Tuesday, June 30, 2009

China Poised for Crash and Burn

Abrose Evans-Pritchard reports that all is not as well as it seems in the Orient:

Fitch Ratings has been warning for some time that China's lenders are wading into dangerous waters, but its latest report is even grimmer than bears had suspected.

"With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary," it said.

"Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear."

"Able to bear," as in, financial collapse a la Iceland. China apparently chose to take extraordinarily loose monetary policy to deal with the economic slump, reducing the interest rate paid on reserves held with the central bank while simultaneously flooding the markets with freshly printed currency. Which means that if banks didn't lend their money out, they would be eaten alive by inflation. Naturally, banks obliged, lending far more than would be rationally advisable:
Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate.
The motive?
The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a "massive lending spree".
This, of course, is completely foolish. As I predicted some time ago, China should experience a very, very severe contraction, having committed itself to the consequences of mercantilism long ago:

China's Banking Regulatory Commission fired a warning shot last week. "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy," it said.

Unfortunately, 40pc of the "real economy" consists of exports, mostly to the US and Europe, the consequence of a mercantilist export model that has crashed and burned. Chinese exports were down 26pc in May.

When 40% of your economy is down 26%, it's tough to break even, let alone show growth. Even if their domestic economy matched last year's product, they would already show the 10% loss I predicted way back when. But it is going to be tough to do even that when such an enormous fraction of your workforce has gone unemployed. And again, I note: this contraction has occurred despite the extraordinary actions taken by the Chinese government and governments across the globe to combat it! So maybe a few of my predictions for contraction were overblown. At least I got the direction right. My wife asked me a year or two ago when I would invest in Chinese stocks, back before the Olympics when their stock market was still on a tear. I told her "when Shanghai burns." It looks like that day might not be too far away. Not sure I'll still be a buyer, though. Poor fellas. They have some serious problems. Unfortunately, the solutions proposed by nearly all audible voices are the same, pathetic, horribly incorrect drivel:
Reformers know what must be done to boost consumption. China needs a welfare revolution. But creating a social security net takes time, and right now Beijing is facing a social crisis as 20m jobless workers retreat to the rural hinterland.
Sad, sad, sad. This is not going to get better any time soon. "Green-shoots?" Ha!

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