China: ‘A Financial Collapse of Unprecedented Magnitude’

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Before we get into today’s Daily Reckoning – and there’s a lot to get in to – if you missed it yesterday check out this video on our upcoming conference, World War D: Money, War and Survival in the Digital Age. We’ll have more from one of our keynote speakers, Jim Rickards, below.

Wow. Where do we start?

The S&P500 surged overnight (along with just about everything else) to new record highs. It peaked near 1,860 points around midday, but couldn’t keep its head up in such rarefied air. During the afternoon it sold off around 0.5%, for a still decent gain on the day of 0.6%.

But we reckon chartists might be a little unnerved about the intra-day moves. A spike to new highs and then a quick reversal isn’t exactly a bullish move. You may think that’s a dumb thing to say when the index is hovering around all-time highs. And you might be right. We’ve said some dumb things before.

But these sorts of moves can be ominous. So take heed. And besides, if you want a bullish view of the world you can always listen to our mate Kris Sayce. He reckons the ASX is on its way to 15,000 points. We think he’s gone a little bonkers, but different opinions are what makes a market, right?

And in our opinion the market has gone a little bonkers too. After selling off sharply in late January on concerns about the impact of tapering on emerging markets, the speculators have jumped right back in. Are they betting on no tapering? Is it a sign of complete confidence in central bankers to not let the markets fall more than, say, 10%?

We don’t know. But we do know it doesn’t make any sense.

Speaking of central bankers, the John Law of our time, Zhou Xiaochuan (boss of the People’s Bank of China) said at the G20 conference in Sydney that China is aiming for economic growth of 7-8%. Because everyone implicitly believes every word uttered by a central banker, no doubt his comments went down well and caused another bout of ‘buy, buy, buy!’

As an aside, we refer to Zhou as the ‘John Law of our time’ because he’s overseen the expansion of the PBoC’s balance sheet to US$5.2 trillion (according to data from Yardeni Research). That compares to the Fed’s balance sheet size of around US$4 trillion and the Bank of Japan’s, which is around $1 trillion. Thanks to his determination to maintain a peg with the US dollar, Zhou has effectively printed like crazy.  

He’s still in the adoration stage, but for how long we don’t know. Despite his calm and assured rhetoric (a hallmark of a good central banker) things are approaching a tipping point in China. Yesterday, for example, data on property prices came out and Chinese stocks tanked. The property developers in particular took a beating.

The following chart, tweeted by Bloomberg’s Tom Orlik, shows that China’s property bubble is losing its momentum.

a
click to enlarge

Reuters reports:

‘China’s home price rises eased for the first time in 14 months in January, the latest sign that the government’s more than four-year campaign to rein in property risk may finally be starting to bite.

‘Average new home prices in China’s 70 major cities rose 9.6 percent in January from a year earlier, easing from the previous month’s 9.9 percent rise, according to Reuters calculations based on data released by the National Bureau of Statistics (NBS) on Monday.

‘It was the first slowdown in the rate of price increases since November 2012.’

The news saw steel and iron ore prices fall in China yesterday. Additional reports that banks were tightening credit to steel and other sectors related to the property market didn’t help sentiment. But you wouldn’t know it from the performance of the Aussie market yesterday. It completely ignored the Chinese data for a change and remained resilient. Perhaps ‘investors’ are just waiting for stocks to trade ex-dividend to bank the precious yield and franking credits?

Or maybe ‘investors’ have just lost their minds. From Bloomberg this morning:

‘Two things explain why the biggest gains in the U.S. stock market this year are coming from companies without profits, according to Jeff Mortimer of BNY Mellon Wealth Management: Greed, and fear of missing out.

‘Unprofitable companies such as Zynga Inc. (ZNGA) and FireEye Inc. (FEYE) are leading gains in the Russell 1000 (RIY) Index. The Nasdaq Biotechnology Index is up 25 percent in the past 10 weeks, the most since February 2012, data compiled by Bloomberg show. Less than a third of its 122 companies earned any money in the last 12 months. Marijuana shares, which trade on venues with less stringent reporting requirements, are among the most active.

