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Consensus Forming: China Heading Back Into Financial Crisis

China’s historic post-2009 debt binge flew largely under the radar — fooling most observers into thinking the global economy was recovering rather than just re-leveraging.

Now Beijing is back at it, borrowing over $1 trillion in this year’s first quarter, buying up commodities and creating the illusion of global growth. But this time the scam hasn’t gone unnoticed. Reporters, editors and money managers seem, at last, to be catching on. Some representative headlines:

George Soros warns of credit crisis in China

Chinese cities dive back into debt to fuel growth even as defaults rise

China debt climbs to US$25 trillion

China’s banks cut bad debt buffer as profits flatline

Doug Noland, meanwhile, goes to the heart of the problem in last night’s Credit Bubble Bulletin:

I recall an early-1998 Financial Times article highlighting the explosive growth in Russian ruble and bond derivatives. Not only had the “insurance” market for risk protection grown phenomenally, Russian banks had become major operators in what had evolved into a huge speculative Bubble in Russian debt exposures. That was never going to end well.

There was ample evidence suggesting Russia was a house of cards. Yet underpinning this Bubble was the market perception that the West would not allow a Russian collapse. With such faith and the accompanying explosion in speculative trading, leverage and a resulting massive derivatives overhang, any break in confidence would lead to illiquidity, panic and a devastating bust. Just such an outcome unfolded in August/September 1998.

From a recent Financial Times article: “The [Chinese] market for pledge-style repos — short-term, bond-backed loans — is currently bigger than the stock of outstanding debt”. Within this undramatic sentence exists the potential for a rather dramatic global financial crisis. And, to be sure, seemingly the entire world has operated under the assumption that Chinese officials (and global policymakers in general) have zero tolerance for crisis – let alone a collapse. So Credit, speculation and leverage have been accommodated – and they combined to run absolute roughshod.

The Financial Times article includes a chart worthy of color printing and thumbtacking to the wall: “China’s Use of Bonds as Loan Collateral Rises Sharply”. The pink line shows “Onshore Market Bonds” having almost doubled since mid-2011 to about 40 TN rmb ($6.17 TN). The Red Line – “Pledge-Style Repos” – has ballooned four-fold since just early 2014 to surpass 40 TN rmb. So basically, in this popular market for inter-bank borrowings, borrowing banks have pledged bond positions larger than the entire market as collateral for their (perceived safe) short-term borrowing needs.

China repos April 16

China has an historic Credit problem. It as well suffers from an unfolding “money” fiasco of epic proportions. My analytical framework attempts to differentiate the two, as each comes with its own set of (related) issues. A Credit Bubble is a self-reinforcing but inevitably unsustainable expansion of debt. Money (the contemporary variety) is a financial claim perceived as a safe and liquid “store of nominal value.” Importantly, systemic risk expands exponentially when risky borrowings are financed by an expansion of “money-like” instruments/financial claims. This typically occurs late (“terminal phase”) in the Credit Bubble Cycle.

If the critics of China’s recent let-it-all-hang-out financial excess are right, a crisis of some sort is coming to a market near you. For instance, a fair bit of that Q1 $1 trillion went to boosting Chinese stockpiles — and therefore the price of — oil…

Oil price April 16

…and other commodities like iron ore. From More iron ore price madness as China’s mom-and-pops pile in:

On Friday the Northern China benchmark iron ore price jumped to $65.20 per dry metric tonne (62% Fe CFR Tianjin port) bringing gains since Wednesday to 7.8% as commodity investment fever grips Chinese investors. Last week iron ore hit a 16-month high following an 11% jump over just two trading days according to data supplied by The Steel Index.

The steelmaking raw material has enjoyed a 52% rise in 2016 and a 76%-plus recovery from nine-year lows reached mid-December. On the Dalian Commodities Exchange the price swings are much wilder.

Iron ore April 16

Despite a clampdown on rogue traders, higher margin requirements and trading fees, circuit breakers on Dalian iron ore futures to curb excessive price movement were triggered for the umpteenth time on Friday. That’s despite the exchange in northeast China “temporarily” upping the daily price change limit to 6%. The most traded contract ended Friday at its highs, exchanging hands for 462 yuan or $71.40 a tonne, duly up 5.97% on the day.

Based on supply/demand fundamentals, oil and iron ore remain in massive gluts. So when China’s stockpiling ends — as it mathematically must — these markets will lose a lot of their exuberance. The question then becomes, how many speculators will default on their loans, and what kind of banking trouble will ensue? That’s unknowable, but it’s safe to assume, given the numbers involved, that the rest of the world will find it distressing.

So think of today’s relative calm as the eye of yet another storm, and what’s coming as a return to the hyper-leveraged new normal.

