Friday, July 24, 2015

Are China's Problems Responsible For Recent Market Slides?

So, WTI oil has slid below$49 per barrel; gold has gone below $1100, although it jumped today. The US stock markets have been down in recent days for no obvious reasons, and some others are not looking so hot either.  Is there a common thread?  The big Greece crisis is over, although that could yet blow up, although I think most markets already know about that.

There have been lots of rumbling that problems in China might have something to do  with all that. There is no way to know this for sure, especially given China's long record of manipulating data.  Furthermore, serious observers are dismissing all this as a bunch of bad hype, most notably Dean Baker recently, accurately dumping on an incompetent story out of the NYTimes (who  seem to be pretending that they were secretly bought by Rupert Murdoch lately).  The Times had a story about the decline of the Chinese stock market, making a big deal about it.  Dean accurately noted that it is still above where it was in February, so the NYT looks pretty silly making such a big deal about it, especially since the Chinese stock market seems to have stabilized, as have the housing markets in Shanghai and Beijing, even if it is still falling in a lot of lower tier cities.

 I have tried to link to a report from just over a week ago by Pete Wargent, an Australian with an accounting background who reports from investing.com, but it did not work.  So, I am just going to lay out a bunch of reported data from a bunch of sources that suggests that while Dean is right about the NYTimes story, things are going on in China that are negatively affecting the world economy and are not being reflected in more aggregated statistics.  One reason I wanted to link to Wargent was not just his immediate report that capital flight from China has been steadily soaring, probably at least quadrupling from about two years ago, he linked to an older report laying out how the Chinese government messes with its GDP accounts, pointing out foreign trade data as one area where things get misreported.  He snarkily noted that China had just reported that the most recent  quarterly growth report was at 7%, just what the government had forecast, but...

So, what he noted is that while these aggregate number can say one thing, looking at more micro data can tell very different stories. Here are some numbers, each taken from a different source:

1.  In March, electrical power production (from all sources) was down 2% from a year before.
2.  In May, oil imports were down 11% from a year before.
3.  Truck sales have fallen by nearly a half between last year and now.
4. Capital flight numbers are accelerating, possibly more  dramatically than the quadrupling figure reported by Wargent.

So, maybe these are consistent with an aggregate 7% growth rate, but does not look like it.  Many outside observers are arguing that the Chinese GDP growth rate is more like 4%, with some saying that in the first quarter it hit zero or even lower, although picking up more recently.

A final point regards the stock market bubble story.  While Dean Baker sneered at the story from the NYTimes, an aspect not reported by them or him, but in Wargent reports and some other sources says that the methods used by the Chinese government in its efforts to halt the stock market slide (so far successful) were very extreme, including simply forbidding many stocks from being sold, and also forcibly confining stock dealers in rooms until they engaged in purchasing some stocks, with portions of  the market still shut down with no transactions allowed. So, the stock market is not at all really stabilized.  We are seeing the ugly side of the old Chinese system, trying to keep a lot of problems under control that they have not had to deal with.

Anyway, declines in oil purchases by them and rumors that the Chinese have guaranteed a gold price floor of $1000, well, I guess we do not know what is really going on with any of this, whether  or not declines in these and other markets are really due to a bigger slide in the Chinese economy than is being officially reported at the aggregate level, this cannot be ruled out.  But, I think there is reason to be concerned.

 Barkley Rosser





31 comments:

john c. halasz said...

If you hadn't sneered at Michael Pettis for not being an economist, he's been on to this for a long time from his perch in Beijing. His main point is that switching from excessive investment and export led growth, to a more realistic domestic consumption level requires a sharp growth slow-down in GDP terms, since it requires rapid consumption growth above GDP growth, which is likely only possible if GDP growth slows sharply, (to about 4% in his estimate).

rosserjb@jmu.edu said...

John,

I have not read Michael Pettis so I have never sneered at him. I shall simply note that he is nowhere near the first person to make this general observation. Pretty much all serious observers, including lots of Chinese economists and officials, have been aware that the old export-led and massive infrastructure investment model of growth China has been following for the last third of a century or so simply cannot go on. They must shift more to internal consumption-led growth at a slower rate. Getting to that, however, is proving hard.

The current situation does seem to indicate their difficulties in managing this, with lots of things getting out of whack, and their longstanding propensities to manipulate data maybe coming to the fore, although who knows? Maybe they did grow at a 7% rate last quarter and can keep it going for some more time.

In any case, since I am not acquainted with Pettis's work, I am certainly not sneering at it. But, the number of people writing about China now is simply humongous.

john c. halasz said...

