Wednesday, May 23, 2012

The Risk of Financial Instability in China

The early stages of the crashing Chinese economy have becoming more evident. Patrick Chovanec, a professor at Tsinghua University's School of Economics and Management in Beijing, China, who is following economic and financial developments in China closely, reports:
In my debate with Andrew Batson in The Guardian in March, I noted that:

There really are two related but distinct things people have in mind when they talk about a “hard landing” for China. The first is a rapid deceleration of GDP growth – below, say, 7%. The second is some kind of financial crisis. I think we’re already seeing some signs of the first, and the second is a bigger risk than most people appreciate.

In my last several posts, I’ve focused on the former — the slowdown in China’s GDP growth. I want to switch gears here for a moment and call attention to a rather alarming story involving the latter — the risk of financial instability — which somehow slipped under most people’s radar screen.

In early April, Caixin magazine ran an article titled “Fool’s Gold Behind Beijing Loan Guarantees”, which documented the silent implosion of Zhongdan Investment Credit Guarantee Co. Ltd., based in China’s capital. “What’s a credit guarantee company?” you might ask — and ask you should, because these companies and the risks they potentially pose are one of the least understood aspects of China’s “shadow banking” system. If the risky trust products and wealth funds that Caixin documented last July are China’s equivalent to CDOs, then credit guarantee companies are China’s version of AIG...

[T]he Zhongdan episode — which I’m amazed hasn’t attracted more attention and concern — illustrates the kind of hidden risks that have developed in China’s financial system, to which bank and regulators have been willing to turn a blind eye in order to meet the insatiable credit demands of investment-led GDP growth.
The "insatiable credit demands" are the result of earlier money printing by the People's Bank of China, printing that climbed over 30% on an annualized basis. Now, with the PBOC printing at a much slower rate, the manipulated financial and economic structure is collapsing, as would be expected by those who understand Austrian Business Cycle Theory.

It appears we are in the early stages of a great unwinding in China. What will be at China's unwound core, given also the political instability, is yet to be determined. Will free market influences prevail or will central planning sweep the nation? The cookie that will tell us China's fortune has not yet been opened.


  1. Historically, the Chinese are so paranoid about maintaining order and avoiding chaos yet they contribute to the seeds of their own destruction by inflating. They are a long lived society that could have patiently used their enormous saving population to fund their growth. And they chide the West for being short-sighted.

  2. If China unwinds, so to does its support of the global economy in terms of playing the role of a major lender. The world's central bankers will be faced with the prospect of a global depression that could easily exceed that of the 1930s depression. What makes the thought of depression even worse is the fact that so many people around the world today depend on their government for their survival. This was not the case in the 1930s depression where the welfare state in most countries was still in its infancy. Here in the US the only welfare scheme that existed at the start of the AGD was unemployment insurance.

    Because of the dependence of so many people on welfare schemes/government employment/government contracts, the policy makers will have no choice but to inflate on a massive scale to avoid all out civil war. My guess is that they will let us go over the edge of the cliff before intervening. My plan, as it was in January, is to buy as much gold, silver and oil as I can when prices collapse.

  3. "In which case, forget about Greece and the euro. China’s capital outflow problem is the real ticking time-bomb for markets."

    But what happens if the strategy fails? What happens if foreigners decide the last thing they want is yuan exposure (due to China economic bubble fears), and would much prefer to keep hold of their US dollars?

    What happens if instead of a dollar inflow you get a mass capital outflow from China, with as many Chinese as possible converting yuan-denominated assets into dollars, seeing the yuan fall in value versus the dollar due to what is now an over-valued position?

    Recent developments in offshore/onshore markets and forward markets, unfortunately, seem to suggest this is exactly what’s happening.

    In other words, the bluff is not working.

    As Michael Derks, chief strategist at FXPro noted on Wednesday:

    "Overnight the Chinese currency has continued to lose ground against the dollar, with yuan forwards declining to a four-month low. The explanation for the continuing softness in the renminbi is twofold – the dollar is in high demand at a time of enormous uncertainty over Europe’s future, and domestic economic conditions in China have been much weaker than expected."

    "Twelve month NDFs are trading at a 1% discount to the onshore spot rate, which implies that the forward market expects a depreciation of the yuan over the next year. As we noted in an extensive blog piece yesterday (More RMB depreciation cannot be ruled out), capital outflow from China has been accelerating in recent weeks, with the likes of the dollar and sterling the major beneficiaries. This capital outflow is likely to be in evidence for some time."

    In which case, forget about Greece and the euro. China’s capital outflow problem is the real ticking time-bomb for markets.

    If China fails to plug this problem sharpish, the world’s biggest put option — the China growth story — could quite genuinely come undone.

  4. Could someone please explain to me how the above China Instability Risk post relates to the post earlier this week with regard to China going directly to Treasury/Fed (cannot remember which)to purchase US Treasury bills? Also, China has for some time now supposedly cut way back on its purchase of US Debt, so I cannot wrap my head around what difference it would make to pay the Primary Dealers a higher rate or illegally go straight to Treasury to get a discounted rate if you are, in fact, slowing or even stopping your purchases to begin with.

    And....what is the strategy long term if China is crashing anyway? That China own the US and therefore, dictate or usher in the One World Govt scenario over us all?

    Thank you for any clarification anyone can provide.