15 thoughts on "Consensus Forming: China Heading Back Into Financial Crisis"

  1. If the “consensus” is that China is “…. heading back into financial crisis” we can be fairly certain the “crisis” is nearly over and / or resolved.

  2. Ok so we know what’s gonna happen now we can add to it what they actually want to achieve in the long-run: China may be seeking to back their SDR participant currency with gold. This is why they are hiding their real reserves (source: http://independenttrader.org/why-china-hides-their-gold-reserves.html) and buying the amount of annual global production (source: http://independenttrader.org/trader21-lecture-presented-at-fx-cuffs.html 01:14:30). Not to mention that if you say yuan appreciated in dollar terms you also have to add that dollar index is showing how overpriced Franklin’s are. If this is not enough check commodities (negatively correlated with USD) being the cheapest since 1974: http://independenttrader.org/commodities-cheapest-since-1974.html

  3. Hello Mr. Rubino,
    As you may remember I am a bit of a contrarian. I truly believe that China is deliberately trying to Crash the system at the most opportune time, which begs the question, “When is the most opportune time?” I think we will see it in the next few months. We are currently exiting a super cycle and when go into another super cycle around the beginning of the third week of July and it will run until the end of the second week of October. I anticipate that it will happen during this time frame.

    Why crash the system? to do away with the dollar in order to introduce a gold backed alternative.

    Have a great one,
    CC

      1. Hi SD3,
        There may or may not be an election but if there is and a president is voted in the Chinese and Russians won’t care one way or the other. They will continue buying and selling within their respective spheres of influence and wait 12-18 months to attack the US. By that time 90% of the residents of America will be dead. Half will die within the first 3 months in the initial wave of violence. Many will die when their supply of meds run out. After 10-12 months the population in the US will stabilize somewhere around the 30 million mark so I don’t see the bear and the dragon waiting much longer than that.

        Please don’t misunderstand; every nation in the world will be affected but the US will be decimated because it has nothing to fall back on. Russia and China have been buying gold by the tons each month and we (US) have been stupid enough to sell it to them.

        Just my opinion though.
        CC

        p.s. I buy precious metals: gold, silver, lead and brass. LOL

        1. Whoever is left….. will be badassed ……. and healthy…… probably gang/tribal ……….. the herd will be culled
          No more “safe spaces”

    1. In the past, crashing the stock market would give the people in the know to buy assets at a bargain. They know the banks will be given free money by Fed called liquidity. This time Fed cannot print the kind of money to rescue the system. Fed is already in the market and the amount of money given to banks could be in the trillions. The world was rescued from the last recession by Fed printing in excess of tens of trillions of $ and China going into more than US$20 trillion in debt. For Fed to come to the rescue at the next recession will crash the US$ and the US$16 trillion in foreign countries will come washing back to US shores. The next recession will require more than 10 times the amount of money required in the 2008 crash.
      China can easily sell their debt when they are able to reprice gold at 10 times the present price. I do not want to put the value in US$ as the value of US$ will plunge if the value of gold go up rapidly. China will use the same template, hopefully, as the US did after WWII to fund all countries to rebuild their economies when US$ crash. It is a win win situation. To fight WWIII will be a lose lose situation and there is nothing left to rebuild. To recapitalise the financial world, gold price will have to be repriced for any credibility of any currency.

    2. Why do you (and so many) give China so much credit ? They don’t have everything figured out and their economy is a centrally controlled one based on debt issuance (not unlike the US but that’s partly my point). They, like Japan and Russia (but for different reasons) are worse off than the US. If the SHTF everybody will get splattered. Most countries depend on the dollar, and dollars are needed to settle most debts. Gold is great but you will need to buy dollars to pay down debt, and that is what would support it. It’s like why the yen has rallied recently, because even though it’s a s— currency so much yen was borrowed in the “global carry trade” that yen is being bought now to settle yen-denominated debts.

      1. Hi Bruce,
        I don’t know about others but I give them a lot of credit because I worked against them while at NSA for 8 years. (Most of my career was spent working the middle-East) They are strategic thinkers. A short term plan for them is 10 years. A long term plan is multi-generational. WHat is happening in the South China Sea and the Senkaku Islands has been in the planning since the 1940’s. Also, you talk about open markets and closed markets but open markets, which we no longer have in America, are in the minority. China, and most nations of the Middle-East and Russia have been authoritarian nations for hundreds of years if not millennia. Look what happened to Iraq, Afghanistan and Libya after we took out the authoritarian regime. China is the same way, only they have functioned as an authoritarian government for millennia. America is only just now getting a taste of authoritarianism. You cannot use an upstart, newby nation like America to judge China.

        There are numerous other reason why I give them credit but I boiled it down to the basics.

        Have a great day,
        CC

        1. Finally! Someone else “gets it” . The Chinese are described as “inscrutable” for a reason and no one seems to completely comprehend what that REALLY means.

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