You did once mention him and said who is this guy, he's not even an economist, just a finance professor. I provided a link to his earlier, much praised book. Pettis has been saying this for years on his blog, and criticizing China bulls. (He wrote a couple of excellent pieces recently there on the Euro-crisis BTW, which he has some stake in, since he actually grew up in Spain).

rosserjb@jmu.edu said...

Sorry if I did not follow through appropriately, but I am certain he did not originate these widely made observations, even if he has been persistently and intelligently making them.

Jen Satchmo said...

Pettis wrote the in January 2014:
http://blog.mpettis.com/2014/01/will-the-reforms-speed-growth-in-china/

Jen Satchmo said...

You might be sure, but I’m afraid you’re very wrong and John is right. If you followed the China debate closely you would know that Pettis is the first person to develop the framework that everyone more or less uses now, although when he started he flew in the face of the consensus. I have been following China for years (although my dates may be a little off), but around 2004-05 I started reading him because back then he was writing that most sell-side analysts were wrong on China and assumed that its model was far more sustainable and unique than it really was. He also said that China's debt burden was rising and would continue to rise many years before it became recognized as a problem. He says this should be obvious to anyone who knows the economic history of developing countries, or to anyone who understands balance sheets. He says, by the way, that the reasons economists are almost always wrong about forecasting developing-country turning points is because they usually know almost nothing about history and they know even less about why debt and balance sheets matter.

He was also the first (that I know anyway) to say that the key to the investment model was suppressing consumption to get high savings by suppressing the growth on household income, and the idea that wages, the currency regime and financial repression are the main mechanisms for suppressing household income growth in China is extremely common now, but he was the first to explain it. This was the first thing he said that shocked and pissed the sell side off because while everyone was saying that China was unique and had invented a brilliant new economic strategy etc. etc. he would laugh at them and say economists say this every time any country experiences an investment growth miracle of a decade or more, but only because they know no history.

China was just an extreme example of what he says is an investment-driven growth model that many countries have followed since WW2 (I think he says around 40), but while they always have genuine growth "miracles" at first, it always becomes politically very difficult to reverse the imbalances and every one of them had a terrible adjustment, either with a debt crisis or many, many years of stagnation.

He said this was happening to China, and of course everyone disagreed with him, but when Wen acknowledged in 2007 that China was unbalanced and debt was growing, and said rebalancing would be Beijing's top priority, this was a big vindication of Pettis, who had said it is the biggest and most intractable problem to resolve (I hope I am not misquoting him). By the way he cites Hirschmann and Gershenkron a lot as the two economists who best explained this model in the 1960s and 1970s.

He is apparently a famous Wall Street trader, taught at Columbia and now at Peking University, and supposedly well known in Latin America, and his book on what causes financial crises in developing countries is a cult classic (Volatility Machine), so people took him seriously even though at first he disagreed with almost every part of the consensus on China. For example when Wen said in 2007 rebalancing was the top priority, and everyone though this meant China would begin to rebalance, Pettis instead said that he wouldn't be able to pull it off and that things would get worse for many years until they got serious about it politically. He said he didn’t think China would rebalance except under a new leader because the politics would be too difficult.

Jen Satchmo said...

Also in 2009-10 he was really the only guy who was saying that the big stimulus was good for short-term employment but would prove to be a disaster in a few years. In 2009 he also started to say that China's next leader would have to centralize power to do the reforms that China needed, otherwise it would be too hard to overcome the vested interests (this is an old problem that Hirschman wrote a lot about, according to Pettis, but few economists seem to have read him). Pettis also said that once rebalancing started, he thought growth would drop every year and would average only 3-4% or even less during the ten years of the next presidency. At the same time debt would soar.

In those days that sounded crazy, and the consensus was that growth would drop a little but average around 9%, but by then everyone recognized that he was the only one who had been right about China, so investors listened to him. The economists mostly didn’t, and so every year they would adjust their forecasts down and give us all sorts of bullshit (I am a PM) about why this didn’t mean they were wrong and Pettis right, and anyway growth has bottomed out and would stay at these new levels. So you can see why there isn't a single big institutional investor involved in China who doesn't read his stuff first, and most investors have written off the economists as only good at explaining why what has happened will always continue happening..

I could go on, but you get the point. Nearly the whole bear case for China was shaped by him, and he still thinks that the reason most analysts have gotten China wrong is because economists do not understand debt, or the way balance sheets work. At any rate he definitely explained China first, and still better than anyone, and he made many of us see, me at least, how to understand this whole issue of a growth and why, as he says, the growth miracles is the easy part but the subsequent adjustment has always been the killer.

