China's debt

China's debt-to-GDP is "unsustainable," say Nomura chief economist.

I came across this article today: Australia warned of future China crisis double whammy

I don't think China's debt is already at unsustainable levels. But I do think the make-up poses a huge risk. Further research uncovered lots of good recent articles on the topic. Here they are ... and why I think they matter:

With 1) the potential for Chinese inflation to increase in an environment of perpetual global monetary stimulus and renewed capital inflows, plus 2) the potential Cyrpus will spark a downshift in eurozone growth expectations and a crisis in confidence, China's financial system and debt could quickly become an issue that influences financial markets at a very inopportune time.

-JR Crooks

Comment

Is this China’s last ditch effort to avoid the hard landing?

shop“We will improve policies that encourage consumption.”

- Wen Jiabao

Let me ask: what have China’s central planners now admitted is integral in supporting sustainable Chinese economic growth?  

  1. New emphasis on consumption-led growth to rebalance the lopsidedness of investment growth that’s currently compensating for softer export growth

  2. The need to cool speculative bubbles within the economy so as to reduce the inflationary pressures and manage social perceptions

I agree. But easier said than done, of course.  

We talk a lot about why the shift to sufficient levels of consumption will be tough for China to achieve with any efficiency. Basically, the consumer faces pressures from inflation and redirected capital flows, from the central government to local government investment projects, which prop up the current system, despite the need for a shift.  

Amidst the puzzle pieces China is using to put together an economic rebalancing, commentators have sought to expose the main obstacles to achieving that goal. Real estate is certainly among the largest obstacles. It is certainly worth watching.  

While we don’t get as much bubble talk as we once did, China’s housing situation is still fragile ... and it is still an important piece in China’s economy.  

It is among the reasons we see comments from the Chinese Premier today regarding a revised growth target lower than the all-important 8% level, a need to stem rising home prices, a commitment to making credit accessible, and:  

He also said the government would defuse rising local government debt, regarded by many investors as the key risk to fiscal sustainability. Government figures show about 10.7 trillion yuan ($1.7 trillion) was owed by local governments at the end of 2010.  

That was from Reuters. So is this:  

China's big four state-backed banks will lend more to qualified property developers to boost entry level housing supply, a statement in the central bank's newspaper on Friday said, a signal that they are ready to ratchet up real estate lending.

...    

According to the statement published on the front page of Financial News, a paper run by the People's Bank of China, the big four banks "will proactively support qualified property developers to develop common commercial housing that is in demand to boost effective supply of common commercial housing."  

There are a lot of conflicting winds blowing through the Chinese economy. Some measures may achieve their intended goal; but much of the policy jawboning amounts to setting perceptions, conveying to the public just what Chinese officials want its people, and investors, to expect.  

When it comes to China’s revised GDP target, it’s anticipated that they are just setting the bar low so they look better once they clear it. Until now 8% marked the floor at which China believed it could achieve growth necessary to keep social concern from boiling over.  

Apparently lowering the growth target offers policymakers room to reform the system and encourage businesses all at the same time. Reuters:  

Lower growth will allow Beijing to reform key price controls without causing an inflation spike, so monetary policy can stay broadly expansionary to ensure a steady flow of credit to the small and medium-sized firms the government wants to encourage.  

In a nutshell, that’s the familiar stop-and-go policymaking Chinese officials have become known for over the last 4 years.  

China has succeeded in recent months to bring inflation down. And CPI out later this week will probably reveal prices are stable around 4%. This opens the window for China to take supportive action aimed at growth numbers, and they know it.  

But one has to wonder if this is China last chance to dance. Besides the internal risks to growth, China continues to tug with a Europe that’s heading into recession and a US that’s fighting to stay above water. If they are able to stabilize investor expectations, their efforts could be supportive for markets through to the end of Q2 or into Q3 assuming there is not some inescapable external shock.  

The Shanghai Composite Index began reflecting the Chinese growth downturn back in the second quarter of 2011; it has since rallied back in 2012. But will we see Chinese stocks foreshadow a renewed downturn in the Chinese economy that is deep enough to disappoint?        

030512 ssec

We might get some near-term selling that is technical in nature. But as I said, China is working overtime to keep things going. That may mean it is still a couple more months before we see real fallout in Chinese stocks and global risk appetite.  

For good measures, here is the Shanghai Composite and the S&P 500:  

030512 ssec spx

Seems like some sort of correction is due.

Comment

7 reasons why the Chinese yuan can't save us now.

describe the image“Be extremely subtle, even to the point of formlessness. Be extremely mysterious, even to the point of soundlessness. Thereby you can be the director of the opponent's fate.”

-Sun Tzu


A theme being discussed more and more is the idea China is going to save us from the monetary mess in which we are now firmly ensconced.  But based on my understanding, it will likely be several decades, if ever, before the Chinese currency seriously challenges the US dollar for global reserve currency status.  

