Reliance on China for export a good idea. Probably not…
How do we know what’s really going on in China’s economy? Given that it’s – at least officially – under central control, that’s not easy. The Chinese leaders know their way around spin and propaganda; one might argue that their lives depend on it. Still, maybe following and connecting the dots as they appear in the news can be helpful. So I thought I’d squirrel together a few data and talking points from the past week, and see what comes out.
Of course the biggest news came 3 weeks ago, when the Custom Administration announced that Chinese exports in February dropped 18.1% from a year earlier. No matter what anybody may claim about Lunar New year, that’s a devastating number. It shows that China is simply losing its buyers. And for an economy that is singlemindedly focused on exports, that is earth shattering. But from inside the nation as well, there are increasing reports that things are not running smoothly.
The manufacturing index seems well embedded below the 50 break even point.
China Manufacturing Gauge Falls as Slowdown Deepens (Bloomberg)
China’s manufacturing industry weakened for a fifth straight month, according to a preliminary measure for March released today, deepening concern the nation will miss its 7.5% growth target this year. The Purchasing Managers’ Index from HSBC and Markit dropped to 48.1, compared with a 48.7 median estimate [..]
Real estate prices are starting to fall. Not everywhere, nor everywhere at the same pace, but for the many dozens of millions who’ve put their money in apartments, this is a grave worry.
Angry Chinese Homeowners Vent Frustrations After Price Cuts
Groups of angry homeowners put up banners and demanded their money back after Hong Kong-listed property developer Wharf Ltd. cut prices on new homes in an eastern Chinese city [..] They said they wanted their money back after prices at the project, called Phoenix Lake Garden, were cut by as much as 16% [..]
Debt levels among local governments are probably one of the murkiest issues in the country. It hardly matters at all what the state auditor says, because government-related debt is just the tip of the iceberg. In China, when you say local government, you say shadow banking. Local officials kept themselves sitting pretty through shadow borrowing. Where the money came from, how leveraged it is, who knows? WHat we do know for sure is that it’s much more expensive than ”official” loans.
China’s Local Government Debt Burden Varies Widely: Moody’s (CNBC)
China’s state auditor said in a report in December that local governments owe almost $3 trillion in outstanding debt as of the end of June last year, up 67% from the last audit in 2011. [..] Among the top 31 upper-tier local governments reporting government-related debt on their websites, indebtedness ranged from 69% to 156% of revenues, with the median at 108%, Moody’s said.
There are new forms of lending popping up, if only because the demand is so great due to debt needing to be rolled over and serviced, lest the scores of little emperors find themselves exposed.
China Banks Drained by Internet Funds Called Vampires (Bloomberg)
It has been labeled a “blood-sucking vampire” by a prominent commentator on state-run television. Executives at China’s largest banks have called for regulators to curb its rapid expansion. [..] The focus of this ire is Internet financing, specifically Yu’E Bao, the fund pioneered nine months ago by Alibaba Group Holding Ltd.’s online-payment affiliate Alipay. Its ease of use, involving a few taps on a smartphone, has drawn deposits from 81 million customers, more than the population of Germany, as they chase returns higher than China’s banks can offer. The total exceeded 500 billion yuan ($80 billion) as of Feb. 28 [..]
Despite surging pollution levels, China actively keeps drawing up plans to get more people into cities. It has understood that this is closely linked to growth numbers. We may find that short-sighted, and it is, but take a step back and imagine what US-style urban sprawl would look like on the scale of China.
China’s Urbanization Loses Momentum as Growth Slows (Bloomberg)
The pace of migration of rural Chinese to cities, a dynamic hailed by Premier Li Keqiang as key to the nation’s development, is set to slow by a third in coming years [..] Today’s report from the World Bank and the State Council’s Development Research Center, which helped inform the government’s plan, recommends changes including on land use to spur more-efficient and denser cities. That can save China $1.4 trillion from a projected $5.3 trillion in infrastructure spending over the next 15 years [..]
Bank runs look inevitable in China. At the first sign that Beijing loses only a little bit of control, people will demand cash to put into their mattresses. Cash that, just like in western nations, is of course not there if everyone wants it at the same time. The government’s biggest nightmare? There are many, but it might well be.
Hundreds Rush To Rural Chinese Banks After Solvency Rumours (Reuters)
Hundreds of people rushed on Tuesday to withdraw money from branches of two small Chinese banks after rumours spread about solvency at one of them, reflecting growing anxiety among investors as regulators signal greater tolerance for credit defaults. The case highlights the urgency of plans to put in place a deposit insurance system to protect investors against bank insolvency, as Chinese grow increasingly nervous about the impact of slowing economic growth on financial institutions.
Or could this be the biggest nightmare? China allegedly has 90,000 property developers in a system that even if it runs well only has space for maybe 30,000. How do you bring down numbers like that in an orderly fashion? I’m very glad that’s not my job. How many of those developers will go down with badly built properties, huge levels of bad debt and scores of very angry “investors”?