By the way don't call him an economist. He says he is a finance guy, and that economists don't understand at all why debt matters. Also check out the crazy predictions he made in 2011:
http://carnegieendowment.org/2011/08/29/predictions-for-rest-of-decade#

In another 2011 post which I am trying to find he said that because of China metal prices would drop by more than 50% by 2015 and that iron would test $50 by 2017. He was right about a 50% crash, but even though iron was $192 when he said that, prices fell even faster than he predicted and iron tested $50 several months ago. I think more than one investor has made a lot of money listening to Pettis, although he is always too early so we always adjust for that.

Jen Satchmo said...

Also in 2009-10 he was really the only guy who was saying that the big stimulus was good for short-term employment but would prove to be a disaster in a few years. In 2009 he also started to say that China's next leader would have to centralize power to do the reforms that China needed, otherwise it would be too hard to overcome the vested interests (this is an old problem that Hirschman wrote a lot about, according to Pettis, but few economists seem to have read him). Pettis also said that once rebalancing started, he thought growth would drop every year and would average only 3-4% or even less during the ten years of the next presidency. At the same time debt would soar.

In those days that sounded crazy, and the consensus was that growth would drop a little but average around 9%, but by then everyone recognized that he was the only one who had been right about China, so investors listened to him. The economists mostly didn’t, and so every year they would adjust their forecasts down and give us all sorts of bullshit (I am a PM) about why this didn’t mean they were wrong and Pettis right, and anyway growth has bottomed out and would stay at these new levels. So you can see why there isn't a single big institutional investor involved in China who doesn't read his stuff first, and most investors have written off the economists as only good at explaining why what has happened will always continue happening..

I could go on, but you get the point. Nearly the whole bear case for China was shaped by him, and he still thinks that the reason most analysts have gotten China wrong is because economists do not understand debt, or the way balance sheets work. At any rate he definitely explained China first, and still better than anyone, and he made many of us see, me at least, how to understand this whole issue of a growth and why, as he says, the growth miracles is the easy part but the subsequent adjustment has always been the killer.

By the way don't call him an economist. He says he is a finance guy, and that economists don't understand at all why debt matters. Also check out the crazy predictions he made in 2011:
http://carnegieendowment.org/2011/08/29/predictions-for-rest-of-decade#

In another 2011 post which I am trying to find he said that because of China metal prices would drop by more than 50% by 2015 and that iron would test $50 by 2017. He was right about a 50% crash, but even though iron was $192 when he said that, prices fell even faster than he predicted and iron tested $50 several months ago. I think more than one investor has made a lot of money listening to Pettis, although he is always too early so we always adjust for that.

rosserjb@jmu.edu said...

Oh, Satchmo, this is just hilarious. So, I have checked on your guy, and while he has published some not bad books and is sitting in Beijing, your claim that he was the first out the door on a lot of this stuff is just a joke. This guy is a major self-promoter with a list of clients. And you and Halasz are suckers for him?

He has only gotten into the China stuff quite recently. My observation is that most of what you report (and I have seen from looking at some of his stuff) is either not new or discovered by others before him, or is simply not true, without getting into a detailed analysis.

BTW, one of the people who was on top of financial volatility in China before he was happens to be me, having published on this matter well before he was saying anything about it. I was publishing things on China when he was still playing games at Manny Hanny. So, I am really not impressed at all. Sorry.

Bobby said...

< Pettis, sample quote from ( 2008 ) He was way ahead of the pack. His older post / lost after PBoC attacked his original blog. I saved all his older works, lucky enough. ; )

....... " Because last night I was invited to be a guest on the CCTV current events show, Dialogue, I tried to get my arms around an easier way of thinking about the adjustment so that I could explain it on TV. Let us assume that the US trade deficit will decline by 50%, from 6% of GDP to 3% of GDP – there are some who have argued that it will go to zero next year and others who have even argued that the US will soon be forced to run a small surplus, but I will assume nothing quite so dramatic. I will also ignore any contraction in net demand from Europe and elsewhere.

Since the Chinese trade surplus is equal to up to 2/3s of the US trade deficit, this suggests that within the overall global balance China should, ideally, absorb about 2/3s of this contraction, roughly equal to 2% of US GDP. This is also equal to about 7% of Chinese GDP, which means that either a) Chinese consumption is going to have to expand by 7% of GDP faster than production, b) Chinese production is going to have to contract by 7% of GDP more than any contraction in demand, or c) both will have to happen so that the sum is equal to 7% of GDP.

