“The China Issue” – Bond defaults continue to climb as credit tightens – Anonymous speculators
Many longtime readers know that I have been skeptical about the Chinese economy for a few years now.
And while the mainstream financial media didn’t care much about China’s economic future – I still do.
This is because China’s growth is extremely important for the global economy (especially since 2008). He has more or less door the global economy.
(Note that via the ‘locomotive effect‘ – a key theory in macroeconomicss – Chinese economy overwhelmed the United States as the engine of marginal growth after 2008. Meaning: Due to China’s economic scale and above-trend growth – their boom and bust cycles drag the world with them).
But – after years of gorging on cheap debt, over-reliance on investment-driven projects with steadily declining returns, and a rapidly aging population – China’s economy has grown more and more. more brittle.
So – to put it simply: I believe the Chinese economy has grown very out of balance. And approaching deflation tipping point – much sooner than many realize.
Let me explain. . .
Due to over a decade of easy money – thanks to the world center banks – governments and companies around the world are stuffing themselves with cheap debt (especially emerging markets).
And so – 11 years later – China’s debt levels have soared to the upper among the major emerging markets. . .
And to make matters worse, it now appears that China’s domestic debt has reached a point where it may no–longer be safely supported by simply ‘rolling over’ maturing debts (aka refinancing).
For example, in the first five months of 2021 – Chinese companies have already missed 99.8 billion yuan ($ 15 billion) in on-shore bond payments. (And defaults on offshore dollar-denominated bonds have also climbed $ 4 billion in the first three months of 2021 – already half of the total for 2020).
Now – not only is it the the biggest missing balance on file. But it is also the fourth consecutive year Chinese companies failing at least 100 billion yuan of bonds. . .
And while most of these defaults (over 25%) were from real estate and real estate development companies – it looks like things will only grow more and more fragile for the over-indebted sector while the Chinese authorities still restrict access to credit. (Meaning: at a time when real estate and real estate companies need easy money to refinance old debts – they are cut).
In fact, this brings us to the the biggest problem facing China’s leveraged economy. . .
Simply: Chinese authorities have raised concerns about the burden of domestic debt, asset bubbles, shadow banking and excessive speculation. Thus, they recently adopted stricter financial policies in an attempt to limit these risks. (Aka, they’re trying to slowly deflate asset bubbles and deleverage enough before a black swan event occurs).
And we already see this financier ‘contraction’ happen. . .
For example – a report in April showed that the People’s Bank of China (aka PBoC – Central Bank of China) urged domestic and foreign banks to continue limiting any major new lending in 2021.
To put this in context: If banks listen to the PBoC and lend at roughly the same rate as last year, it would cause credit growth to slow to a level. Lower for 15 years. . .
But – what is more serious is that China six and twelve months “Credit impulse” – a key leading indicator that measures the change in new loans issued as a percentage of GDP – are now both negative.
(Note that – historically – China’s credit impulse signaled the onset of the two ups and downs for economic growth and various asset classes. And since China is now the engine of global growth – when they sneeze, the whole world catches a cold).
The most significant element of this decline in the credit impulse was how quickly it happened. It just took seven months go from peak to negative – much less than previous cycles).
What does that mean?
Well, this indicates that the Chinese economy could slow down significantly over the next few quarters, and could last until mid-2022. (And with it – the demand for the main commodities).
Or – in other words: due to tighter credit policies in China – bond defaults can rise at a time when growth is slowing. This greatly increases the risks of negative tail (aka black swan events) and the possibility of triggering a wave of deflation across the world. (China consumes a huge amount of energy and raw materials – so any slowdown would have a negative effect on these sectors).
So in summary, the Chinese economy is far more fragile than the traditional financial media suggest.
Years of easy money have allowed the Chinese economy to grow aggressively, leaving companies gorging on cheap debt.
But – as we have seen time and time again – once the credit starts contraction, downside risks significantly grow.
(Note that Chinese companies were already struggling with sour debt for years before any tightening. So I imagine it will only get worse in the future).
Keep in mind that the situation in China is strangely similar to Japan in the 1980s and 1990s.
Like China today, Japan has built its economy by focusing on its export sector and domestic investment projects (shopping malls, apartments, infrastructure, etc.).
And during the boom years, the Japanese economy also very extended credit – allowing domestic firms to take on debt cheaply.
But overtime – as credit tightens – a big chunk of that investment and debt embittered.
Adding salt to the wound – asset prices and investment returns have plunged as well. To subject creditors and banks to heavy losses – thus triggering credit downgrades. What he did After difficult for debtors to raise funds.
And so on. . .
Eventually – Japan had to endure (to this day) a decades-long deflationary bust because of the enormous deleveraging that was to occur.
Now is China like Japan? No. This does not mean that there will be a repeat crisis.
But it is important to note the similarities. And that historically – prolonged periods of credit expansion have almost always come at a high price. . .
To date, it remains to be seen whether the U.S. economy (which has been fueled by significant liquidity) can grow enough to offset China’s tightening. (Not to mention the continuing global post-COVID boom doesn’t hurt).
But – still – I think the Chinese economy is approaching a tipping point. Especially since more and more debt is maturing as credit growth tightens (creating stress).
And any slowdown in China would most likely trigger a wave of unintended consequences across the global economy. and financial system.
Well, only time will tell.
PS – with the market expecting higher growth from China, I think there is a contrarian opportunity. So, I am using the option to shorten China. Check Anonymous Speculators: Premium for more information.
PPS – I highly recommend these of them underestimated books on China’s fragile economy. “The great rebalancing” by Michael Pettis + “China: the bubble that never bursts” by Thomas Orlik