Humpty Dumpty Sitting on China's Great Wall?

Humpty Dumpty, which we all now know as an egg, was a poem originally written as a riddle in 1810 for which “an egg” was the answer. Egg shells crack when you drop them from a wall or even a few inches off a table and the size of the mess is fully dependent on whether or not the egg itself has been cooked and if so, to what degree.

All this talk of eggs and walls and cracks does have a purpose as there could be evidence mounting that the nation we think of when we here the term “Great Wall” as opposed to HD’s “great fall” might be developing some cracks of its own in its efforts to stimulate its economy.

The controlled capitalism that China practices made it easier for the powers that be to insure that government stimulus programs were carried out as designed and have been a major factor in the GDP growth experienced in the “Middle Kingdom” while that same statistic was shrinking in just about every other economy across the globe.

At a time when loan volume is up about around 30% in China, it appears bank earnings are down and because the new loans have been made as corporate profits were falling, the riskiness of those loans is something people are taking notice of. “Everyone agrees that China’s stimulus lending is damaging future bank balance sheets,” says Daniel Rosen, a partner at Rhodium Group and a visiting fellow at the Peterson Institute for International Economics said.

It has been a trying time for the world as a whole and the deficits being piled up have caused consternation here in the U.S. as well as a downgrade of Ireland by S&P and the placement of Britain on negative credit watch. Mr. Rosen understands the need to act but cautions that “pillaging bank balance sheets is not a strategy for recovery”. Isn’t that a lesson we have all learned by now!

Wang Zhenning, spokesperson for the Industrial & Commercial Bank of China Ltd. counters Daniel’s warnings by saying, “We have never loosened our risk control assessment, not even for government-stimulus projects and infrastructure lending”.

Given that the government in China has, now, has only slightly more say as to whether Wang gets to keep his job than the CEO of GM in this country, it would be hard to imagine a different response.

Problems are also starting to appear at the sovereign level as China’s plans to hold its budget deficit to 3% of GDP are being scrutinized. The questions arise because it is not certain that all of the debt being issued within the country’s borders is being properly recorded.

The push to get China’s economy moving has left local authorities with a requirement to get projects under way but has not provided the funding for those projects, resulting in exponential growth of local government liabilities. Stephen Green, an economist with Standard & Chartered in Shanghai puts a spin on the adage about a “free lunch” when he stated, “There is no such thing as a free stimulus package”. He goes on to say he believes, “There is a huge amount of unreported government debt, and we’re adding to it now clearly.”

Ma Guoxian, a specialist on public finance at the Shanghai University of Finance and Economics, concurs saying, “Giving local governments some freedom to stimulate the economy is necessary, but the problem is that we don’t know what they’re doing. This could become a big fiscal burden in the future”.

At the sovereign level benchmark default protection for China peaked at 220bps on March 2nd and moved down to 70bps 3 months later, almost to the day. As of last night close that number was 77bps.

There are no CDS quoted on the local government debt that appears to be the crux of the issue here but with the country’s CDS trading near its lows the market appears to be ignoring the cracks at the moment.

Hopefully “All the King’s horses and all the King’s men” won’t be needed to put China back together again once the crisis has passed.

Enjoy the week.

Comments

[User 353732:]

The pathological misallocation of resources by Govt. fiat and the force feeding of politically favored industries, companies and clients is now a disease that has reached pandemic proportions, globally.
Cheap captive labor, incentives for foreign capital, the slow but steady diffusion of property rights, endorsement of free trade and a focus on making real things have been essential to China's economic growth , falling poverty rates and emergence as a great power.
However, Chinese bosses in their hubris, callous contempt for their very poor, dispossed and unskilled rural population and impatience to displace the US as a hyperpower are starting to make strategic (economic and social )mistakes. The Chinese, too, will learn that global, connected, markets are more potent than isolated national governments. Instead of learning from the banking/credit mistakes and deceits of the West, the Chinese are begining to emulate them. The credit bubble is now inflating in China.It too will collapse.

Jul 07 07:59 AM

[Dave Wrixon:]

Yes, so as a consequence of a major financial emergency cause by outside forces, China is invoking the kind of deficit budgeting that has been a way of life in the US for a generation. Seems crassly hypocritical that the imploding economy that has cause these short-term pressures now feels that it is has the moral authority to judge those that are responding to the crisis that it has caused. People in the US just don't seem to understand that deficits are not debt, they only become debt when factored by time. The time factor in the US is about two decades. The time factor in the China is about one year and counting. This basic miscomprehension also applies to borrowing and the issuance of Treasuries. If the amount of Treasuries that China subscribes to is constant but the maturity period of the debt is cut from 30 years to say three months, then the total availibity of rolled over credit is effectively being reduced by a 100 fold, even if the amount outstanding has yet to reduced. The US is getting much much closer to default than it has previously admitted because the rate at which it must repayments is rapidly accelerating. But if you feel this the appropriate time to chastise those that remain your main source of credit don't let me stop you, provided you are happy to look much more rediculous than a painted egg. You lot may twitter on about second derivatives, but frankly most of you cannot even cope with the Maths involved in the first derivative.

Jul 07 08:15 AM

[Graham and ...:]

China's "stimulus" program is hurting their banks. The same here.

Jul 07 08:53 AM

[Moon Kil Woong:]

China has very poor market indicators in which to direct an efficient flow of capital. The result is often inefficiency bordering on corruption. The need for a free market there is as crucial today as it has been for the last 12 years. The longer they hold it off the riskier their position gets when a significant downturn materializes. If it gets too big social unrest will undoubtedly result since a socialist ideal can hardly justify less than 1% of the population hoarding over 75% of the nations wealth. Ironically, a vast majority of those people are communist party members.

Jul 07 01:35 PM

[jits:]

the cracks i hear about is that the money lent out during the stimulus package is going into speculative activity in the stock market. also a very large real estate bubble is occuring in china, with a non existent secondary market. Does anyone have anymore information on this?

Jul 07 08:46 PM

[Ben Gee:]

Chinese banks are backed by the Chinese government and the Chinese money printing press. They can write off unlimited amount of bad loans. However, the stock market can go bust but so what? Can the property market go bust? Not likely because again the government can regulate the money supply. If there is a sign of overheating, the banks can stop making real estate loans at will.

Jul 08 05:01 AM