Clearly the first cannot happen very quickly. The second would mean economic chaos for China, so that leaves the third. In the best of cases China would be given enough time to get as close as possible to the first of the three adjustments, but without a very strong international framework and coordinated action the most likely outcome is for at least some contraction in production.

The problem with all my scenarios is that the numbers are so big it is not easy to make the case for a smooth adjustment, except under the assumption that the rest of the world will do everything it can, including suffer rising unemployment, to pull China out of the crisis. That is unlikely. " ......... html>

Bobby said...

more Pettis from 2009

.... " Remember that there are two reasons for hot money to leave China – one on which most of us have focused, and another, which may be more important but which hasn’t received the attention it deserves. The first is the expected excess return for bringing money into China or taking it out – basically the RMB deposit rate plus the expected appreciation of the RMB less the equivalent US dollar deposit rate. When there were tremendous expectations for RMB appreciation, money poured into China, and now that those expectations are evaporating, or even going negative (i.e. there is some concern that the RMB may depreciate), it is likely to leave.
The second reason for hot money flows, not as widely discussed but at least as important, is the perception of risk, especially of the financial system. Remember that whether any given level of expected appreciation results in outflows or inflows depends also on the expected risk. As risk rises, it will take a lager expected return to encourage inflows. As China’s economy contracts, and as local businesses become increasingly worried about the potential for the current crisis to lead to deeper problems, including problems with the banking system, there is an increasing incentive for wealthy Chinese businessmen to take money put of the country.
For much of 2007 and early 2008 I argued that Chinese monetary policy had locked the country into a dangerously pro-cyclical trap, and unless the PBoC engineered a one-off revaluation that would stop hot money inflows, there was a real risk of incurring destabilizing capital inflows and outflows. When things were going well and the country’s economy was booming, hot money would pour into the country, unleashing a credit bubble and exacerbating the problem of overheating and overcapacity.
Once conditions turned around, however, I worried that hot money outflows would have exactly the opposite impact, causing a contraction in the money supply that would lead to credit contraction and an even sharper economic slowdown. This is always the great danger of hot money – when things are going well it pushes the economy into overheating, while squeezing the economy just as things start to get bad. " ...........

Bobby said...

tick, tick, tick, ... boom. Now the numbers dwarf this and the PBoC has been rolling over debt ( npl's ) since the asian flu crisis. The new debt / credit issued in 2015, rate cuts are for the insolvent banking system as the bump in GDP from said credit issuance is long gone ......

victor shin 2011

.... " On Monday, the Chinese government took an important step toward revealing the extent of borrowing by local governments. But full disclosure is still a long way off.

The National Audit Office released a report showing local government financing vehicle (LGFV) debt at 4.97 trillion yuan ($768 billion), a figure that is much lower than previous government estimates and thus should be discounted. However, the NAO report also disclosed for the first time that non-LGFV local governmental debt totaled 5.7 trillion yuan at the end of 2010.

Combining the 5.7 trillion yuan in non-LGFV debt with previous China Banking Regulatory Commission and People's Bank of China estimates on LGFV loans outstanding, we arrive at total local governmental debt ranging between 15.4 trillion yuan and 20.1 trillion yuan, or 40% to 50% of China's 2010 GDP.

Important pieces of the local debt puzzle remain hidden, including local state-owned enterprise debt and the non-loan liabilities of LGFVs. Nevertheless, the recent government reports should be a wake-up call to Beijing that it urgently needs to address this issue.

That hasn't happened yet. Even as government audits begin to reveal the true scale of the problem, local governments across China continue to finance new construction projects. Because the central government has not made clear whether anyone would bear any serious costs for allowing the debt to grow, local governments have every incentive to continue their leveraging. " ........

Bobby said...

And the top 1% in China ( ie: rich / smart money ) start the hot money exodus ( it already started ), they hold 4 Trillion alone. The PBoC can't handle this exodus as 2 Trillion in treasuries support the banking system in share holdings.

So get out the popcorn, in complex systems like China's financial system, cracks emerge and nobody knows what small " event " ( stock market crash ? ) can call into question " control " and cause chaos within said system .......

Bobby said...

And lets not forget the global ponzi ie : ( 90's - 2007 securitization ) that inflated / warped perception underlying every single global asset class including the build-out of China's massive manufacturing complex counting on said leveraged credit continuing for ever.

