Commentary on Political Economy

Saturday 31 August 2019


Suddenly, it seems the entire world is waking up - in fright! - to the astounding lunacy of the Chinese Dictatorship and the Han Chinese genocidal evil empire, and to the reality of frail and crumbling economy. Now is the time to be relentlessly ruthless and ferocious to kill and slaughter the Han Chinese Dragon. Now is the time to action every lever, muster every bit of mettle and energy in us to destroy once and for all this cancerous growth on the face of the Earth! Onwards, my friends! Once more into the charge and let us slay these disgusting Han Chinese Rats!

This just in from the Financial Times:

Arthur Budaghyan yesterday

 The escalation of the trade conflict between the US and China has raised the likelihood of greater stimulus by Beijing to prop up the economy. While China’s excessive debt isn’t news, investors must wake up to the reality of “helicopter money” — enormous money creation by Chinese banks “out of thin air”. While this sugar rush may provide short and medium-term cover for investors, the long-term effects will exacerbate China’s credit bubble. China, like any nation, faces constraints on frequent and large stimulus, and its vast and still rapidly expanding money supply will produce growing devaluation pressures on the renminbi. When a bubble emerges we are often told that this bubble is different. Many economists justify China’s credit and money bubble and continuing stimulus by pointing to the nation’s high savings rate. But this narrative is false.

At its root is the idea that banks are channelling or intermediating deposits into loans. This is not how banks operate. When a bank expands its balance sheet, it simultaneously creates an asset (say, a loan) and a liability (a deposit, or money supply). No one needs to save for this loan and money to be originated. The bank does not transfer someone else’s deposits to the borrower; it creates a new deposit when it lends. In all economies, neither the amount of deposits nor the money supply hinge on national or household savings. When households and companies save, they do not alter the money supply.Banks also create deposits/money out of thin air when they buy securities from non-banks. As banks in China buy more than 80 per cent of government bonds, fiscal stimulus also leads to substantial money creation. In short, when banks engage in too much credit origination — as they have done in China — they generate a money bubble.

Over the past 10 years, Chinese banks have been on a credit and money creation binge. They have created Rmb144tn ($21tn) of new money since 2009, more than twice the amount of money supply created in the US, the eurozone and Japan combined over the same period. In total, China’s money supply stands at Rmb192tn, equivalent to $28tn. It equals the size of broad money supply in the US and the eurozone put together, yet China’s nominal GDP is only two-thirds that of the US. In a market-based economy constraints are in place, such as the scrutiny of bank shareholders and regulators, which prevent this sort of excess. In a socialist system, such constraints do not exist. Apparently, the Chinese banking system still operates in the latter. There are clear downsides. Helicopter money discourages innovation and breeds capital misallocation, which reduces productivity growth. Slowing productivity and strong money growth ultimately lead to rising inflation — the dynamics inherent to socialist systems. In the long run, more stimulus in China will entail more money creation and will heighten devaluation pressures on the renminbi.

As we all know, when the supply of something surges, its price typically drops. In this case, the drop will take the form of currency devaluation. As it stands, China’s money bubble is like a sword of Damocles over the nation’s exchange rate. Chinese households and businesses have become reluctant to hold this ballooning amount of local currency. Continuous helicopter money will increase their desire to diversify their renminbi deposits into foreign currencies and assets. Yet, there is no sufficient supply of foreign currency to accommodate this conversion. China’s current account surplus has almost vanished. As to the central bank’s foreign exchange reserves, at $3tn they are less than a ninth of the amount of renminbi deposits and cash in circulation. It is inconceivable that China can open its capital account in the foreseeable future.

If China chooses the path of unrelenting stimulus, investors should recognise the long-term negative outlook for the renminbi. Continuous stimulus will beef up investment returns in local currency terms, but currency depreciation will substantially erode returns in US dollars or euros in the long run. The investment implications go beyond Chinese markets. Market volatility over the past few months as the talk of stimulus picked up has given us a peek into the future. As the renminbi has depreciated by 12 per cent since early 2018, the pain has reverberated across Asian and other emerging markets. The MSCI Asia and MSCI EM equities indices have each fallen 24 per cent in dollar terms since their peak in January 2018. Long-term pressures could play out even more dramatically. Fortunately, Chinese authorities recognise these issues. Yet they face an immense task of stabilising growth while containing credit and money expansion. This will be hard to achieve in an economy that has become addicted to credit creation.

