Report that appeared in the Telegraph on the topic,
William Pesek at Bloomberg has recently also written an article about
Charlene Chu (formerly with Fitch, nowadays with private firm Autonomous
Research) and her opinions on China's shadow banking system and the
dangers it represents. The article is ominously entitled “China, the Death Star of Emerging Markets”.
China
has recently made unwelcome headlines, as one of the shadow banking
system's countless 'wealth management trusts' which was evidently
invested in a bankrupt venture (in this case in a coal company –
reportedly a great many such investments in insolvent coal mines exist)
was about to go belly-up and then was bailed out at the last minute.
Here is a recent article by Mish on the trust that was ironically named “Credit Equals Gold Number 1”.
At first it was reported that the trust wouldn't be bailed out, but in
the end its 700 investors were able to 'breathe a sigh of relief' as Tom Holland remarked in the South China Morning Post (SCMP).
However, Holland also cautioned that by bailing out this trust, China
has laid the foundations for a much bigger crisis down the road, as
moral hazard has increased considerably as a result.
The size of shadow-bank lending relative to China's GDP, via the SCMP
Interestingly, Holland actually disagrees on a major point with Charlene Chu and Pesek. Let us first look at what Pesek writes:
“On any list of banking accidents waiting to happen, China is assured a place at the very top. But could a crash there take the entire global economy down with it? Absolutely, says Charlene Chu, who until recently was Fitch's headline-generating analyst in Beijing. Chu has fearlessly trod into an area that China is trying desperately to keep off limits: its vast shadow-banking system. Now that she's working for a private firm that doesn't have to rely to governments for revenue, as do rating companies, Chu is free to speak completely openly. And is she ever."The banking sector has extended $14 trillion to $15 trillion in the span of five years," Chu, who is now with Autonomous Research, told the Telegraph. "There’s no way that we are not going to have massive problems in China." What's more, she added, China "could trigger global meltdown."The travails of Greece continue to preoccupy the world, but its $249 billion economy is a rounding error compared to China's $8.2 trillion one. In December 2005, for example, China announced its output had unexpectedly grown by $285 billion. In other words, it had suddenly found an economy bigger than Singapore's that its statisticians hadn't known about. Today, simply put, a Chinese crash would make the 2008 collapse of Lehman Brothers seem like a mere market correction.The kind of meltdown Chu suggests is possible would end Japan's revival, slam economies from South Korea to Vietnam, savage stock and commodity prices everywhere, force the Federal Reserve to end its tapering process and prompt emergency national-security briefings in Washington. So feel free to obsess over Turkey and Argentina, but the real "wild card" is the world's second-biggest economy.”
(emphasis added)
As noted above, that certainly sounds quite ominous.
Opinions Differ …
Not
so fast, says Tom Holland. While agreeing that China will eventually
face a credit crisis and quite possibly a severe economic downturn, he
points to the fact that the closed capital account and China's vast
foreign reserves make a 'global contagion' event of such enormous
magnitude unlikely. This particular scare story he avers, is not something to worry about, which he inter alia
tries to buttress by comparing China's situation to Indonesia's prior
to the Asian crisis. Below are a few relevant excerpts from his article:
“As a headline, it was certainly eye-catching. "Currency crisis at Chinese banks could trigger global meltdown," declared a story in the Sunday edition of London's Daily Telegraph. The article noted nervously that foreign currency borrowing by Chinese companies has almost quadrupled in just four years to more than US$1 trillion. Any substantial appreciation of the US dollar – and many analysts are indeed expecting gains this year – could open up a dangerous cross-currency mismatch, forcing Chinese borrowers to default and inflicting shattering losses on international lenders, the story warned.[…]The chance that China will suffer a currency crisis at any time in the foreseeable future is precisely zero. And even if the country were struck by crisis, there would be no danger of a global financial meltdown. It is certainly true that China's foreign liabilities have grown rapidly in recent years; a quadrupling since 2009 is about right. But, if anything, the Telegraph's figure of US$1 trillion is rather too modest. According to Beijing's State Administration of Foreign Exchange, at the end of 2013 China had foreign liabilities of a thumping US$3.85 trillion; roughly 40 per cent of its gross domestic product.But the lion's share of those liabilities – some US$2.32 trillion – consists of highly illiquid inward foreign direct investment. That money is staying where it is. On top of that, a further US$374 billion is foreign portfolio investment in China's stock and bond markets. That's money that has flowed in under Beijing's qualified foreign institutional investor program, whose rules impose strict limits on the size and frequency of repatriation payments. However, that still leaves around US$1.15 trillion in short-term foreign liabilities, consisting largely of loans from international banks.[…]In 2014, China has no such problems [compared to Indonesia prior to the Asian crisis, ed.] . External debt is small relative to GDP. And with US$3.82 trillion in foreign reserves at the end of last year, Beijing can cover China's near-term foreign liabilities more than three times over. Sure, the shrinkage of the central bank's balance sheet were it actually forced to sell assets in order to fund the country's external liabilities would inflict a painful monetary tightening on China's domestic economy.But with Beijing sitting on such a large pot of foreign reserves, such an extreme crisis is hardly likely. And even if it did happen, there would be no "global meltdown". Despite the opening of recent years, Beijing's controls on the free flow of capital mean China's financial sector remains relatively closed, and the exposure of the global financial system to the country is low.That's not to say there wouldn't be casualties from a sudden strengthening of the US dollar against the yuan, or from a marked slowdown in China's domestic economy. At the end of October last year Hong Kong's banking system was owed US$300 billion by mainland banks and another US$100 billion by mainland companies. Clearly the local pain would be intense. But a Chinese currency crisis triggering global meltdown? Happily not.”
