Seeking Alpha
Research analyst, dividend investing, ETF investing, long/short equity
Profile| Send Message|
( followers)  

Something Might Be Going Wrong Over There

Now it's official – even the credit rating agencies are noticing the huge credit bubble in China, which has in recent years been mainly driven by the 'shadow banking' market. Keep in mind though, the shadow banking market is still financed by the banks – it is a method by which they are escaping official credit restrictions.

Albert Edwards and his colleagues at CLSA have recently darkly muttered about an "approaching Minsky moment" for China, as the recent surge in credit seems not to have fueled much growth – on the contrary, growth seems to be weakening seemingly in spite of vast credit growth.

Of course it is not really "in spite," but "because of" – the only difference to earlier phases is that this time, it is noticed right away. Instead of producing another boom-bust phase, the credit expansion now apparently produces bust exclusively – which is a strong sign that the pool of real funding in China is in trouble.

Lately there have also been stresses in the interbank market, which haven't really gone away just yet (at least we now know that there has indeed been a bank that was unable to repay its obligations, see further below).

(click to enlarge)

The 5-day moving average of overnight SHIBOR as of Friday

(click to enlarge)

The Telegraph writes regarding Fitch's assessment:

China's shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned.

The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.

"The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation," said Charlene Chu, the agency's senior director in Beijing. "There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signaling," she told The Daily Telegraph.

While the non-performing loan rate of the banks may look benign at just 1pc, this has become irrelevant as trusts, wealth-management funds, offshore vehicles and other forms of irregular lending make up over half of all new credit. "It means nothing if you can off-load any bad asset you want. A lot of the banking exposure to property is not booked as property," she said.

Concerns are rising after a string of upsets in Quingdao, Ordos, Jilin and elsewhere, in so-called trust products, a $1.4 trillion (£0.9 trillion) segment of the shadow banking system.

Bank Everbright defaulted on an interbank loan 10 days ago amid wild spikes in short-term "Shibor" borrowing rates, a sign that liquidity has suddenly dried up. "Typically stress starts in the periphery and moves to the core, and that is what we are already seeing with defaults in trust products," she said.

Fitch warned that wealth products worth $2 trillion of lending are in reality a "hidden second balance sheet" for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.

This niche is the epicentre of risk. Half the loans must be rolled over every three months, and another 25pc in less than six months. This has echoes of Northern Rock, Lehman Brothers and others that came to grief in the West on short-term liabilities when the wholesale capital markets froze.

Mrs Chu said the banks had been forced to park over $3 trillion in reserves at the central bank, giving them a "massive savings account that can be drawn down" in a crisis, but this may not be enough to avert trouble given the sheer scale of the lending boom. Overall credit has jumped from $9 trillion to $23 trillion since the Lehman crisis. "They have replicated the entire US commercial banking system in five years," she said.

The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990. "This is beyond anything we have ever seen before in a large economy. We don't know how this will play out. The next six months will be crucial," she said.

(Emphasis added)

Frankly, we don't see in what way the next six months can make any difference to the situation. All of this sounds rather like we are now at the point where it's way too late to do anything about it.

China's leaders surely must be worried greatly – a flight forward makes no sense, as that would only worsen the situation and set up an even bigger bust down the road. On the other hand, considering the data related by th Telegraph above, if a bust were to begin now, it would not exactly be great fun either.

What's most baffling is why Fitch only notices this now, instead oft, say, two or three years ago.

Implications for Ancillary Bubble Countries

A lot hinges on what transpires in China. We should point out that China credit bubble watchers have been waiting for a long time for something untoward to happen, and the Chinese leadership has so far always managed to pull yet another rabbit out of its collective hat when things began to look serious. So maybe they will manage to do so again, but we have our doubts, especially as credit growth has evidently become ineffective in goosing the economy. One thing they might try is to eventually join Japan's little currency war and let the yuan come down. That would however not make China any richer, and obviously the policy hitherto was to let the currency slowly appreciate.

Quite a few countries that have experienced their own credit-driven bubbles in the wake of China's boom, such as Australia, Canada or Brazil are in danger of getting into severe trouble as well if China's economy falters. In fact, if China gets into serious trouble over its shadow-banking boom, it's a good bet the effects will be noticed world-wide.

The stock market in Shanghai has meanwhile drifted lower again after the vigorous year-end rally in 2012 and is back in no-man's land:

(click to enlarge)

The Shanghai stock index over the past two years – going nowhere with a downward bias

(click to enlarge)

Conclusion

This time things could finally really get out of hand. This needs to be watched closely (yet another thing that needs to be watched). All over the world, the great central planning experiment based on pure fiat money that has been in train since the 1970s is running into trouble. China has become another gray swan and like Japan, it's a big one.

Charts by: Bigcharts, Bloomberg

Source: Fitch Notices Credit Bubble In China