China’s Credit Boom Krakatoa

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Ahh, St Kilda, we’re going to miss you. From Monday, Daily Reckoning headquarters moves to salubrious Middle Park. It’s a slight shift from the grunge and grime of Fitzroy Street.

Clearly, the locals must know we’re moving on. This morning, one thoughtful soul left a parting gift…a used syringe in the doorway to the office. Nice touch.

But drugs are all-pervasive in this day and age. Bernanke and Co are handing out syringes left, right and centre. The market is completely juiced up. The ‘market on drugs’ metaphor is an apt but crude one. Australian Small Cap Investigator editor Kris Sayce prefers to call it a ‘torrent’, and for the past few months he’s been identifying small-cap plays the he expects to get swept along in this ‘torrent’ of cash coming from global central bankers. He’s just identified another two. Click here for more.

Speaking of torrent, did you see the data on Chinese credit growth released yesterday? It was truly a sight to behold. We could be wrong, but we don’t think there has ever been a surge, torrent, or avalanche of credit as strong as you’ve seen in China over the past few months, EVER.

We’ll get to the details in a moment, but here’s the weird thing about it: it’s not doing anything for the stock market. And the economy is not particularly robust, at least not relative to what it was a few years ago. Have a look at the performance of the Shanghai Stock Exchange:

China’s Stock Market Yawns at Credit Surge

Shanghai Stock Exchange

After rallying strongly from December last year through to February, it’s corrected lower since then. Perhaps it will move higher from here, but the price action during the March credit boom is not encouraging.

So how about the March credit data? Well, the traditional banking sector created 1.06 trillion in new yuan denominated loans during the month, equivalent to about US$170 billion. But when you add in credit created by the shadow banking system, ‘total social financing’ hit 2.54 trillion yuan FOR THE MONTH. That’s US$410 billion, or US$4.9 trillion annualised.

China’s economy is around US$8.26 trillion, or US$12.4 trillion if measured on a purchasing power parity (PPP) basis. The March credit torrent then, if annualised, comes in at an astounding 60% or 40% (on a PPP basis) of GDP. Either way it’s massive and bodes ill for the future of China’s economic growth.

Put simply, you can’t have such rapid credit growth and expect the investments made from it to be productive. What’s keeping China’s economy ticking over is the ongoing flow of credit. But it will need to maintain an ever greater flow to keep the economy from sinking. China, more than any other economy, can probably keep up this facade for a while longer yet.

But the question is, do they want to? Can they afford to? China’s leaders must know they are on a ‘treadmill to hell’ (as Jim Chanos called it) and they must jump off sooner or later. They’ve talked the rebalancing game for a while now, but haven’t been able to engineer it.

They had a go last year by tapping on the brakes. It slowed things down more than they liked so the foot went back to the accelerator. Now, credit growth is getting out of control. We get the feeling China’s leadership is worried. They know they must rebalance but don’t want to because it will lead to a sharp economic slowdown. But they know that letting the boom run on will only lead to bigger problems in the future.

Even Glenn Stevens is a tad concerned. In a speech given yesterday called ‘Financing the Asian Century’ (what, the one where Japan blows up its currency, starts a trade war with its neighbours and ends up in a real war with China?) he commented:


‘In particular, concern has been expressed about the risks that may be growing in the ‘shadow banking’ system in China. In recent years, an increasing share of financing in China has been provided by non-bank entities and through banks’ off-balance sheet activities. In no small part, this growth in shadow banking reflects restrictions on both the quantity of bank credit, and controls on loan and deposit rates.

‘Such restrictions lead to demand for credit exceeding the formal banking sector’s ability to supply it, and also provide an incentive for savers to seek alternatives to low-yielding bank deposits. The Chinese authorities have introduced a number of measures to mitigate the risks, and many types of shadow banking activities in China are now subject to some regulatory oversight.

‘Hopefully, this will lead to a stable outcome. But China’s experience is one that others have had at various times: as long as there are incentives to by-pass the formal banking sector, the shadow banking system may keep on growing together with the risks.’

That’s central banker speak for ‘if you keep going down this path you’ll blow your economy up’.

For the Australian economy it’s a worry. It looks like we’re well past receiving the benefits of China’s monetary largesse. The unemployment rate is beginning to tick up. The high Australian dollar, a direct result of global central bank liquidity, is hurting a range of industries. In another blow to the resource sector, the Financial Review reports today that Woodside is likely to shelve plans to develop its $45 billion Browse LNG project in Western Australia.

Another point to consider in all this is the effect of US and now Japanese money printing on China’s economy. Along with the credit data released yesterday, we learned that China’s foreign exchange (FX) reserves grew to US$3.44 trillion, a jump of US$128 billion in the first quarter, the strongest since the second quarter of 2011.

This is probably directly related to the US Fed starting up it US$85 billion per month bond purchasing program. The Fed creates the money, but it can’t control where it goes. Some of it is clearly heading to China, providing fuel for China’s own credit boom.

It’s all to do with the US dollar-yuan peg. As the dollars flow in (and add to China’s FX pile) China must print yuan to hold its currency down against the US dollar. This money flows into the Chinese economy and creates all kinds of havoc.

And now China must contend with Japan’s monetary craziness. Right now, China’s looking like the real loser in this currency war. But don’t think the Chinese won’t retaliate. It’s only a matter of time.

We’re getting to a point where the three major global economies (US, China and Japan) are increasingly fragile. Two are resorting to the ‘printing press’ to get out of trouble. In a globalised system, this strategy creates all kinds of unintended consequences. One of those is an out of control credit boom in China.

This is all getting very dangerous…

Regards,
Greg Canavan
for The Daily Reckoning Australia

Join me on Google+

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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’s Credit Boom Krakatoa"

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slewie the pi-rat
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i would say, offhand, that China just needs to keep the checks in the mail, like every other fiat ‘regime’.
nothing more.
nothing less.
but here, the credit expando may be at least partially due to financing the change in “party” & “governance” “leadership”.
those morons don’t come cheap.
…or, go?

China certainly has its own gestalt [don’t we all?], but i’m talkin bout a universal human “trait” here…

…in slewienomics, this is jocularly remarked as: “noblesse oblige”.
or [following theMogambo, here]: “DOOM!!”

Ross
Guest
LGFV’s … http://www.reuters.com/article/2013/04/11/china-debt-local-idUSL3N0CXF8420130411 Maoism will make a return if LG’s don’t back their paper. Too scary to fail for the politburo. The Chinese remain the takers rather than the makers. The mercantile export boom can’t be replaced. Infrastructure spending in China was a patch that bailed out the west momentarily on the farcical expectation that Bernanke’s liquidity drops would work and restart western consumer demand. No Chinese thinks that peasants will stop saving and start spending beyond their means to replace mercantile exports as that economy’s driver. Re-educating the Chinese culturally Mao style was a flop despite all the slaughter… Read more »
x
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What is with syringes and Australia. Decades ago I traveled about OZ with a local woman. I still recall the time she adroitly pointed out the syringes laying on the ground in a parking lot …(OK, disclaimer …it was a Kings Cross parking lot). Still, I don’t see syringes laying about in U.S cities (Ok, another disclaimer … HUGE, various problems exist in U.S. currently. Acknowledged). Still …the question remains … WHY (even 20 years after my stay) are used syringes so prevalent on the ground in Ozzie cities? St Kilda … isn’t that the over priced, trendy waterfront section… Read more »
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