So we have the world’s second largest economy on the brink of a major credit crisis, a US economy still giving mixed economic signals and the Federal Reserve intent on slowly withdrawing liquidity…meanwhile emerging markets are slowing down and social tensions are on the rise.

And the response to this is to buy stocks hand over fist with no concern about earnings? Or in Australia’s case, buy property in the belief that it always goes up?

Well. We’re happy to bet against such lunacy. Speculating like this never pays off. You’ll look like a genius now, but a fool later. We’d prefer to look like a fool now…and less foolish later.

To end today’s Reckoning we’ll leave you with an excerpt from a recent article by Jim Rickards, keynote speaker at our World War D conference. He’s writing about China…and he doesn’t mince his words…

‘China is on the verge of a financial collapse of unprecedented magnitude. This is due to China’s policy of paying bank depositors low rates of interest in a manner similar to the U.S. Federal Reserve’s zero interest rate policy. These low rates send Chinese investors in search of higher yields elsewhere. Because of capital controls, Chinese citizens are not able to invest in foreign assets such as U.S. or Canadian stocks and bonds. The only investments available to most Chinese other than low-rate bank deposits are gold, real estate and so-called “wealth management products.” These wealth management products are offered by banks but are not guaranteed by them. Investor assets are pooled into the products and then invested in commercial projects with the proceeds shared among the investors.

‘The banks promise high returns on these products, which resemble the notorious collateralized debt obligations popular in the U.S. before the Panic of 2008. Actual performance on the wealth management products is below the promised returns in many cases. Banks cover this up by selling new products and using the proceeds to pay off the old ones. This is exactly how a Ponzi scheme operates.

‘Eventually some event such as a project failure or admitted fraud will start a panic in which investors demand that the banks redeem their wealth management products all at once. The banks will be unable to do so and will suspend redemptions on the products. Investors will claim that the products were backed by the banks but the banks will deny this. A run on the banks will commence that only government intervention and bailouts can contain. The result will be a general collapse in Chinese asset values for real estate, stocks and bonds as investors hoard cash, buy gold and move to the sidelines.’

Regards,

Greg Canavan+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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3 Comments on "China: ‘A Financial Collapse of Unprecedented Magnitude’"

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Jason
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Much of China’s woes also stems from demography and high oil prices. In 2013 China began running out of young people and it’s fertility rate fell to 1.3, but it goes unreported in Australia except, perhaps, a tiny column on page 16 or 18 in Murdoch’s Australian. China’s decline bodes ill for China’s vassal states like Australia and Canada. The United State’s ‘mixed signals’ is simple. America is in decline. America’s fertility rate is still declining, immigration is declining, emigration is slowly increasing, wages are declining, living costs are increasing, shale production is peaking, oil production is declining, bullshit from… Read more »
bob
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GOOD ON YOU MATE,
HIT IN THE MIDDLE OF THE BLACK….
By now it became just a bad joke, the delusions of aussies about their countries soverenity and standing, while at all times voting into power politicians that are selling them out on every turn…ha!
The Great Southern Province of China, formerly known as AUSTRALIA.
HA, you will sleep the way you made your bed!

Ross
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3 things 1. The Carry Trade – http://www.prudentbear.com/2014/02/curriencies-carry-trades-fat-pigs-and.html 2. Since the afforementioned report we have seen the Yuan weakness thing continue to run. Notable is that the reverse carry scenario for China primarily involves unwinding unofficial hot capital flows. We expect such opaque manners of investment to be correlated with even more opaquely collateralised USD debt positions that might unwind more messily than US mortgages, and rather likely an extremis derivatives expose. 3. The framework of how China might burn up or deflate in journalists minds always appears to be the external shock thing…. The reference points are all wrong… Read more »
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