Arthur Budaghyan is chief emerging market strategist at BCA Research.


Michael Mackenzie 10 hours ago

 During the autumn of 2007, a bond manager from California popped into the Financial Times’s New York office with a timely warning after a long road trip through the then-frothy housing states of the US south-west. Lately, investors fresh from fact-finding missions to China and Hong Kong have voiced concerns that a major shift is playing out behind the smoke of trade tensions — a change that helps provide context for the massive rally seen in global bond prices over the past month. The mood across government bond markets reflects a dour outlook for the global economy and a need for owning insurance against a bigger shock for investment portfolios. This month’s clamour for long-dated government debt suggests that buyers reckon the recession clock is counting down to a day of reckoning, as it did in 2007.Historically, recessions take time to emerge, usually about 18 months, whenever bond markets send 10-year and 30-year yields below rates set by central banks and short-term government paper with a maturity of two years. Certainly an escalating trade war worries many, particularly as it suggests that a long era of global co-operation is fading. That point was underlined by the lack of an official communiqué from last weekend’s G7 meeting of leading nations, marking the first time there had been no formal sign-off.

But the ramifications of a prolonged stand-off over trade do not justify the collapse seen in bond yields over the past month or the rapid rise in gold prices. For example, one barometer of future growth expectations are real yields, adjusted for inflation. Here, the US 10-year measure is negative and this week fell below its nadir of 2016, the previous time that global growth worries sparked pronounced risk aversion. Markets can often run well ahead of fundamentals, but as a clearing house of countless transactions from around the world, they do send a valuable message, which means extreme moves warrant close attention.

What the bond and gold markets are now implying goes beyond the popular narrative of a trade war clipping global manufacturing and unsettling complex supply chains. They are sending a far more worrying message: China, now growing at its slowest pace in three decades, is not going to ride to the rescue as it did in 2009 and 2015 when it sparked another global upswing via significant spending. This time is different, as Beijing faces structural challenges while it weans the country off its export- and infrastructure-led growth. Indeed, the costs of past fiscal and credit binges and the threat of a deflationary wave via a sliding renminbi are what worry many investors and explain in part this month’s big drive into havens — particularly when they look at heavily indebted Chinese companies and the Asia region in general.

Recently, McKinsey & Co released a study of stress levels on corporate balance sheets from more than 23,000 companies across 11 markets in the Asia-Pacific region. The results were far from comforting, with the global consulting firm concluding: “In 2017, Australia, mainland China, Hong Kong . . ., India, and Indonesia had more than 25 per cent of long-term debt held by companies with an interest coverage ratio of less than 1.5, and the share has increased materially since 2007.” When companies are spending a significant amount of earnings to service their debts, broader economic conditions are vulnerable to any kind of shock. More specifically, China in recent years has been trying to tame its vast shadow banking sector, efforts that have helped cool this murky $9.1tn sector for the first time in a decade, but a side-effect is that corporate defaults are picking up.

Although McKinsey notes “a large share of the lending in mainland China continues to be denominated in local currency’’, which spares these borrowers from the pain of a stronger US dollar, the consultancy adds: “Default risk remains high, especially from corporate clients in poor financial health.” Of late, China has been bolstering its economy’s credit conditions after clipping the shadow lending sector, and together with many other central banks easing policies, this has supported a view among some observers that there will be a rebound in global activity early next year. That suggests the current state of low and, in many cases, deeply negative-yielding government debt is vulnerable and has scope for reversal, but only briefly. But the longer-term view from global havens is that the likelihood of China spurring another synchronised global upswing has passed. 

Not only are buyers of global sovereign debt and gold casting plenty of doubt over a repeat performance, they are questioning the ability of central banks and mooted fiscal stimulus in Europe and the US to step up and prevent an extended period of slumbering yields and inflation expectations.

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