(emphasis added)
Readers may recall that we have also recently mentioned the exposure of Hong Kong's banks to Mainland China. We believe Mr. Holland is correct in one sense, but we also think he underestimates the contagion potential.
Contagion Through Many Different Channels
It
is true that China's closed capital account as well as the government's
tight control over the financial system makes China's situation
fundamentally different from that of countries with open capital
accounts from whence foreign investors can at anytime flee in droves if
they get cold feet over an overextended bubble.
In fact, we have pointed out in the past
that the great degree of central control over the economy (and
especially the banking system) which China's government enjoys makes it
inherently more difficult to time a putative demise of the credit bubble
than elsewhere – and such things aren't easy to time to begin with.
However,
a sharp decline in the yuan's exchange rate may be seen as necessary by
China's leadership if a crisis threatens social stability (and with it
the party's rule) in China. China has already devalued a great deal on
one occasion (in 1994), an event that in hindsight seems to have
precipitated a chain reaction (first the yen followed the yuan lower,
and then the currency pegs in various 'Asian Tiger' economies went
overboard).
Today, China is a far bigger player in the world economy than in 1994,
and we believe that Mr. Holland underestimates how today's economic and
financial interconnectedness may produce contagion effects even in
light of the closed capital account and China's large reserves. We also
don't necessarily regard the exposure of Hong Kong's banks as a de
facto 'internal affair', as the territory is outside of the ambit of
China's capital controls and the yuan. It is not only Hong Kong's
banking system that one must worry about though. Consider what would
happen if China were indeed forced to draw down its reserves to serve
the $1.5 trillion in short term foreign liabilities, or a sizable chunk
thereof. Given that this would inevitably result in a much tighter
domestic monetary policy (provided the PBoC doesn't take inflationary
measures independent of its forex reserves), all sorts of malinvestments
in China would be revealed as unsustainable. A number of industries
would be faced with a major bust, and it is a good bet that commodity
imports would plunge.
However,
once that happens, one must immediately begin to worry about
Australia's banks, which have financed a giant housing bubble on the
back of the country's commodities boom and in turn rely greatly on short
term foreign funding. So there would immediately be a crisis in both
Hong Kong's and Australia's banking systems, and it does not take a
great leap of the imagination to see how contagion could spread further
from them. Naturally many other raw materials exporting countries would
also be hit hard, we mainly picked Australia as an example because its
banks are so reliant on short term foreign funding, so they would
presumably be among the first in line.
Lastly, here is a recent chart of NPLs in China's official banking system (listed banks only, i.e. the biggest ones):
NPLs at China's biggest banks – this looks good! In fact, it looks too good – click to enlarge.
As
can be seen, NPLs at the major banks have declined to a negligible
percentage (compare this with crisis-stricken Spain's near 13% or so NPL
ratio, which is understated to boot). However, there are plenty of
credible rumors that China's banks are keeping loans that would normally
be regarded as dubious alive by all sorts of tricks. Not only that,
they are definitely backing a great many of the 'shadow banking'
businesses, which have developed in China mainly in order to circumvent
restrictions on banking activities.
In
view of everything that is known about credit growth in China, we would
regard this extremely low NPL ratio as a contrary indicator even if it
were credible.
Conclusion:
No-one
knows for sure how big a problem China's economy will eventually face
due to the massive credit and money supply growth that has occurred in
recent years and no-one know when exactly it will happen either.
There have been many dire predictions over the years, but so far none
have come true. And yet, it is clear that there is a looming problem of
considerable magnitude that won't simply go away painlessly. The
greatest credit excesses have been built up after 2008, which suggests
that there can be no comfort in the knowledge that 'nothing has happened
yet'. Given China's importance to the global economy, it seems
impossible for this not to have grave consequences for the rest of the
world, in spite of China's peculiar attributes in terms of government
control over the economy and the closed capital account.
No comments:
Post a Comment