USD- Chinese yuan (CNY) Monthly:    

021712 cny

However, it is not to say there won’t be a different global monetary solution in the years ahead.  It will depend on whether or not there is a repudiation of US debt.  If so, I think some new order will take place, along the lines of what Keynes’ talked about -- the Bancor.  He knew early on the dangers attached to a dominant world reserve currency.  [Mr. Triffin, aka ofTriffin’s dilemma fame, warned the US would be facing structural current account deficits as far as the eye could see in its role of world currency reserve supplier.]  Thus, these two were very aware of the danger of global imbalances before it became popular in this cycle. The Great Depression was a valuable teacher for them.  

Of course history tells us global monetary systems are more haphazardly morphing events than they are planned occurrences.  All we have to do is watch the G-20 to see how difficult serious, multi-global planning can be; heck, those guys can hardly decide on what wine to serve and the order of photo ops.   

The handoff from pound Sterling to the US dollar was an unplanned evolving event that accelerated after WWI.  There was no great planning when President Richard Nixon took us off the gold standard and ushered in the error of floating rate currencies.  The gold was draining out of Fort Knox, something had to be done.  Game over.  Dirty float for a couple of years, then no pretense whatsoever of anything backing the currencies of the world’s major powers.  Just faith!  No pretense was justifiable; from that point onward money was a store of value.  Purely a unit of exchange it became.  Case closed.  

So, it leaves us where we are, as I shared with you yesterday, thanks to the excellent insight from Professor Barry Eichengreen.  Now I think it is time to explode the myth China’s currency will replace the dollar.  Many newsletter writers think that will happen tomorrow.  Proving once again newsletter writers never have to answer for their inflated farcicality. But even some serious people believe within the next decade China’s currency will rule.  I think even some serious people are wrong.  

Rather than turn this into a LONG essay, I will try to breakdown the reasons why I think the Chinese yuan is a very long way from world reserve currency status:

  1. It is never as simple as “the world reserve currency goes to the country with the largest global GDP.”  The US surpassed the UK in terms of total GDP back in the 1870s.  Yet pound Sterling remained the reserve currency for another 40 years or so. 

  2. Remember, the world reserve currency country is saddled with a consistent current account deficit. Thus, China must push out trillions of renminbi and renminbi-based asssets into the world economy.  Fine if your model is open and based on consumption.  Not so good if it is driven primarily by exports, as China’s is.  So we will need to see a big shift in China’s growth model.  That will be a wrenching long-term process.

  3. The reserve currency country must open its market to allow foreign investors to hold local assets.  This means China will have to make a complete change to its current political structure to allow much more freedoms for citizens (not only allow money to flow in, but allow its citizens money to flow out freely).  The system in place is not something that is likely to change anytime soon despite the window dressing.  The communist party still maintains absolute power, despite the comments from visitors that all they saw was free market capitalism during their trip to the Orwellian Hall of Mirrors.  It shows just how well the central committee is doing its job.  If you want a better insight into this issue, I strongly suggest you read, The Party: The Secret World of China’s Communist Rulers, by Richard McGregor.  I think this does a great job of showing us how the West in general is duped by the Chinese leadership.

  4. The US is becoming wealthier relative to China.  Say what?  All true.  The fact is since 1991, “the average Chinese citizen is more than $17,000 poorer relative to the average American than he was in 1991.” Per capita income for relatively large states is the best single determinant of competitiveness long term. So, until this trend changes, it is highly unlikely the US will give up the mantle of currency reserve status.  [See “China’s Century?” by Michael Beckley, International Security, Vol. 36, No. 3 (Winter 2011/12), pp. 41-78.   

  5. Even optimistic assumptions from those who should know, assuming China’s growth remains on track, suggest by 2035 up to 12% of global reserves may be held in yuan. [See Jong-Wah Lee, Asian Development Bank, “Will the Renminbi Emerge as an International Reserve Currency?”]

  6. Officially, all is good.  But unofficially, China may be facing its own debt bomb that could dampen growth for years, not just one or two quarters.  It happened to Japan.  Never say never! “The government’s official debt is only 15 percent of GDP, but it adds up quickly. Ratings agency Fitch estimates a bailout could cost 20 percent of GDP. Add the unpaid cost of the last bailout, debts at state-owned entities, local governments and pension liabilities, and a Breakingviews calculation suggests Beijing’s debt rises to roughly 130 percent of GDP,” according to Reuters Breakingview. 

  7. The current attempts at internationalization of the yuan seem backwards.  Normally a country opens its capital account and upgrades its domestic financial system before attempting to internationalize its currency.  Instead China is offering bi-lateral exchange deals with some trade partners, and that gets a lot of press.  But that seems to be mere window dressing as countries are really taking up the credit China is offering.  And the developing offshore yuan deposits in Hong Kong may actually backfire, as the unofficial yuan rate in Hong Kong (CNH) is fluctuatiing around the official rate in China (CNY).  This may force China’s central bank to actually hold more dollars. 

So as much as it might be a good thing for the global economy to have a new reserve currency on the scene, it doesn’t seem as if it will happen soon enough to help in this cycle. 

Comment