I had the pleasure of presenting my thesis on China and Japan at the Casey Research Summit in San Diego in early October. Here is a link to my updated presentation on China and Japan (Japan starts on slide 40).
Short URL: http://ContrarianEdge.com/?p=2279
I saw your China Black Swan article today in ZH. We are fellow travellers on doom for China. I published this 2 months ago in lots of blogs.
CHINA IS ABOUT TO SUFFER THE MOTHER OF ALL BANKING CRISIS
It is ironic that as China is demanding greater control of the World Bank and International Monetary Fund, just as the nation’s banking system is about to be devastated by the white hot flames of inflation.
From a distance, China’s economy seems to be the poster child of sustainable growth. Recent government reports show the economy expanding by 9.7%, retail sales up a blistering 17.4%, foreign reserves at $3 trillion, and inflation only 5.4%. But these statistics mask a dark side, Chinese communist authorities have been artificially holding down fierce inflationary pressures by subsidizing consumer prices. Over the last six months the government artificially restricted increases in retail food prices to 11%, while wholesale commodity food prices have jumped by 35%. In the last two months the government capped retail gasoline price increases at 10%, even as Middle East turmoil caused crude oil prices to leap by over 30%.
Most Americans believe that the secret-weapon of the “China Economic Miracle” has been currency manipulation of Chinese yuan’s exchange rate with the U.S. dollar. In the past two years as Asian economies and foreign exchange reserves expanded dramatically, the yuan gained only 4.6% versus the dollar. This modest rise compares currency gains of 31% for the Indonesian rupiah, 22% for the South Korean won, and 21%for the Singapore dollar. China has subsidized its exporters by recycling its export earnings back into over-valued U.S. dollars. The strategy makes China’s exports more competitive, but at the cost of spiking inflation at home.
The less known and far more important secret-weapon of the “China Economic Miracle” is the absolute control of the banking industry by China’s four largest state-owned banks (“SOB”); Industrial and Commercial Bank, Agricultural Bank, People’s Bank of China and Construction. Since the government does not provide adequate social welfare programs and restricts its citizen’s investment options to bank accounts, about 40% of Chinese household income is deposited in SOBs each month. The SOBs then leverage the deposits by ten times and loan 75% of this massive amount of cash at extremely low interest rates to state-owned enterprises (“SOE”). The other 25% of lending is allocated to real estate development.
China is no stranger to bankers making risky loans to communist party officials and their crony real estate developers. During the Asian Financial Crisis of the mid-1990s, it is estimated that 40% of all SOB loans were non-performing and most were written off. The Chinese paid for the SOB losses with a 76% devaluation of their currency that crushed the people’s buying-power by 76%. From 1997 to 2004 Chinese frivolous lending was somewhat restrained, but since 2003 the bureaucrats have mandated a massive expansion of lending. In comparison to the U.S. and Europe where bank lending is flat, SOBs have been expanding loans by 25% annually.
With inflation fears rising and bank leverage at an all-time high, the Chinese authorities just began to raise interest rates and instruct SOBs to slow the growth of lending to avoid another banking crisis. Outsiders have no idea what percent of SOB loans to SOEs over the last seven years are already non-performing, but the China Economic Miracle for real estate is quickly turning into a horrendous nightmare. Quoting from CNN Market News “Prices of new homes in China’s capital plunged 26.7% month-on-month in March, the Beijing News reported Tuesday, citing data from the city’s Housing and Urban-Rural Development Commission.” The cumulative plunge in real estate prices in China’s capital this year is 34% and similar losses are being reported in fast growing Hangzhou near Shanghai.
The Chinese officials like to present an image of their population as very industrious, but also stoic and reserved. But with the real estate bubble bursting, banks stuffed with non-performing loans, interest rates rising and inflation raging, the flames of social protest may soon ignite. Fitch Ratings just lowered China’s AA- sovereign credit rating to “negative” from “stable”; citing a “high likelihood of a significant deterioration” in banks’ asset quality within three years. Credit rating agencies also like to present a stoic and reserved image; but this eloquent language is actually code words for “duck and cover”.
China may have achieved the fastest economic growth in world history, but that growth has been powered by currency manipulation and an exponential growth of risky bank lending. The Chinese authorities have been shielding their citizens from the inflationary effect of their strategies through subsidies paid for with more bank lending. Now that inflation is out of control and the Chinese government to trying to shrink lending; the mother of all banking crisis is looming!
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Vitaliy Katsenelson Contrarian Edge. All Rights Reserved.
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