As the global yield seeking money ebb's and flows in and out of markets, carry trades ect .... The deflation tsunami building offshore buttressed by said securitization leverage, has every single economist, banker wondering, groping in the dark looking for a chair wondering when the mandarin music stops playing. Blinded by the innovation of financial alchemy forgetting debt issuance 101' in a fiat world that trembles at the altar of deflation.

The commodity complex, global growth projection combined with technology crushing longer term job growth leaves the MIT greats along with four year olds holding a simple calculator .... Aghast .....

rosserjb@jmu.edu said...

Oh my heavens, we have an even bigger and more ridiculous Pettis-worshipper than Satchmo or John H. (who mostly stays pretty reasonable). What is it with you clowns, are you paying clients of Pettis who need to have your expenditure of money justified? All the statements about how insightful and original he is I suspect you are getting from him, which is what all shyster self-promoters do, go read Ron Paul. If you were actually reading more widely, you would realize how totally commonplace and unoriginal his remarks, even when they are correct, which they frequently are not.

Let me just take one example of the latter. This is from the first piece you posted, Bobby. You provide what is supposedly some absolutely brilliant and farsighted analysis about changing trade balances and how this will negatively affect the Chinese economy. First of all, although maybe he mentioned elsewhere in the piece, and there is a hint of it in his remark about falling net demand from Europe, 2008 was the year the world economy went to hell in a massive financial crash. China held up amazingly well out of all that, although in ways that I see from later quotes provided here he was aware had their problems, although he was hardly the only, and certainly not the first, person to note this.

But then we get to the bottom line. While Pettis is correct that the share of US GDP that is net negative current account balance has fallen since 2008, in fact the net negative bilateral trade balance has become dramatically more negative since then. That balance was around -268 billion $ in 2008. In 2014 it was -343 billion $. In short, Pettis was totally full of shit and dead wrong. I hope you have not been actually investing money based on this fraud's advice.

BTW, he was presented as someone with a massively innovative view of economic development more generally. No, sorry, I do not see one shred of innovative insight coming out of him on that matter. He has not written the book to replace the textbooks on economic development. I find it funny that something that supposedly shows how innovative he is is that he has read Alexander Gerschenkron. Well, so have all the authors of the established (and not so established) works on economic development. Sorry. For that matter, I not only read Gerschenkron back before Pettis began stealing money from clients at Manny Hanny, but I actually met the guy and heard him speak. But, I have probably forgotten all his great ideas and should go buy all of Pettis's books to re-educate myself on these matters...

rosserjb@jmu.edu said...

That net negative bilateral trade balance is that between US and China. US is now net buying a good $80 billion more now than it did in 2008. Ooooops.

Oh, and I did not quite finish it. In the quotes from 2008, Pettis says nothing about the financial crash or crashing world economy in what is quoted there, although maybe he did elsewhere. But that was the big story, not some longer run incorrect speculation about China having to absorb falling exports to the US because of some change in the ratio of its current account deficit to GDP.

The guy is really not impressive, and most of his claim to anything might be for readers of his blog, where he does have quick access to recent government reports. Following his blog might not be a total waste of time, if one takes his predictions with the appropriate amounts of well-salted soy sauce.

Bobby said...

And the only answer the keynesian worshipers have is spend, spend, spend .....

Oh, Blythe Masters what have you done ..... ? A second-rate snake oil alchemist, oh mistress of big .gov, the socialist dream now engulfed by the technology driven, sound money deflation tsunami coming ashore.

Solving a debt problem with more debt ? Not possible the children scream not in this world build upon prior amortization unfunded liabilities.

The foundations made of sand, these are the days of our lives and our children's future.....

rosserjb@jmu.edu said...

Um, Bobby, I have not said anything about how I would solve China's problems. I have studied China for over a half century, its history, culture, art, as well as its society and economics. I have published on it, and I personally know most of the top scholars on the Chinese economy, none of whom are named Michael Pettis.

Since you have no idea what I think should be done or not done about the Chinese economy, why are you presuming to rant here as you did? Are you some kind of nutjob like anne over on Economists View who just shoots off her mouth irrelevantly? Frankly, I think you need to take your meds, if you can still afford them after wasting money on fraudster Pettis.

Bobby said...

Said problems can't be fixed within China as we will see very, very soon indeed. The hot money is already exiting ...

