Analysis of
Chinas Economy: Debt Fueled Growth, Trade Deal to Test Trump, Risks of Shadow
Banking, etc.
By Victor Sperandeo
with the Curmudgeon
Introduction:
This is the third in a series of
articles about China. The first two were: China Economy Expands but
Debt and New Loans Soar; Trade Deal Revisited (01/19) and Phase One Trade Agreement
Signed, but Tariffs Remain in Place (01/15).
Victor provides his comments and incisive analysis on the
Chinese economy and Phase One trade deal in this piece. The Curmudgeon offers a
perspective on Chinas shadow banking system and why it might be another debt
bomb.
Analysis of China Economy (Victor):
Lets start by noting that no one who analyzes China
professionally believes the economic statistics the Chinese government releases
are accurate. The growth rate for the last several years is more likely on the
order of 3% or less -- not 6+ % as reported by the government.
Chinas economic growth comes from debt. The debt comes from printed money by the People's Bank of
China. Kyle Bass, founder of Hayman
Capital Management, told CNBC: The Chinese print more money than any other
country has printed, in gross terms, in world history
Since 2001, theyve printed
roughly $30 trillion worth of RMB (Chinese Yuan).
Moreover, the inflation rate in China is controlled by the
government as one might expect. Chinas
inflation averaged 5.13% from 1986 until 2019, reaching an all-time high of
28.40% in February of 1989 and a record low of -2.20% in April of 1999.
[Source: National Bureau of Statistics
of China]
Most of the average Chinese save a huge portion of their
income. They buy gold, then hide
it. That gold never leaves China.
Also understand that no property rights exist in China. Thereby,
the government effectively owns most of its citizens net worth. That is why the greatest amount of effort and
energy, for a so-called wealthy Chinese, is getting their money out of the
country. Bitcoins, precious gems, paintings, and other assets are used to get
money out of China. Due to government
capital controls, only $50,000. per year per person, is permitted to be taken
out of the country.
.
The U.S.-China trade deal is 90% perception (Victor):
No real U.S. GDP growth will come out of the Phase One
agreement. Whatever China agreed to in
the deal will likely not be done or executed.
Furthermore, there is no enforcement mechanism to assure
compliance.
China government officials want Trump out of office as he has
made their life quite difficult. Trumps
tariffs have greatly weakened Chinas economy, his administration has pressed
the country to respect intellectual property rights and U.S. trade secrets, and
he has banned Huawei and restricted component sales by U.S. companies to
that company. In October 2019, the
Financial Times reported that the Trump administration was considering options
to crack down on shipments of contraband goods from China, adding a new point of
friction with Beijing. Finally, the U.S.
military was ordered to stand up to Chinas island building and provocations in
the South China Sea while also sending guided-missile destroyer ships through
the Taiwan strait (as reported in our January 19th post).
Expect China to test Trump
by not adhering to their Phase One trade agreements. Remember that 2020 is an election year and Chinas government
doesnt want Trump to be re-elected President so its in their interest to
create havoc for his campaign.
Also, there is nothing in Phase one to curtail Chinas massive government intervention
in their economy to turn China into a technological power (e.g. Huawei grants,
subsidies and tax breaks as reported by the Wall Street Journal).
In summary, Phase one is a sham deal to stall and hope -with
Chinas help -to get rid of Trump. Even perception doesnt do justice to the
China trade deal.
Side Comment: Let me stress Trump is
trying to save or create manufacturing jobs in the U.S. In this case, his intent is in the right
place. It is the Republican establishment that does not care about the workers
of America, but rather the corporate payoffs (which amounts to legal bribery)
they get for keeping profits flowing to U.S. multinational corporations.
The Problems with Chinas
Shadow Banking System (Curmudgeon):
Shadow banking refers to lending and credit intermediation
outside of the typical banking system. Shadow banking in China is a vast
ecosystem which connects thousands of financial institutions with companies,
local governments and hundreds of millions of households. Its growth in recent
years, fueled by asset management products and peer-to-peer lending, lifted a
broad measure of shadow banking assets to an estimated $10 trillion. But then the
crackdown came, prompted by a China government campaign to tackle risks in the
financial industry that might threaten the wider economy.
Chinas shadow banking sector had grown rapidly in recent years
but has recently slowed. The China
Banking and Insurance Regulatory Commission (CBIRC) said in a notice published January 12th that the
total assets of the countrys shadow banking sector had fallen by 16 trillion
yuan over the past three years. The
contraction in shadow banking sector was primarily led by continued decline in
asset management business originated by banks and non-bank financial
institutions, according to a Moodys Investors Service report.
