research gets to a similarly large number by looking at losses realized by other countries following their own credit bubbles. This far outstrips the loss-absorbing capacity of the financial system, and would therefore require significant state support to resolve.”
  • Shifting our attention further West (if the reference point is China), Anna Andrianova and Andrey Biryukov of Bloomberg highlight that Russia is grappling with deflation as its economic sickness gets worse.
    • “Russia’s longest recession in two decades has obliterated consumer demand. Price growth has slowed for a seventh month. Goldman Sachs predicts Russia’s annual inflation, now 7.3%, will slip below 6% in the third quarter and finish the year at 4.5%. In March of last year inflation was 16.9%. It’s enough for Bank of America to warn that the country faces a ‘sharply rising’ risk of deflation.” 
    • “After President Vladimir Putin came to power in 2000, the poverty level fell until 2014, when oil prices collapsed. Now millions are sinking into poverty and wages are rising minimally.” 
    • “Savings rose to 14.1% of disposable income last year, up from 5.4% in 2008, according to the Federal State Statistics Service.” 
    • “Poor demographics add another wrinkle. The working-age population has shrunk by 5 million since its peak in 2006 and will continue to contract, cutting Russia’s potential economic growth to near zero in 2016-2017, according to BofA economists.” 
  • Back to the U.S., Sam Fleming and Shawn Donnan point out in the Financial Times that the middle class in most US cities have taken a financial hit so far this century.
    • “The research on urban centers that are home to three-quarters of the US population shows that median household incomes, adjusted for the cost of living in the area, grew in just 39 out of 229 metro areas between 1999 and 2014.”

Graphics

FT – The biggest problem with China’s latest credit boom, charted 5/4

FT_China Bank Credit and M2 growth_5-4-16

FT_China credit charts_5-4-16

FT – China companies borrow to repay debts in latest credit binge – James Kynge 5/9

FT_Inefficient Chinese investments_5-9-16

FT_China debt repayment_5-9-16

FT_China bonds for construction_5-9-16

FT_China uses of muni bond funds_5-9-16

Economist – Shadow banks: Dark and stormy

Economist_Chinese shadow banking system_5-7-16

FT – EM millennials out-earn their elders 5/11

FT_EM millennials in the money_5-11-16

FT – Air pollution hits ‘catastrophic’ levels 5/11

FT_PM10 air pollution levels_5-11-16

Featured

*Note: bold emphasis is mine, italic sections are from the articles.

The coming debt bust: It is a question of when, not if, real trouble will hit in China. Economist. 7 May 2016.

“The country’s debt has increased just as quickly over the past two years as in the two years after the 2008 crunch. It’s debt-to-GDP ratio has soared from 150% to nearly 260% over a decade, the kind of surge that is usually followed by a financial bust or an abrupt slowdown.” 

“China will not be an exception to that rule. Problem loans have doubled in two years and, officially, are already 5.5% of banks’ total lending. The reality is grimmer. Roughly two-fifths of new debt is swallowed by interest on existing loans; in 2014, 16% of the 1,000 biggest Chinese firms owed more in interest than they earned before tax. China requires more and more credit to generate less and less growth: it now takes nearly four yuan of new borrowing to generate one yuan of additional GDP, up from just over one yuan of credit before the financial crisis.” 

“It is true that China has been fastidious in capping its external liabilities (it is a net creditor)… But the damage from a big Chinese credit blow-up would still be immense. China is the world’s second-biggest economy; its banking sector is the biggest, with assets equivalent to 40% of global GDP. 

“Optimists have drawn comfort from two ideas. First, over three-plus decades of reform, China’s officials have consistently shown that once they have identified problems, they had the will and skill to fix them. Second, control of the financial system – the state owns the major banks and most of the biggest debtors – gave them time to clean things up.” 

“Both these sources of comfort are fading away. This is a government not so much guiding events as struggling to keep up with them. In the past year alone, China has spent nearly $200 billion to prop up the stock market; $65 billion of bank loans have gone bad; financial frauds have cost investors at least $20 billion; and $600 billion of capital has left the country. To help pump up growth, officials have inflated a property bubble. Debt is still expanding twice as fast as the economy.” 

Further, “despite repeated efforts to restrain them, loosely regulated forms of lending are growing quickly: such “shadow assets” have increased by more than 30% annually over the past three years.”

The risks are first “higher-than-expected losses for the banks. Hungry for profits in a slowing economy, plenty of Chinese banks have mis-categorized risky loans as investments to dodge scrutiny and lessen capital requirements. These shadow loans were worth roughly 16% of standard loans in mid-2015, up from just 4% in 2012. The second risk is liquidity. The banks have become ever more reliant on ‘wealth management products,’ whereby they pay higher rates for what are, in effect, short-term deposits and put them into longer-term assets. For years China restricted bank loans to less than 75% of their deposit base, ensuring that they had plenty of cash in reserve. Now the real level is nearing 100%, a threshold where a sudden shortage in funding – the classic precursor to a banking crises – is well within the realm of possibility. Midsized banks have been the most active in expanding; they are the place to look for sudden trouble.” 

“…it is too late for China to avoid pain. The task now is to avert something far worse.”

Other Interesting Articles

Bloomberg Businessweek

The Economist

Bloomberg – Manhattan’s Latest Tower Heats Up Hudson Yards Race for Tenants 5/9

FT – MetLife takes axe to hedge fund portfolio 5/5

FT – Alarm bells ring over negative interest rates 5/5

FT – Buffett and Bogle unite against hedge funds 5/7

FT – The real cost of big tech’s accounting games 5/8

FT – PwC to deploy drone army 5/8

FT – Alarm grows as investors get bulk of listed groups’ profits 5/9

FT – China capital outflows persist despite FX reserves rebound 5/9

FT – Rosneft head: Opec no longer united organization 5/10

FT – China insurance regulator sends inspectors to Anbang 5/11

FT – Linn Energy files for bankruptcy protection 5/11

FT – Macy’s joins American retail descent into the doldrums 5/11

FT – Grantham on the paradigm shift that never was 5/11

FT – Abu Dhabi raises stakes in 1MDB dispute with $1.2bn demand 5/11

WSJ – Stuck at Zero: The Long-Term Challenge for Investors 5/6

WSJ – Opportunity to Squeeze More From China’s Biggest Mall Developer 5/9

WSJ – What a China U-Turn Would Mean for Global Growth 5/10

WSJ – Luxury Condo Boom Is Ending in Manhattan 5/10

WSJ – Mall Landlords Go for Novelty in China 5/10

WSJ – Malaysian Leader Najib’s Stepson Allegedly Funded U.S. Property Deals With 1MDB Money 5/12

 

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