Dollar denominated global debts, money velocity crashing ( shudder ), un-fundable liabilities, history repeating regarding currency wars / trade markets closing, China's off balance sheet leverage, China's pollution, China's north / south water crisis, China's social historic abhorrence with materialism, China's embedded competition province for resources, China's 2nd-tier ghost city conundrum, asian manufacturing blow-back undercutting China as she rebalances, lowering of interest rates for the insolvent banking complex as rate cram-down not being passed onto those starving for credit with debt's denominated in a rising dollar, population mismatch by way of unholy abortion construct, the unstable history of China itself regarding rulers supported by reams of data going back centuries.....

So many assumptions indeed ... / insults dirty the waters of learning. Deflecting indeed, useful only for those exiting clown cars or those of simple minds that believe more debt can solve a debt crisis in a cauldron of deflation, zero bound it is, full steam ahead into the abyss of offloaded sovereign obligations ...

rosserjb@jmu.edu said...

Now you are making more sense, Bobby. You do not need Pettis for these observations. I do not have the answer for what China should do, nor do I know how bad their situation is. It is a very big and complicated country. But my post was about highlighting that they appear to have gone back to manipulating data, which is a sign they aren't on top of things. I have never heard of a nation that grew 7% while having its electricity consumption fall by 2%, not even close.

rosserjb@jmu.edu said...

BTW, Chinese stock markets were down 8.5% yesterday. I am no pollyanna on this, as some of the Pettis fans seem to think, but neither am I some imperialist "anti-Chinese" swine spouting "gossip" while ignoring the massive triumphs of the Chinese economy, as claimed by Mark Thoma's lapdog, anne, who completely went off her meds and made these accusations about me after Mark linked to this post. The argument got so bad that Mark deleted some of it, probably to the benefit of anne and me, who used to tangle about Krugman and other matters in the past, although we have been reasonably peaceful and agreeable mostly in recent years.

Also, after she pulled her garbage, some clown named RGC jumped in even more vigorously, more intensively accusing me of being some sort of imperalist stooge who should undergo self-criticism while wearing a dunce cap in public as in the goof old days of the Great Proletarian Cultural Revolution.

Sorry to all of you, I shall stick with my original post here, which I think is reasonably balanced and properly calls attention to some disturbing phenomena coming out of China (and not only are the Chinese markets down, but the US ones are skidding again today after several days of doing so pretty sharply, with me suspecting that what is coming out of China being a major, if not the major, factor involved here).

BTW, I hope that anne gets it together. She is mostly a useful commentator, but she really lost it on this latest round.

Bobby said...

China is a major factor ......

The USD being reserve ( all currencies / dollar denominated debt's ) built upon this. The velocity has crashed, the deflation engulfing all thing now could be projected and foreseen from miles away as the massive securitization complex was broken in 2007. Velocity / securitization took off in the 90's warping all asset classes / global. The realization of this is lost on most ... From Macau slowing down, Hong Kong sales slump, the 26 Trillion USD of debt China has amassed ( could be higher as many debts buried off balance sheet ) The Lehman redux is upon us. China driving global growth since 2007 was never sustainable not with per capita / GDP very low with gini coefficient flashing warning signals.

I would go all in regarding China regarding investing in markets / renminbi around 2019-2020.

The #1 question moving forward is discontent and social unrest playing out as corruption is blamed ( very warranted ) upon the politburo / princelings. The current leadership is going after corruption but the entire country has been run like a mafia state gunning down the farmers / opposition standing in the way of short sighted monetary gains.

Those living near the poverty line hold the keys, they have dealt with the pollution, the knock-off effect of currency driving the great leap forward all these year transferring wealth from the broader population into those controlling the manufacturing complex / financial. With a very deep culture ( languages / diversity ) if viewing the entire country, the transfer into a consumer driven economy was never gonna be easy or take place over 5 years. The balance between manufacturing driven / consumer driven GDP must balance regarding payments coming into and exiting the economy. No matter what, as the global economic slowdown exposes this the PBoC really has no choice but revalue the renminbi downward ( huge mistake ) just as the global IMF currency basket demands stability.

The fear of losing control is driving market manipulation ( 40 interventions in 5 week period ). The dollar racing upward is a global margin call, the rate hike at the fed would be devastating. The computer hacking, the long term energy deals, pipe lines all play a part in this. The relationship between the largest trade / currency partners is also key as China needs help rebalancing and who really knows how those back room talks are going. The scary thing for everyone is history repeats and we are repeating mistakes made in the 30's and lurching toward the 40's quickly ....

Bobby said...

And just clarifying above ....

China total debt stands at 26 Trillion USD and yes it can print it's own currency. But regarding the carry trade it holds over 3 Trillion in liabilities with the USD looking at another breakout, this puts enormous stress on the leveraged USD as the quality of investment is unknown.