High Debt, Slow Sales Loom Over Chinese Property Firms (SCMP)
All eyes are now on a few Chinese real estate developers particularly vulnerable to slow sales and tight credit, as mainland China’s property market enters a new downturn. [..] At the end of June, Glorious Property (36%) and Hopson (42.8%) had the lowest ratio of cash versus short-term debt among all mainland Chinese developers rated by Moody’s.
China’s stimulus far outnumbers anything the US has done. And that’s when you get these insane debt levels. Which may be sort of bearable, temporarily, when exports keep growing at double digit rates. Not when they’re down 18%. Note also that China now needs $7-8 of new debt to generate $1 of economic growth, approaching levels that are set to doom western economies.
China Finds The Credit Habit Hard To Kick (Satyajit Das)
Chinese government debt, including local government debt, is about 55% of GDP –about $5 trillion (£3 trillion) – an increase of about 60% from 2010.
But the official Chinese government debt figure may not be complete, as it may exclude debts from local governments and central departments outside the finance ministry. If these items are included, China’s government debt including contingent liabilities would be higher, perhaps 90% of GDP. There has been a parallel increase in private sector debt. Corporate debt has increased sharply, approaching 150% of GDP. Traditionally considered compulsive savers, Chinese households have increased borrowing levels from about 20-30% to 40-50% of GDP. [..]
Another measure is the credit gap – the difference between increases in private sector credit growth and economic output. Research studies have found that 33 countries with credit gaps experienced a subsequent rapid slowdown in growth, typically by at least 50%. In China, the credit gap since 2008 is over 70% of GDP. Chinese credit intensity (the amount of debt needed to create additional economic activity) has increased. China now needs about $3-$5 to generate $1 of additional economic growth, although some economists put it even higher, at $6-$8. This is an increase from the $1-$2 needed for each dollar of growth 8 to 10 years ago.
I personally find this one especially worrisome, because it raises the question: where do Chinese industry and Chinese local government get their credit? And under what terms? As a local official, if you need those $7-8 of new debt to generate $1 of growth, you’re probably going to take it, as long as interest rates allow for it. But what are you getting your community into for the future?
Who are China’s lenders? How solid are they? How leveraged? What’s the level of bad loans they already have on their books? And who are the borrowers? Does either side do proper research on the other?
In the end, just about everything is state owned, all factories, enterprises etc. And as we know from history (Soviet Union), parties involved figure out very quickly that state enterprises don’t need to make a killing; the profit would only go to the state anyway. So buyers, suppliers, middle men and local officials start skimming off profits.
A company will buy an X amount of steel or copper with credit from lender Y. It will then turn to lender Z and use the steel as collateral to get credit for the purchase of an even larger amount of copper or steel. And down the line, who is worth what anymore? The individuals involved have all loaded up their pockets, preferably with dollars, but what’s going to happen to the company that’s left with all that steel? I would expect imports to start falling quite dramatically.
Hong Kong’s Soaring Bank Exposure to China Sparks Credit Concerns (Reuters)
In just a few years, Hong Kong banks have ramped up lending to China from near zero to $430 billion [..] Foreign bank claims on China hit $1 trillion last year, up from nearly zero 10 years ago, Bank of International Settlements data shows. The biggest portion of that is provided by Hong Kong, according to analyst estimates of the BIS data. The $430 billion in loans outstanding represents 165% of Hong Kong’s GDP [..] By the end of 2013, Hong Kong banks’ net claims on China as a percentage of their total loan book was nearing 40%, compared with zero in 2010.
If Beijing no longer offers implicit guarantees of loans state banks have put on their books, these banks are going to be a whole lot worse off than merely “spooked”. And the economy will become even more dependent on financing from the deep dark shadows. Beijing has put so much money into the economy that doubling up on that is hardly an option anymore. What seems left for Xi and Li now is to try and manage the path down. Whether that’s even an option is a great unknown and anyone’s guess.
Spooked By Defaults, China Banks Begin Retreat From Risk (Reuters)
Some of China’s struggling firms are finally getting the reception that regulators have been hoping for — a cold shoulder from banks in the form of smaller and costlier loans. [..]There are signs that even state-owned firms, in the past fawned over by lenders for their government connections, have to contend with higher rates, lower lending limits and more onerous checks by banks. “Interest rates are going up 10% for the entire industry …” [..]
Some gauges of China’s corporate debt are already flashing red. Non-financial firms’ debt jumped to 134% of China’s GDP in 2012 from 103% in 2007, according to Standard & Poor’s. It predicted China’s corporate debt will reach “stratospheric levels” and become the world’s largest, overtaking the United States this year or next.
Don’t be surprised if heavy industry in China gets a series of very hard blows. The levels of leveraged finance will be crucial, and it’s not easy to be confident in that respect.
Default Risks Surge At China Steel Mills (FT)
Chinese steel mills were suffering a medley of woes in mid-March as sales slowed, production levels slumped and profits plunged, according to an investment bank survey published on Tuesday that foreshadows the rising risk of debt defaults in the world’s largest steel producer.
