Home » Economy » What Blows Up First? Part 4: China

What Blows Up First? Part 4: China

by John Rubino on February 18, 2014 · 8 comments

To Westerners, China has always been a mystery. The huge population of very smart, hard-working people. The succession of unfamiliar, authoritarian governments. The sense that they’re playing the long game while we’re obsessed with quarterly reports – and that they’re laughing at our naiveté and lack of historical sense. We don’t get the Chinese, but we’ve always been impressed with them.

Never was this more true than in the past decade. While the developed world flailed around, trying to figure out how to pay its bills now that new debt no longer automatically translates into new paper wealth, China seemed to be the country that got it right. A dictatorship, sure, but a capitalist dictatorship, ordering its citizens around in the cause of economic development. Their numbers might be unverifiable, but one couldn’t deny the reality of all those skyscrapers and roads and power plants.

But now it turns out that China was behaving just like us, albeit more secretively, borrowing like crazy and investing more-or-less randomly. And, like us, they’re discovering that randomly investing other people’s money carries some risks. Two long articles that cover China’s plight in some detail were recently posted by Mike Shedlock and Automatic Earth.

In the meantime, here’s the short version:

In 2008, when the West – the biggest market for Chinese goods – appeared to be imploding, China began using its vast foreign exchange reserves and borrowing power to build truly amazing numbers of skyscrapers, roads and airports, among many other things. At the same time, it encouraged the creation of a “shadow banking system” of local/regional development agencies and investment funds that could borrow and lend more-or-less off the books. The result of this stealth QE was even more new debt than the U.S., Europe and Japan were taking on, something like $15 trillion in five years.

Now a growing part of that debt is going bad and China is not sure how to fix it. They’re bailing out some of the more serious insolvencies while trying to rein in the shadow banking sector. But it’s not working. Bank lending soared in January, even while the list of potential problem borrowers lengthened. Apparently the coal companies are in especially bad shape.

So what does this mean for the rest of us? Since China was thought (rightly, as it turned out) to be one of the engines pulling the global financial system back from the abyss, how would a financial crisis there affect, say, the S&P 500 and Treasury bonds? The logical answer is that “risk on” would switch to “risk off” overnight, sending stocks down and Treasuries, as the last financial safe haven, way up.

Precious metals are a trickier call. China has been a huge buyer of gold, so presumably a crisis would lead it to buy less. On the other hand, if safe havens are back in style, then a suddenly-terrified world might more than make up for China’s lower demand. Gold certainly looks better than growth stocks for the early part of such a crisis.

And then, of course, there’s the question of how the Fed, ECB and Bank of Japan will react to China’s problems spreading to the developing world. Almost certainly they’ll double down on their current debt monetization policy (or in the case of the ECB, join that party). In the past this has sent the leveraged speculating community back into “risk on” — which is why the world is in the current mess.

Someday, the markets will see such policies as the acts of desperation that they clearly are. This might be that time, or it might not. We’ll only know in retrospect.

The previous articles in the “What Blows Up First?” series:
Europe
Japan
Subprime Countries

  • Bob

    Am sick of trying to time this thing, best just to stack and forget. One day the herd won’t reflexively move to treasuries.

  • Selaretus

    What the world, the Oboob administration, and the Fed don’t get: if we do not manage permanent compressive contraction, it will manage us.

    • hum4me

      I am afraid that they have already missed their cue. the signs are there, when the criminals get rewarded, and honesty gets jail time, what else is there to wait for?
      We can only attempt to outguess their moves. I do believe that they are working towards that one world currency and order. Who is going to lead it? Surely not the liar in Chief.

  • pipefit9

    This whole series on ‘what blows up first’ is certainly interesting for those of us that study finance and monetary matters. However, considering the great degree to which the entire world’s economy is intertwined, it matters little which domino falls over first. They will all be on the floor with a few seconds of each other.

    There would appear to be two possible scenarios going forward. The one presented by John R. seems to be that these bank masters are holding things together with financial duct tape. At some point, the edifice will be too large to be held together in this way, and it will all come crashing down into new Dark Ages, assuming it doesn’t end in nuclear war.

    The other, equally likely scenario (IMHO), is that the sheeple are being prepared for a one world govt., including a single global currency. They will let the global economy collapse, or induce it to so. Then, as the cacophony grows to ‘do something’, they will, lol. The bankers will be seen as heroes for ‘saving’ the planet, lolol.

  • Bruce C

    It’s hard to say if it’s a compliment or an insult that the “very smart, hard-working” Chinese have behaved just like us. In fact, not only has the Chinese version of centrally planned capitalism included unregulated “shadow” banking but the monetarists also think that the best way to reign in sub-prime credit growth is to bail-out the most egregious insolvencies. No wonder bank lending has only increased as a result; what have they got to lose?

    So, assuming that Chinese central planners continue to follow the wisdom of all other central planners every where and every time, the POB will continue to buy up bad debt so the prodigal “banks” and investors don’t have to take any hits.

    If so, this time may be different: That may not be considered a financial crisis any more. After all, investors should be pretty inured to this by now. The BOJ started doing it in the early 90’s to avoid corporate and banking bankruptcies, the Fed started doing it in 2008 for similar reasons, and what else could explain the rising European stock and bond markets if not for the assurance that the ECB would do whatever it takes to save the euro? So, if slow-poke China’s central bank starts to play ball too then history would suggest a “risk-on”, ‘got my back’ relief rally rather than “a flight to safety.”

    But I don’t mean to imply that gold/PMs would not take off. On the contrary. I think China will continue to buy gold no matter what, and maybe even faster if the POB balance sheet starts to swell. Besides that being perhaps the best thing China could do with new yuan or dollar reserves, we’re also talking chump change to boot. A metric ton of gold is about $42 million at today’s prices, so 2000 tonnes (supposedly its current annual consumption) is only about $85 billion, which was about 1/12th of the annual monetization of the Fed last year, and about 1/4th that of the BOJ, and it’s only 0.3% of its own debt level. Peanuts.

    The bottom line is that PMs should rise from here no matter what happens next.

  • Perplexed

    And you’re only figuring this out now? Have something to sell?

  • Pingback: John Rubino weighs in on the Chinese debt plight

  • Digby Green

    Did the Chinese only begin building skyscrapers in 2008 ?
    I don’t think so.
    China’s foreign reserves keep going UP.
    China also invested in roads, bridges, railways and ports – useful infrastructure, while the US let its infrastructure fall further into disrepair – remember “shovel ready!’”


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