Sunday 10 July 2011

Head In The Sand

We are reading all sorts of news that China is headed for hard landing.

Recently Standard Chartered Bank, Singapore, in its report has warned that local government’s debt in China could possibly trigger a credit crisis. However, from the data obtained from the People's Bank of China, the central bank, there are more than 10,000 financing vehicles set up by local governments, with a total debt of 14.4 trillion Yuan (US$2.22 trillion), or 30 percent of the country's outstanding loans denominated in Yuan -- much higher than Standard Charterer’s estimate of 10 trillion Yuan (US$1.54 trillion).

The Chinese official auditors are warning that there are significant repayment risks from 2,746 out of2,800 local bodies. That is 98% of all financial bodies in China!

Moody’s Investor Service identified an additional 3.5Tn Yuan ($540Bn Dollars) that was not mentioned in the NAO report.  Moody’s explains, “The potential scale of the problem loans at Chinese banks may be closer to its stress case than its base case, according to an assessment that the rating agency conducted following the release of new data by China's National Audit Office. “When considering the apparent absence of a clear master plan to deal with this issue, Moody's also views the credit outlook for the Chinese banking system as potentially turning to negative. ‘We assume that the majority of loans to local governments are of good quality, but based on our assessment of the loan classifications and risk characteristics, as provided by the NAO and other Chinese agencies, we conclude that the banks' exposure to local government borrowers is greater than we anticipated,’ says Yvonne Zhang, the author of the report and Moody’s vice president.

We are now faced with few simple facts about Chinese economy :

·         Chinese economy is totally export dependent. When the economy of US and Europe starts to slow down, which they are now, Chinese will find it hard to continue the fantasy accounting.
·         The domestic economy in China is centrally planned and the central planners are trying to keep people engaged to construction. They are making massive cities, housing and other infrastructures which are not much in use. In the process, the local bodies are piling up huge debts.
·         With inflation rising above the comfort zone, China has already increased its reserve ratio for the banks and increased the rate of interest. That will take out the extra liquidity from the system and stagnate the economy. When the growth in GDP is below the growth in debt, there come systemic risk to the economy, as we are seeing all over the world. China is no exception.
·         The financial reporting system in China is very suspect, to say the least. If we consider the CPI and labor force reports coming out of USA as manipulation by FED and US Govt. Can you imagine what is coming out of China? We should immediately discount every report by 50% to the downside, because the life of the small local governments in China very much depends on generating good report for the politburo.
·         When the 2008 economic crisis hit the world, China survived by spending on its infrastructure and construction projects which were either not needed in the economy or just created ghost cities and underperforming assets. The law of economics is now catching up.

So the fact remains that US Economy is slowing down, Europe is on the brink of financial contagion risk and China is ready for hard landing soon. What effect it will have on the stock market? I think in short term the Stock Market will go up. That is because 90% of the volume is coming from day traders and momentum chasers, as well as yield hungry funds of all kinds, who are now taking huge risk by being long in such situation. The objective of the black box traders and manipulators is to suck out  all the money that are sitting on the sideline.

The smart money knows these and I think they are ready for the flight. It’s only the last minute efforts going on to grab as much as possible. We shall see stock markets in the world, more so in USA, rise to its highest level in the next few months.  The news media in USA and world is price driven. So when they see the stock prices going up, people forget the structural problems and just jump in the buying frenzy. We are about to see that buying frenzy from 3rd week of July till end of August. That is when the smart money will sell high.

I think the lights will be turned off very soon but not just yet. We shall see.

1 comment:

  1. In your post you are saying that recently Standard Chartered Bank (Singapore) in its report has warned that local government’s debt in China could possibly trigger a credit crisis. But it did not happen. This is not the first time I get myself to think that some news are being created on purpose. As for this one, it encourages people to go and apply for a credit or even apply for payday loans. This is not a good way of making a business. There has to be at least something honest about people treating each other nicely.