The CBIRC has been trying to tackle growing financial risks in
China, with dozens of small lenders under pressure as a result of the economic
slowdown. The notice said loans to the real economy had continued to
increase, reaching 17 trillion yuan in 2019, up nearly 7 percent compared
to the previous year.
One of the main problems is that regular banks in China -- unlike
in the U.S. -- are major participants, keeping shadow-banking assets off their
balance sheets to sidestep regulatory constraints on lending.
A new worry is that products arranged by Chinas independent
wealth managers will face mounting
losses as Chinas economic slowdown continues and corporate defaults surge.
Confidence in the industry has plunged since July 2019 when Noah Holdings Ltd.
said that 3.4 billion yuan ($477 million) of credit products overseen by one of
its units were exposed to an alleged fraud by a Chinese conglomerate.
Reuters Breakingviews reported on
January 16th that the Chinese shadow banking is poised for a comeback. A recent survey by China Beige Book suggests
a sharp revival in shadow credit in mid-2019, contradicting official data
(remember that Victor stated you should
not trust the China government economic data).
During the second quarter, the share of non-bank lending surged
from 30% at the start of the year to 45% of total loans the highest on record
- and has remained high since. Sources of credit ranged from non-bank
state-owned companies, trusts, online services and individuals.
In a recent conversation with Breakingviews, one Chinese finance professional admitted to
personally lending to small companies and spoke glowingly of double-digit
returns. To compare, the one-year loan prime rate is just 4.15%. China regulators are trying to bring the cost
of credit down, but Beige Book data shows interest
rates for small and medium firms shot up 266 basis points
quarter-on-quarter in the three months to December 2019.
Another headache for China officials is that such informal and
mostly illegal loans are hidden from them, akin to the back-alley lending
that fueled the private economy in the early days of reform. Unsurprising, the
back-alley charges more for risk.
Because shadow bank lending is opaque and regulation is minimal
or non-existent, nobody knows exactly how much money is at risk. The repercussions
could be significant if losses on shadow banking products fuel a broader
retreat from high-yield assets in China. That, in turn, poses risks for the
wider Chinese economy because shadow banking is not subject to banking
regulations which constrain risks.
Hence, shadow banking losses and defaults could spread to negatively
impact Chinas real economy.
Summary and Conclusions
(Victor):
To reiterate, the whole China growth story is based on debt. The Chinese Communist Party (CCP) rules the country. Xi (pronounced SHE) Jinping is a Maoist. He can order the military (Peoples Liberation
Army) to knock on any persons door and take 100% of what that Chinese citizen
owns to pay down the government debt if so needed.
A wealthy Chinese citizen that has accumulated lots of Yuan,
urgently wants to convert his or her savings to U.S. dollars that are held
outside the country. That is why 25% of Vancouver, Canada population is Chinese
and why Vancouver real estate is double what house prices should be there.
For the well off, it is not about making money in China, its
about getting it out of CCP control. Thats analogous to U.S. corporate share
buybacks which are not about making money for stockholders; its to boost the
stock price so that insiders can cash out of their warrants and stock options
with a hefty profit.
Rhetoric became reality last year, from Andrew Batson (head of
research at Gavekal Dragonomics
in Beijing) is the only phrase about China you need to know and remember.
We had a deepening slowdown in the (China) domestic economy
last year and unprecedented pressures on the external front from the trade war
with the U.S. In the face of all that, the Chinese leadership actually did very little, Batson added.
..
.................
Closing Comment and End Quote:
It took 72 years for the USSR to fail. [See The
Collapse of the Soviet Union]
The U.S. began its decline in 1971 48.5 years ago when Nixon
took the U.S. off the Gold standard.
Deng Xiaoping began changing
China in 1978. He is totally responsible
for Chinas economic success. His quote
speaks volumes:
Absorbing foreign capital
and technology and even allowing foreigners to construct plants in China can
only play a complementary role to our effort to develop the productive forces
in a Socialist society. Of course, this will bring some decadent capitalist
influences into China. We are aware of this possibility; it's nothing to be
AFRAID of.
Deng Xiaopings meaning was
that China can change very quickly. It
will be interesting to see if any change will result from the sham trade deal.
Good luck and till next time
.
The Curmudgeon
ajwdct@gmail.com
Follow
the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has
been involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor
Sperandeo is a historian, economist and financial innovator who
has re-invented himself and the companies he's owned (since 1971) to profit in
the ever changing and arcane world of markets, economies and government
policies. Victor started his Wall Street
career in 1966 and began trading for a living in 1968. As President and CEO of
Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and
development platform, which is used to create innovative solutions for
different futures markets, risk parameters and other factors.
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