Macquarie Commodities Research, quoting a proprietary survey of Chinese steel mills and traders conducted in mid-March, found that large, medium and small steel mills were all enduring a contraction in orders compared to the same period in February, and profits had declined to historic lows. “Looking at profitability, it is clear why the smaller mills are making the largest cuts (in production) – for the first time in the history of the steel survey not one smaller mill reported that they are making money …
Oh yeah, why not give the developers, of which there are far too many to begin with, the option to sell mortgage-backed securities and things like that, offering people more great returns on their investments that way. Worked great in the US!
Chinese Developers Seek Alternative Financing As Investors Grow Wary (Reuters)
China’s property developers are turning to commercial mortgage-backed securities and looking at other alternative financing as creditors grow more discriminating in the face of rising concerns about the country’s real estate and debt markets. Bond buyers are shying away from second-tier developers because property sales have cooled as the economy slows. The expected bankruptcy of a local developer and the country’s first domestic bond default this month have heightened scrutiny of borrowers. [..]
Chinese regulators last week allowed developers Tianjin Tianbao Infrastructure Co. and Join.In Holding Co. to offer a private placement of shares, opening up a fund raising avenue that had been closed for nearly four years. New rules were also unveiled last week allowing certain companies to issue preferred shares [..]
Big one. Importers backing out of deals. A system built on quicksand falls back to earth. They have to pay back the loans they bought the soy and rubber with, and are squeezed between those payments and less demand for their products. China’s like an oceanliner at full steam ahead that needs to step on the brakes. Too much inertia.
China Soybean, Rubber Importers Renege on Deals (WSJ)
Chinese importers of soybeans and rubber are backing out of deals, adding to a wide range of evidence showing rising financial stress in the world’s second-biggest economy. Most purchases are private, with little data on the volumes affected, but traders at Asian trading firms say they are seeing a sharp rise in canceled contracts this year while other buyers are demanding heavy discounts. The U.S. Department of Agriculture confirmed that China has canceled orders for 517,000 metric tons of soybeans … [..]
The cancellations are a big worry for the commodity markets as exporters around the world had relied for years on China’s insatiable appetite for a wide range of raw ingredients. But now as jitters rise over the health of the economy, the fallout is rippling through into agricultural commodities, just weeks after the price of copper and iron ore tumbled on worries they had been used in risky Chinese financing deals. [..]
Rubber prices have dropped more than 20% since the beginning of the year, due to worries over China’s slowing economy and a global surplus of the commodity. Many sellers who bought at high prices are unwilling to sell at a loss, pushing up stocks at the port of Qingdao to near-record levels recently. Stockpiles in some other commodities like soybeans and iron ore are also high as buyers hang on.
More developers, more trouble. Pray tell, what’s the difference with the US, Ireland or Spain in 2006? Well, true, Chinese debt may well be even more leveraged.
China’s Developers Face Shakeout as Easy Money Ends (Bloomberg)
The collapse of a Chinese developer in a city south of Shanghai foreshadows a shakeout among the nation’s almost 90,000 real estate companies as the government reins in credit and the housing market slows. [..] Zhejiang Xingrun’s demise comes after a policy shift by Premier Li Keqiang to tighten credit. The effort to contain surging home prices comes after they climbed 60% since the government’s 4 trillion yuan of fiscal stimulus in 2008 to bolster the economy after the global financial crisis. Officials have stepped on the brakes even as economic growth was already estimated to grow 7.4% this year, the slowest pace since 1990 [..] China’s seven-day repurchase rate, which measures interbank funding availability, hit a record high of 10.8% on June 20
Bad banks are rarely a good idea. China is no exception. Wait till the state banks begin to wobble, that should be fun.
China’s Rapidly Expanding Black Box (WSJ)
China’s “bad bank” experiment is entering unchartered territory. China Cinda Asset Management, created as a bailout vehicle for China’s bad debts, is scooping up distressed loans at blistering pace. Assets rose by 51% last year to 384 billion yuan ($62 billion), much faster than earlier management guidance of 20% to 30% [..]
A loan bought for 30% to 40% of face value, as seems the company’s historical precedent, should provide enough cushion. But investors know little about the assets. Debt backed by a closed coal mine or property in a ghost city might be worth even less. Cinda, like much of China’s financial system, is still in many ways a black box. In the meantime, Cinda’s financial performance is weakening. Return on assets fell to 2.9% in 2013 from 3.4%, the third straight year of decline. And despite the rise in leverage, return on shareholder equity fell, to 13.8% from 15.8%.
So, anybody feel good about China after all that?
China. A behemoth government stimulus since 2008, a shadow banking system that has grown exponentially and is as opaque as can be, and a level of corruption most South American countries cannot touch. What’s not to like? And then it all comes back to earth. The transition from central control to free(r) market is never going to be easy, trying to juggle both at the same time is another thing still. And yes, China’s easily big enough to drag us all down with it.
I don’t know about you, but I don’t see this end well. The sunny side, though, is that we’ll need to start making a lot of our own stuff again. Sunny because, you know, we’ll create jobs. And can we please not do all the useless plastic trinkets, have a little more taste when we rebuild our manufacturing?