Move Aside Mr Soros, IMF and Chinese Insiders Warn of China’s Debt Trap!

Step aside George Soros, the IMF and insiders from the Chinese government has joined hands to warn on China’s credit bubble and debt trap. 

From the Financial Times (June 11, 2016) [bold added]

It is the latest red flag over China’s ballooning debt, which rose to a record 237 per cent of gross domestic product in the first quarter on the back of massive lending designed to boost economic growth. 

That has put the subject to the fore of this year’s annual IMF review of the Chinese economy with a team from the Fund set to conclude its latest monitoring mission on Tuesday. 

“Corporate debt remains a serious — and growing — problem [in China] that must be addressed immediately and with a commitment to serious reforms,” said David Lipton, the IMF’s number two and the leader of its latest mission, which ends on Tuesday. 

Speaking in Shenzhen, where then-paramount leader Deng Xiaoping kicked off China’s experiments with capitalism more than three decades ago, Mr Lipton pointed to the potential risk to the global economy. 

“We have learned over and over in the past 20 years how disruptions in one country’s economy and markets can reverberate worldwide,” he said, citing the global “spillovers” from last year’s turmoil in Chinese markets. 

He warned that efforts to address China’s corporate debt load — which at 145 per cent of GDP was “very high by any measure” — had seen only “limited progress”. 

“With the rapid increase in credit growth in 2015 and early 2016, and the continued high rates of investment, the problem is growing. This is a key faultline in the Chinese economy . . . And it is important that China tackles it soon,” he said. 

Now from the insiders of the Chinese government… 

Zhou Xiaochuan, governor of the People’s Bank of China, has long warned of the dangers of the corporate debt build-up, according to people familiar with the central bank’s deliberations. 

In May the official People’s Daily newspaper picked up the theme, running a front-page interview with an unidentified “authoritative figure” who warned that soaring debt levels could trigger a “systemic” financial crisis. 

As of the 1Q of 2016, official tabulation of Chinese banking assets was at 208.6 trillion yuan ($32.09 trillion) at the end of March, up 16.7 percent year on year, according to China Daily Europe 

China’s problem is not just about growing its way out of debt, that’s because China’s problem has essentially been the reverse—debt has been become the one of the key obstacle towards attaining growth. 

From Bloomberg April 12, 2016

Just as monetary easing is pushing Chinese bond yields to record lows, the ability of listed companies to service their debt has dropped to the weakest on record. 

Firms generated just enough operating profit to cover the interest expenses on their debt twice, down from almost six times in 2010, according to data compiled by Bloomberg going back to 1992 from non-financial companies traded in Shanghai and Shenzhen. Oil and gas corporates were the weakest at 0.24 times, followed by the metals and mining sector at 0.52.  

The People’s Bank of China has lowered benchmark interest rates six times since 2014, driving a record rally in the bond market and underpinning a jump in debt to 247 percent of gross domestic product. Yet economic growth has slumped to the slowest in a quarter century and profits for the listed companies grew only 3 percent in 2015, down from 11 percent in 2014. The mounting debt burden has caused at least seven firms to miss local bond payments this year, already reaching the tally for the whole of last year. 

Of course the issue is not just about debt, which merely represents a symptom.  Debt has signified as instruments for spending. Or resources were not just borrowed, they were used. 

This means that the debt outgrowth had financed China’s race to build supply in order to juice up the GDP. In short, the obverse side of huge debt has been a gargantuan excess capacity. 

So both huge debt and excess capacity have led to “growth” pressures. And China’s previous artificial credit inflated boom is now in the process of a reversal—a debt deflation and excess capacity spiral. From Boom to Bust.

China’s bank loans have almost been TWICE the US (chart from Yardeni.com)! 

And to dispute claims of a hard landing, Deutsche Bank suggested last February that of their estimated $34 trillion of Banking assets, only around 60 percent, or $20.5 trillion, were credit-type assets, the remaining assets are mainly required reserves at the People's Bank of China, interbank deposits/lending, and investment in treasury bonds. 

This should be an example of shouting statistics to ward of perceived economic and financial evils 

To use the US mortgage crisis as example, subprime loans only constituted 20% of total originations in 2006 or prior to the crisis. So then Fed chief Ben Bernanke used this to sanitize or exorcise the debt problem by stating in March 2007 that the subprime issue was contained 

In a talk before the US congress March 28, 2007, Mr Bernanke said (bold mine) 

Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear. The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency. We will continue to monitor this situation closely. 

You see it turned out that shouting numbers had not been enough. 

That’s because the problem will NOT just be the debt numbers. 

As in the case of the US subprime, the ‘debt’ problem in reality represented a combination of many other factors; chief of them were, deteriorating balance sheet conditions via rising accounts of impaired loans and the lack of cash, general financial conditions or the tightening of liquidity, diminishing NGDP or Aggregate Demand, housing oversupply (real economy) and psychology (from euphoria to panic). 

The crisis emerged to spread gradually. Then it morphed into ‘suddenly’ (Ernest Hemingway’sbankruptcy law).   That’s after problems hit a critical mass. 

Of course, politics played a role here. Bernanke’s denial should be a wonderful example. Although of course, the markets were looking to vent on the accumulated imbalances which means that there was little Mr Bernanke could have done. 

And whatever perceived efficacies from the belated political response (alphabet soup of bailout tools) occurred when markets had already worked out or cleared some of those imbalances through the Great Recession and the real estate-stock market crash. 

Conditions of the subprime era hardly seem different for China and other heavily leveraged DM-EM economies today. In fact, it could be worse because the same debt-overcapacity disease has spread to infect a significant number of DM and EM economies.  

In short, the disease has been almost everywhere or, the malinvestments has been global in scale!

Even more the scale of leverage has been alot bigger today. 

Updated to add: For China, even if only $18-20 trillion of bank assets are credit type assets, say 10% of these are at risk of default, then that would be about $1.8 to $2 trillion or about three times the US subprime! If these will be allowed to default then China may experience a banking crisis. Yet if China will bailout most of the these, then the yuan will dramatically fall.

So what has the Chinese government done so far? Well in the 1Q 2016, $1 trillion worth of credit ballooned in the system! This means the Chinese government tried to solve her debt problem by adding more debt!

And given that the biggest debt trap has been held by China, has it not been a wonder why George Soros made a huge bet on a market crash and called for a sell on Asia?