Thursday, 20 February 2020

CHINA'S FINANCIAL PYRAMID ON THE VERGE OF COLLAPSE

Let us explain in some detail what we mean by "financial pyramid". Suppose that an entrepreneur makes a profit of 10% on his investment. He has two choices: one is to re-invest the profit in his enterprise because he believes he can make 10% or more profit or even less profit, but at an acceptable rate. Or else, if the rate is unacceptable, the entrepreneur can lend the profit or part of it to another entrepreneur who can achieve the desired rate of profit, but this time it will be paid to him as "interest". So therefore our entrepreneur has now turned into a "financier" or "rentier" living not from direct investment but from interest. Now, repeat this process at the general economic level, and then you have an economy divided into entrepreneurs, lenders and borrowers.

At each step, the lenders or financiers expect that they will receive a "return on capital" from the entrepreneurs to whom they lend. But once the process is repeated enough times, the rate of interest paid to the lenders will begin to flatten and reduce as fewer profitable investments are available to entrepreneurs! In that case, we get fast enough to a point where the principal concern of financiers (lenders) is no longer "return on capital" or "interest" but much rather "return of capital", or the apprehension that their capital - let alone their interest on it - will not be returned by the entrepreneur borrowers! 

At this precise point, the financiers (renters) call in their loans, which deprives the entrepreneur borrowers of the capital needed to run whatever is left of their now less profitable businesses! At this stage, the financial credit pyramid collapses and a socio-economic and political crisis ensues and engulfs the entire economy and society. THIS is what is happening in Ratland China right now!

From the Financial Times today:

China's banks face up to $1.1tn surge in questionable loans, S&P warns 


 China's lenders may be hit with an increase of as much as Rmb7.7tn ($1.1tn) in questionable loans as the coronavirus outbreak deals a heavy blow to China's economy, S&P Global Ratings has warned. The Covid-19 outbreak, which has prompted China to lock down large swaths of its sprawling economy, will cause some individuals and companies to "have difficulty with debt repayment," S&P said in a report issued on Thursday in Hong Kong. In a worst-case scenario in which the outbreak does not peak until April, S&P forecasts China's economy, the second biggest in the world, will expand 4.4 per cent in 2020. That would mark a dramatic slowdown from the 6.1 per cent growth in 2019 and be the weakest pace since 1990, according to World Bank data. S&P's base scenario, in which the virus peaks next month, points to 2020 growth of 5 per cent, which would also be the lowest in three decades. Even in the best case in which the virus peaks in February, GDP growth is forecast at 5.5 per cent. The "growth shock" would cause the value of non-performing loans in China's banking sector to surge by Rmb7.7tn to Rmb10.1tn in S&P's worst-case scenario. In the base case, the figure would jump Rmb5.4tn to Rmb7.8tn. In the best case, the NPLs would rise Rmb3.4tn to Rmb5.8tn. The ratio of NPLs to total loans would be 7.8 per cent, 6 per cent and 4.5 per cent in the worst, base and best case scenarios, respectively. S&P said it also expects Chinese regulators to relax rules for what counts as a bad loan and potentially give certain loans to affected communities and business "special consideration" in how they are accounted for on bank balance sheets. The ratings firm said it "may take years for domestic banks to revert to normal standards, with long-term repercussions for the creditworthiness of some institutions." China has already begun to take action aimed at stimulating its economy and easing conditions in its financial system. The loan prime rate, a key lending rate, was reduced on Thursday after the People's Bank of China earlier this week reduced another important medium-term lending rate.  

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