The market meltdown exposed total panic on the PBoC part and calls into question what control they really have at this point. The market collapse is far from over as the leverage from the bubble driven market must unwind no matter the threats being placed on the evil short sellers. The oversight of allowing the leveraged bubble in the first place in the slowing economic environment really leaves one scratching one's head asking who is in charge at the central bank as the reaction after the fact in this context should scare the crap out of everybody.

The emperor has no clothes, plan or foresight. Panic time ....

Bobby said...

( BofAML’s David Cui ) - This high leverage [within financial institutions] by itself is not alarming in the sense that it is the natural order of the financial business globally. However, there are a few factors in China that make the financial system particularly vulnerable to major losses in our view, although it appears more stable in times of small losses.

One is that most of the FIs are intertwined via direct equity stake, product distribution and channeling, i.e. cross-fertilization of products (Shadow banking monitor 22: web of connections, Jan 15). When losses are small, the companies tend to cross subsidize each other to cover up losses, sometimes encouraged by the government (banks typically have the strongest bargaining power during the process). This has helped to stabilize the market over the past few years but greatly strengthened the public perception of implicit guarantees behind many financial products, including bank WMP, broker TAM, funds’ TAMC, trust and bond. However, when the losses are major and when some FIs are unwilling or unable to foot the bill, the psychological shock to the market can be severe.

Unless the government is prepared to shoulder the ultimate stock-market related losses by itself, via CSFC or other vehicles, various financial products funding the leverage may suffer from trillions of Rmb losses when the dust finally settles, by our estimate. Given the particularly-thin capital base of the front line FIs, including brokers, trusts and TAMCs, we suspect that it’s a matter of time before banks may have to face the music – bank WMP is by far the largest indirect leverage provider. Banks can decide, voluntarily or forced by the potential of social unrest, to take the losses on their book, which means their capital base would suffer severely. If they decide to pass on the losses to WMP buyers, we expect the shadow banking sector to wobble. We believe that the natural reaction of WMP buyers is to stop buying, given that they have been buying based on implicit guarantees and have little visibility as to which products are supported given the low transparency in the financial system. That effectively would be a bank-run in China’s shadow banking sector because bank WMP is by far the largest “depositor” in the shadow bank.

It’s possible that banks may take the losses on their books without explicitly acknowledging it, i.e. not marking to the market. In this case, we expect them to be much more cautious granting loans going forward as they would know their balance sheets are weak – that’s how the Japanese banks behaved post the bust of the property bubble.

Whichever way we look at this, what just happened in the A-share market will likely have profound impact on China’s economy and financial system one way or another, by our assessment.

Bobby said...

( BofAML’s David Cui ) - Leverage, inflated collateral & unclear risk responsibility

We estimate that margin outstanding, only from the seven channels that we can estimate reasonably, easily exceeds Rmb3.7tr. Assuming an average 1x leverage, it means that at least Rmb7.5tr market positions are being carried on margin, equivalent to some 13% of A-share’s market cap and 34% of its free float. Meanwhile, A-shares ex. banks are still trading at 36.6x 12M trailing PER. We believe that the government will struggle to hold up the market beyond a few months, unless it is prepared to let go some of its other policy objectives including RMB credibility … When the market ultimately settles at a level that can be sustained on fundamental reasons, we expect that the balance sheet of most financial institutions (FIs) may get impaired and the financial system may wobble, due to high contagion risk.

Leverage means relentless selling pressure

The seven channels mentioned above are margin financing (MF), stock collateralized lending (SCL), umbrella trust (UT), stock benefits swap (SBS), structured mutual fund (SMF), P2P and offline private fund matching (Table 1 [we'll pop this at the bottom of the post]). There are a few other difficult–to-estimate channels, such as banks’ corporate/personal loans that ended up in stocks, brokers’ proprietary desk and funds’ subsidiaries. We suspect that the size of these may be Rmb1-2tr. In addition, China Securities Finance Corp. (CSFC) might have borrowed Rmb1.5tr from banks & PBoC to buy stocks. All the leveraged positions may want to unwind at certain point given the inflated collateral value, in our view. Additional selling pressure may come from hedge funds with compulsory winding-down clauses, when the market heads lower.

Balance sheet damage & contagion risk

It seems to us that A-shares ex. banks could at least halve, which would only bring down their average PER to just below 20x, before any reasonable case about valuation support could be made. This means that most leveraged positions may suffer from losses ultimately, likely in Rmb trillions. On the other hand, the capital base of brokers and trusts, who are the first loss takers behind investors, is only Rmb1.6tr (Table 2). Banks’ capital may suffer greatly as well once the equity of the other FIs is depleted – banks provide or channel most of the leverage directly or indirectly. The risk is that the unwinding of the leverage will be disorderly – due to implicit guarantees behind most shadow banking financial products, investors could easily panic if they suffer from meaningful capital losses, by our assessment. The key risk to our view is that the government may be prepared to take on substantially all the leverage, in which case, we expect RMB or growth to come under pressure.

Bobby said...

Around 97% of existing yuan-denominated bonds hold ratings of double-A to triple-A—the best a company can get.

https://twitter.com/alexfrangos/status/625465995805626368

john c. halasz said...

Barkley:

Just to be clear, I never made any claims for exclusivity, priority, or uniqueness on the part of Pettis. I'm not a fanboy. But he has been astute and insightful in his commentary over the years. (Your ad hominems about his pecuniary interests were thoroughly inappropriate, as if he were Fredrick Myshkin shilling for Iceland shortly before its collapse. I have no idea what his pecuniary interests are, except that 1) I could hardly think that his salary in Beijing is all that attractive, and 2) if he has a subscription service, it would likely be continuous with his blog commentary,- and a China bear stance isn't likely to boost sales,- and 3) if he's got his money, likely it was when he was a trader for Bear Stearns back in the day).

What he does bring, (which most economists lack, though I doubt you belong in that category), is an acute sense of economic history and an ability to draw informed historical analogies to the analysis, as opposed to the "this time is different" crowd. His 2001 book which made his name has a blurb from Dani Rodrik, who AFAICT is a pretty decent (in both senses of the word) international macro and trade economist.

But you've done this before, hysterically over-reacting and ending up just tripping over your own shoe-laces. I'm just glad I missed the latest kerfuffle between you and anne.

rosserjb@jmu.edu said...

John,

Maybe I have been a bad and rotten boy here, but when I checked him out, I was not that impressed. It was not that he was saying things that were obviously wrong, although some were questionable, more that none of it was all that original while all kinds of people are jumping up and down declaring that it is.

He does have some sort of subscription service. Maybe it does not amount to much, and I imagine he made good money in his earlier career before he went off to China. Really, his private finances are irrelevant, although his insistence on claiming all this original priority when it is not there was what drove those remarks.

I will give him credit for having a broader view than most economists. He is clearly quite smart and well-informed and following things closely on the ground there. I am not following it, but I imagine following his blog might well be reasonably informative. I did note, I think, that his latest book has been put out by Princeton University Press, which is certainly respectable.

Do I now have your permission to tie my shoelaces up again? :-)

john c. halasz said...

That's not proper hip-hop style. But suit yourself!

rosserjb@jmu.edu said...

I'm all suited up, John,

I shall add a bit. My wife and I are revising our textbook on comparative economic systems, third edition for MIT Press. China chapter will be last done. Have accumulated lots of books for all the case studies. There are more on China than on all the others put together. The lit on it is simply enormous, so it is hard for Pettis to really be too original or out there, even if he is very good. There is simply an enormous number of people studying and writing about China, and lots of them know a lot more than just econ.

For me personally, my late mother was a deep student of Chinese art and culture and knew many top scholars as well as possessing some rare and unusual books on the subjects. I began studying these matters, as well as Chinese history and philosophy from here when I was quite young, well befoe I ever studied economics at all, much less about the Cninese economy. There are indeed lots of people, including quite a few of the top scholars on the Chinese economy, who know a great deal about China beyond economics. Pettis is not alone at all in this regard.

In the meantime, I shall try to hip and hop more carefully, :-).

Myrtle Blackwood said...

My understanding is that around 2005 China's energy and food demands became a drag on the global economy. See:
China’s resource demand at the turning point
March 2011
http://epress.anu.edu.au/wp-content/uploads/2011/03/ch14.pdf

Financial stimulus in China (and elsewhere) can facilitate the diversion of resources within an economy but money doesn't produce those resources.

I was following the global forest story for a decade and part of China's growth story involved an alarming rate of deforestation of large parts of Asia and Australia. Factories there were churning out furniture and other wood products, not to make a profit, but to simply employ people. China needs to paradigm shift, as we do.

I hope our economic ideas shift away from mass employment for mass sustenance (or profit) and focus much more on sustainable well-being.

As for the '90s securitisation, it shows up the lack of real collateral behind finance.