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).



ShiborThe 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 (see earlier post) 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:



$SSECThe Shanghai stock index over the past two years – going nowhere with a downward bias – click to enlarge.




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.



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10 Responses to “Fitch Notices Credit Bubble in China”

  • I have been waiting several years for this. They never cleared out the mess they had 10 years ago and there have been massive mistakes made since, especially over the past 5 years. Bubble needs another bigger bubble. This time, there isn’t any expanding outside demand to keep the game going. They are running out of airports to build as showpieces. I wonder if Field of Dreams is a popular movie there. The massive construction projects are about over for a long time to come. 60% of that economy is in trouble and the other 40% will be impacted.

  • SavvyGuy:

    My untrained eye sees the Shanghai stock index carving out a bullish inverse head and shoulders pattern, currently trying to form the right shoulder.

    • That is possible, but I would wait for confirmation…although Chinese shares have already decline a lot, one must not forget that the big banks make up a big chunk of the A-share index. And they seem to be at great risk here.

  • JasonEmery:

    I saw that Telegraph (Ambrose Evans-Pritchard) piece, posted at 321gold dot com. I also wondered what is so special about the next six months when the most likely scenario is that they loosen monetary policy a little and attempt a soft landing. This would not be a heavy favorite to work, but rather just postpone the day of reckoning, making the next six months boring, not important.

    What sort of surprises me about doomsday articles on China and Japan is why the various authors don’t deem it important to speculate as to what will happen to the trillions in USA Treasury and Agency debt held by Asia’s two largest countries. I mean, so what if the NPL rate is 30% instead of 1%? Can they touch any of the $2 trillion in reserves each of these nations has, in order to recapitalize their banks?

    Or are they quietly unloading a little of it already, and this is what is pushing up USA 10-yr Treasury yields? But if that were the case, I’d expect them to be buying up outfits like Harmony and Gold Fields, and other S. African miners by the dozens at the present depressed prices.

    • rodney:

      For China reserves are something to be diversified and invested abroad, not something to be spent in the domestic economy, like e.g. recapitalizing the banks. If they did that the Yuan would appreciate massively and that’s out of the question for them (the policy is to let it appreciate very slowly).

      • Crysangle:

        Correct me where wrong , but the Yuan is a pegged exchange and varies according to political will . Within China the government may print in Yuan more or less as desired , the currency will tend to stay within China . Earnings of foreign currency are taken by the government at state rates and invested abroad (treasuries , resources , banking etc.) . China does not need to use its reserves to increase the supply of Yuan , or to finance banks . I expect most contracts within China are in Yuan . China would need to liquidate its dollar investments to convert an outflow of money from the country – so as to provide dollars at the official window. That might explain the yield rising in the US . I think it is fair to assume that China/US policy is either coordinated , or where not , is purposefully conflictive . I don’t think we would have two large nations pulling shots without a good idea of the outcome for the other , and hence agreement or disagreement .

        They might attempt a soft landing – what that means is monetizing the existing accounting reality while cracking down on its method via legislation . I am not sure that it would work , and certainly the shift of values would be unpredictable , including socially . Personally I don’t reckon that it is properly in the states hands . You could almost compare it to EU trying to land past lending practice and false values, or the US – the whole show gets caught in a more and more complex circle. At some point the state is understood to have failed in its efforts – not because of a default or obvious losses necessarily, but due to society finding itself unfairly treated in one arena or another as a consequence . In China, for example, the dollar earnings have been effectively confiscated by the state to be put to national use – the Chinese authorities are on the line as to justifying their choice of investment to the people of the country, as well as the overall handling of the countries economy.

        • JasonEmery:

          Correct. The Yuan has been allowed to appreciate slowly over the last decade, probably in order to keep the USA Congress at bay. The present system seems to have a lot of winners on both sides: Wal-Mart, Bernanke (low inflation), USA consumers that haven’t been laid off yet, US Treasury bond sales, on one hand;

          On the other hand, Chinese workers are modestly better off than on the farm, the Communist Party is raking in the dough and building a military powerhouse, and acquiring gold, the quasi private sector is booming, etc.

          My question was and is, ‘what happens when the wheels fall off’? Like if the world’s economy contracts a modest 5 or 6% for a couple of years? Or if China has a failed harvest? War in the Middle East and crude oil goes to $200/bbl? Or the most obvious, the bubble deflates, as they always do.

          • Crysangle:

            I think that that is what everyone is wondering in one way or another , and I don’t think anyone has an answer . I expect most people think it will be a period of remanagement and readapatation both nationally and between countries , maybe a slow creative destruction and an evolution towards a more balanced model which still retains the better of the current direction.

            From perspectives such as ActingMan we are more aware of the nonsense that does exist , but personally I don’t take ‘the managers’ for idiots as a whole – it is more likely the general public is being taken for stupid by those in power , dishonestly but probably with a certain truth too , if not voluntarily . Anyone who wields the amount of knowledge and authority as current government would be able to make most anyone look stupid if it tried . Unfortunately that brings into question the base values of any society and that is not reassuring when it comes to how the whole will react if the wheels fall off. The most basic example would be externalization of the reasons of any problems by blaming a foreign country, while cracking down on any dissent domestically .

            From that point on it would become very difficult to tell what will happen, not least because all decisions and reactions would be reasoned behind national strategy without a combined international presentation . It is hard enough to tell nowadays how much of the differences presented are bluff or show , add domestic tensions and we become aware that governments find themselves unable to back down when they lay blame .

            And so on …

  • Kreditanstalt:

    “…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.”

    JUST China?

    The same thing is happening in the U.S. too – only perhaps it’s better hidden with inaccurate BLS data , jawboning, S&P=”real economy” nonsense, continuous capital misallocations & artificial pulling-forward of demand in sectors such as autos & housebuilding.

    • I agree, it seems in fact possible that the pool of real funding of the whole world is in trouble. Which would explain why it is becoming more and more difficult to divert resources into ultimately unprofitable economic activities that masquerade as ‘growth’.

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