China’s Debt-Fueled Growth

The Bank of International Settlement (BIS) issued a dire warning earlier this year, opining that a full-blown Chinese banking crisis could be lurking on the horizon. In its September quarterly report, the BIS said that China’s credit to GDP ratio- which measures bank lending against the size of a country’s economy- had reached 30.1, the country’s highest to date. In the context of sluggish economic growth, the risk of individuals and corporations defaulting on their loans rises, increasing the risk of a banking crisis.

China’s soaring debt levels have been the subject of much concern and speculation. Outstanding loans have reached $28 trillion, as much as the commercial banking loans of Japan and the US combined. Total Chinese debt rose to 255% of GDP at the end of 2015, marking a 107% increase over eight years, and currently stands above 260%. Corporate debt alone is 171% of GDP. Worryingly, these figures do not account for the billions in Chinese shadow banking activity occurring outside of the formal banking sector.

According to Ambrose Evans-Pritchard of the Telegraph, these debt levels are “enough to threaten a worldwide shock if China ever loses control”, making China a global epicenter of risk.

Though economists and regulators have entreated China to ramp down its debt, China has relied on this debt to fuel and sustain its economic growth, which has slowed down significantly. In just the 12 months leading up to September 2016, China took on more credit than it did in 2009, when it implemented a great bout of stimulus spending in response to the recession. Property transactions and car sales in China have also ballooned.

The Chinese government is undoubtedly aware of the risk and has sounded warnings about the ballooning national debt through state mouthpieces such as the People’s Daily. However, it has yet to take any concrete action and is perhaps unwilling to deal with the political costs of slowing growth and laying off workers in order to rein in its debt. China’s bank system is also largely state-controlled, meaning they would likely be bailed out in the event of a crisis.

References:

http://www.bbc.com/news/business-37404838

http://www.telegraph.co.uk/business/2016/09/18/bis-flashes-red-alert-for-a-banking-crisis-in-china/

http://www.wsj.com/articles/chinese-debt-soars-into-space-1473755429

http://www.bbc.com/news/business-37114643

China Is Not In A Housing Bubble, