September 16 – September 22, 2016

Chinese corporate debt…geez…Someone’s going to have to take a haircut. US pension crisis.

Headlines

WSJ – China’s Property Bubble Keeps Getting Bigger 9/19. “With so many parties including banks and local governments all depending on real estate, it may not make sense for them to pop the bubble.”
WSJ – China Capital Outflows Bubbles Below the Surface 9/20. “China’s outflows this year are north of $400bn, which is reflected both in a $190bn decline in the country’s foreign-exchange reserves and a weaker yuan, down about 3% this year against the dollar and more than 6% against a basket of currencies.”
FT – Drugmaker raises price of acne cream to $10,000 a tube 9/20. Chicago-based Novum Pharma has raised its price on Aloquin nearly 3,900% since May of 2015 and yet it still manages to “cost” consumers about $35 after rebates, coupons, etc.; seriously…
FT- Petrobras cuts planned investment by a quarter 9/20. “With $124bn of gross debt at the end of June, Petrobas now ranks as the world’s most heavily-indebted oil company.”

Briefs

Jeevan Vasagar of the Financial Times covered how a toxic haze killed about 100,000 people in Southeast Asia in 2015.

A recent study that was published in Environmental Research Letters, a top academic journal, indicated that the “toxic haze that spread across Southeast Asia from Indonesia forest fires last year caused the deaths of about 100,000 people across the region.”
“The death toll was concentrated in Indonesia, which had about 92,000 excess deaths from persistent haze that choked the region between July and October, according to researchers at Harvard and Columbia.”

Gabriel Wildau of the Financial Times highlighted the BIS’s recent report on China’s debt levels.

“What the BIS (Bank for International Settlements) terms the country’s ‘credit gap’ is now three times higher than the typical danger level, the research shows.”
“The BIS rates a reading above 10% as cause for concern; China’s gap hit 30.1% in March.”
“The International Monetary Fund estimated in June that Chinese companies that had borrowed a collective $1.3tn did not have enough earnings before interest, taxes, depreciation and amortization to meet interest payments.”
“China first breached the 10% threshold in 2009 and has not yet experienced a crisis. Many analysts believe that the country’s low level of foreign currency debt and its government-controlled banking system make crisis less likely.”

Mani of ValueWalk discussed Nomura’s recent analysis on China and that the “only one practical way to reduce the stock of outstanding debts: defaults.”

“China Debt Default? To alleviate its debt problem, China should adopt appropriate macro-economic policies encompassing currency depreciation and cutting interest rates to an ultra-low-level within two to three years, believe Nomura analysts. Yang Zhao and team said in their September 14 research piece titled “China: Solving the debt problem” that they believe RMB depreciation will continue and forecast USD/CNH at 7.1 at the end of 2017.”

Hudson Lockett of the Financial Times illustrated the scale of potential shadow finance losses that lurk in China.
- “Losses from bad debt in China’s shadow financing sector could amount to 3.7% of GDP, according to a new analysis of off-the-books lending and investment.”
- “The new report from CLSA also estimates shadow financing in China grew to Rmb54tn ($8.1tn) by the end of 2015 – equivalent to 79% of gross domestic product, with 64% of the total originating at or relating to mainland banks.”
- “The firm also reiterated its May estimate for Chinese banks’ non-performing loan ratio of 15%, or Rmb11.4tn, assuming the same recovery ratio of 40%, which would entail potential losses of 10% of GDP. The total losses when combined with those from bad debt in shadow financing would come to 13.7% of GDP.”
Takashi Nakamichi and Rachel Rosenthal of the Wall Street Journal discussed the Bank of Japan’s recent bond-rate target in its policy revamp.
- “The Japanese central bank, which has struggled for nearly two decades to bring about steady inflation, said Wednesday it wants to keep the yield on 10-year Japanese government bonds at zero, and will adjust the pace of its bond buying as needed to achieve that.”
- “The long-term-rate target, the first in the BOJ’s century long history, challenged conventional wisdom that rates in the huge government-bond market are ultimately set by market forces and can’t be fully controlled by an official entity. Central banks are usually assumed to have much more control over short-term rates, and many around the world target rates for debt with a term of less than a year.”
- “One worry: ‘In theory, they could be forced to buy an unlimited amount of bonds,’ said Marcel Thieliant, Japan economist at research firm Capital Economics in Singapore.”
- “Mr. Kuroda called the new policy a ‘reinforcement’ of easing. The BOJ also took the unexpected step of saying it would aim for inflation to exceed 2% instead of merely hitting it, a nod to calls from some U.S. economists for a higher target.”
Peter Wells of the Financial Times highlighted that the universe of negative-yielding sovereign debt just fell to $10.9tn.
- “The universe of negative-yielding sovereign debt fell to $10.9tn as of September 12, a drop of $1tn since June 27 largely due to yields on some longer-dated maturities moving back into positive territory, according to a new report from Fitch Ratings.”
- “Of the countries afflicted by negative yields, Switzerland has 95% of its outstanding debt trading with a yield below zero.”
- “Fitch also calculates that as a result of low and negative yields, investment income for sovereign investors globally are ‘prospectively earning nearly $500 billion less annually in investment income than they would have earned with yields available in 2011.’ The investment-grade sovereign debt market is $38bn.”

Special Reports / Opinion Pieces

Mauldin Economics – The BIS Warns on China – Ambrose Evans-Pritchard 9/19
- “No, I do not think China is going to massively implode, but the world is really not ready for a China that is only growing at 2% or 3% a year. (Even though 2-3% growth would sound pretty good if it was happening in the US.)”
NYT – How Bad Off Is Oil-Rich Venezuela? It’s Buying U.S. Oil – Nicholas Casey and Clifford Krauss 9/20

Graphics

WSJ – Japan’s Central Bank Splits Over Easing Program – Takashi Nakamichi 9/15

Bloomberg – Money Is Pouring Into Property Deals Banks Won’t Touch – Sarah Mulholland and Heather Perlberg 9/18

Economist – Chinese investment: A sponge wrung dry 9/17

WSJ – China Capital Outflows Bubbles Below the Surface – Anjani Trivedi 9/20

FT – Bond bubble brings with it an odor of rotting fish – Robin Wigglesworth 9/20

Bloomberg – Not for Sale: The Best Land in America 9/8

FT – China local governments revive off-budget fiscal stimulus – Gabriel Wildau 9/20

Featured

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

Who’s next? The science of Chinese corporate defaults. James Kynge. Financial Times. 18 Sep. 2016.

“A total of 41 default cases have hit China’s domestic debt markets in the year to mid-September, more than the previous two years combined, according to Wind Information, a Shanghai-based financial data company. Some 70% of defaults by end-July were by state-owned enterprises, according to IHS, a consultancy.”

“The big picture behind China’s local government debt problem is stark. The liabilities of well over 100,000 companies problem is stark. The liabilities of well over 100,000 companies owned by local governments across the country grew at an average annual rate of 14.1% from 2012 to 2015 to reach Rmb35.4tn ($5.3tn), according to Moody’s research.”

“These are treated as contingent liabilities – or potential liabilities – because although local governments do not guarantee the debts of their corporate subsidiaries, they nevertheless are responsible for generating local economic growth, employment and public services so they would be loath to let an important contributor to such goals go under.”

“But in recent years, some local governments have built up such hefty debt burdens that even if they would like to bail out an important local employer, they may not be able to. Total direct local government debt, according to Moody’s, was Rmb16tn in 2015. Thus direct and contingent liabilities come to Rmb51tn – more than the GDPs of Japan and Germany combined.”

As to which companies to let default… “Nicholas Zhu, vice-president at Moody’s, describes a clear hierarchy of debt vulnerability. The most likely to default would be lossmaking, indebted companies owned by lower-tier governments – at the prefectural, city or county level – that have little revenue and large debts. The problem, however, with lower-tier administrations is that they often publish sparse statistics, so it is difficult to know the true state of their financial health.”

Nomura First Major Bank To Predict China Default Calculates Total debt to GDP at 309%; BIS Sounds The Alarm. Mark Melin. ValueWalk. 18 Sep. 2016.

“Nomura, which estimates China’s total debt – government and corporate debt – is Rmb211.8 trillion or 309% of GDP. The vast majority of this debt is corporate, which from a leverage perspective looks better. Non-financial sector accounted for Rmb158.5tn (231% of GDP, up by 92pp from 2007) and the financial sector for Rmb53.3tn (78% of GDP, up by 49pp).”

“The debt is up nearly 141% since 2007, which leads Nomura to conclude “a rising default rate is inevitable.”

“What this all means is that interest rates are likely to head near zero – the place at which such defaults can find their most advantageous environments. And of course, when interest rates fall, so, too, does the currency values. In the end, it is likely to become one big mess that might have global implications.”

US building up to pension crisis. Robin Wigglesworth and Barney Jopson. Financial Times. 20 Sep. 2016.

“The number are severe. According to the National Institute on Retirement Security, nearly 40m working-age households – 45% of the total – had no retirement savings whatsoever in 2013, whether an employer-sponsored 401(k) plan or an individual retirement account (IRA).”

“If you look for the black hole in the pension system, this is it. And these are the most vulnerable people in society.” – David Hunt, chief executive of PGIM, Prudential Financial’s asset management arm.

“Indeed, while younger people are less likely to have some sort of a retirement nest egg than older Americans, the biggest factor is income. Households with a retirement account have a median income of $86,235, while those without one have a median income of $35,509, according to the NIRS.”

“We have a crisis unfolding here. We’re asking people to set aside precious resources they don’t have… For millions and millions of Americans, the only thing they’ll have is Social Security.” – Russ Kamp, a pensions consultant

Social Security “together with the Supplemental Security Income program account for over 90% of the income for the bottom quarter of retirees, according to the NIRS.”

“But Social Security’s future is as uncertain as it is politically divisive. When it was set up, retirees would only have to be supported for less than 13 years on average. These days the average American can expect to draw Social Security for almost two decades, and unlike traditional public sector pension plans, it operates on a pay-as-you-go basis.”

“Citi estimated earlier this year that the unfunded liabilities were over $10tn.”

Other Interesting Articles

Bloomberg Businessweek