{"id":15217,"date":"2017-05-05T04:49:19","date_gmt":"2017-05-05T08:49:19","guid":{"rendered":"http:\/\/goldstocksforex.com\/?p=15217"},"modified":"2017-05-05T04:49:19","modified_gmt":"2017-05-05T08:49:19","slug":"is-the-great-china-crash-upon-us-macrobusiness","status":"publish","type":"post","link":"https:\/\/thepatientinvestor.com\/index.php\/2017\/05\/05\/is-the-great-china-crash-upon-us-macrobusiness\/","title":{"rendered":"Is the great China crash upon us? | Macrobusiness"},"content":{"rendered":"

By Houses and Holes<\/a>
\nReproduced with kind permission from Macrobusiness<\/a>.<\/p>\n

From Axiom Capital<\/a>:<\/p>\n

While we, as well as the few bearish peers we have, have warned of a pending \u201ccredit event\u201d in China for some time now \u2013 admittedly incorrectly (China has proved much more resilient than expected) \u2013 the more recent red flags are among the most profound we\u2019ve seen in years \u2013 in short, we agree with fresh observations made by some of the world\u2019s most famous iron ore bears. Thus, while it is nearly impossible to pinpoint exactly when the credit bubble will definitively pop in China, a number of recent events, in our view, suggest the threat level is currently at red\/severe.<\/p>\n

WHERE IS CHINA AT TODAY VS. WHERE THE US WAS AT AHEAD OF THE SUBPRIME CRISIS? <\/strong>At the peak of the US subprime bubble (before the failure of Bear Stearns in Mar. \u201808, and subsequently Lehman Brothers in Sep. \u201908, troubles in the US credit system emerged as early as Feb. \u201907), the asset\/liability mismatch was 2% when compared to the total banking system. However, in China, currently, there is a massive duration mismatch in wealth management products (\u201cWMPs\u201d). And, at $4tn in total WMPs outstanding, the asset\/liability mismatch in China is now above 10% \u2013 China\u2019s entire banking system is ~$34tn, which is a scary scenario. In our view, this is a very important dynamic to track given it foretells where a country is at in the credit cycle.<\/p>\n

WHAT ARE THE SIGNS WE ARE SEEING? <\/strong>In short, we see a number of signs that point to what could be the beginning of the \u201cpopping\u201d of the credit bubble in China. More specifically: (1) interbank rates in China are spiking, meaning banks, increasingly, don\u2019t trust each other \u2013 this is how any banking crisis begins (Exhibit 1), (2) China\u2019s Minsheng Bank recently issued a ghost\/fraudulent WMP (they raised $436mn in funds for a CDO-like asset that had no assets backing it [yes, you heard that right] \u2013 link<\/a>), (2) Anbang, the Chinese conglomerate who has used WMP issuance as a means to buy a number of assets globally (including the Waldorf Astoria here in the US),\u00a0 is now having issues gaining approval for incremental asset purchases (link<\/a>), suggesting global investors may be getting weary of the way in which Anbang has \u201cbeefed up\u201d its balance sheet, (3) China\u2019s top insurance regulator, Xiang Junbo, chairman of the China Insurance Regulatory Commission, is currently under investigation for \u201csevere\u201d disciplinary violations (link<\/a>), implying some\/many of the \u201cshadow\u201d forms of transacting in China could become a bit harder to maneuver (which would manifest itself in higher rates, which his exactly what we are seeing today), and (4) as would be expected from all of this, as was revealed overnight in China, bank WMP issuance crashed 15% m\/m in April to 10,038 from 11,823 in March, a strong indicator that faith in these products is indeed waning.<\/p>\n

Exhibit 1: Interbank Rates in China<\/em><\/p>\n

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Source: Bloomberg.<\/p>\n

DOES CHINESE PRESIDENT XI JINPING HAVE ALL OF THIS UNDER CONTROL? <\/strong>In a word, increasingly, it seems the answer is no. What\u2019s the evidence? Well, in March, interbank rates spiked WAY past the upper corridor of 3.45% to ~11% (Exhibit 2), a strong indicator that the PBoC is losing its ability to \u201cmaintain order\u201d. And, admittedly, while there are levers the PBoC can pull, FX reserves are at scary low levels (discussed below), suggesting the PBoC is quickly running out of bullets. Furthermore, corporate bond issuance in China was negative in C1Q, which means M2 is going to be VERY hard to grow (when MO is negative); at risk of stating the obvious, without M2 growth in China, economic growth (i.e., GDP) will undoubtedly slow \u2013 this is not the current Consensus among market prognosticators who think things are quite rosy right now in China; yet, while global stock markets are soaring, the ChiNext Composite index is down -7.5% YTD vs. the Nasdaq Composite Index being up +12.8% YTD. <\/em>In our view, given China\u2019s importance to the global commodity backdrop, we see this as a key leading indicator (the folks on the ground in China are betting with their wallets, while global investors continue to place their hopes on: [a.] a reflationary tailwind that we do not believe is ever coming [China is now destocking], and [b.] hope that President Trump will deliver everything he\u2019s promised [which, in this political environment, we see is virtually impossible]).<\/p>\n

Exhibit 2: Overnight Reverse Repo Rate<\/em><\/p>\n

<\/a><\/figure>\n

Source: Bloomberg.<\/p>\n

CHINA\u2019S FOREIGN EXCHANGE (\u201cFX\u201d) RESERVES ARE DANGEROUSLY CLOSE TO LOW LEVELS THAT WILL LIKELY CAUSE AN INFLECTION LOWER IN THE CURRENCY<\/strong>. Based on a fine-tuning of its formula to calculate \u201creserve-adequacy\u201d over the years, the International Monetary Funds\u2019 (\u201cIMF\u201d) approach can be best summed up as follows: Minimum FX Reserves = 10% of Exports + 30% of Short-term FX Debt + 10% of M2 + 15% of Other Liabilities<\/em>. Thus, for China, the equation is as follows: 10% * $2.2tn + 30% * $680bn + 10% * (RMB 139.3tn \u00f7 6.6) + 15% * $1.0tn = $2.7tn of required minimum reserves. Furthermore, when considering China\u2019s FX reserve balance was roughly $4tn just 2 years ago, we find it concerning that experts now peg China\u2019s unofficial FX reserve balance somewhere in the $1.6-$1.7tn range. Why does this differ from China\u2019s $3.0tn in reported FX reserves as of Feb. 2017? Well, according to our contacts, when adjusting for China\u2019s investment in its own sovereign wealth fund (i.e., the CIC) of roughly $600bn, as well as bank injections from: (a) China Development Bank (\u201cCDB\u201d) of roughly $975bn, (b) The Export-Import Bank of China (\u201cEXIM\u201d) of roughly $30bn, (c) the Agricultural Development Bank of China (\u201cADBC\u201d) of roughly $10bn, as well as capital commitments from, (d) the BRICs Bank of roughly $50bn, (e) the Asian Infrastructure Investment Bank (\u201cAIIB\u201d) of $50bn, (f) open short RMB forwards by agent banks of $300bn, (g) the China Africa Fund of roughly $50bn, and (h) Oil-Currency Swaps with Russia of roughly $50bn, the actual FX reserve balance in China is closer to $1.69tn (Exhibit 3).<\/p>\n

Stated differently, based on the IMFs formula, sharply contrasting the Consensus view that China has years of reserves to burn through, China is already below the critical level of minimum reserve adequacy. <\/strong>However, using expert estimates that $1.0tn-$1.5tn in reserves is the \u201ccritical level\u201d, and also considering that China is burning $25bn-$75bn in reserves each month, the point at which the country will no longer be able to support the renminbi via FX reserves appears to be a 2017 event. At that point, there would be considerable devaluation in China\u2019s currency, sending a deflationary shock through the world\u2019s commodity markets; in short, we feel this would be bad for the steel\/iron ore stocks we cover, yet is being completely un-discounted in stocks today (no one ever expects this event to occur).<\/p>\n

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The early 2007 analogy is a good one. This is coming at some point in the next few years. I remain on guard but skeptical at this point given China does have other levers it can pull to keep the credit running and is indeed pulling them in fiscal policy. As well, the problem can always be made worse before it\u2019s made better. Authorities are, after all, bringing this on.<\/p>\n

It\u2019s a fascinating question. Could China endure a \u201csudden stop\u201d in credit if counter-party risk exploded, much like happened to Wall St in 2008? The usual analysis reckons that China\u2019s publicly owned banks can always be ordered to lend more but what if they lose faith in each other? It\u2019s probably true that Chinese authorities could still force feed credit into the economy but, equally, it\u2019s difficult to see how an interbank crash in confidence would not slow the injection, at minimum via choked off-balance sheet vehicles like WMPs.<\/p>\n

There is no doubt, at least, about what happens when it does arrive:<\/p>\n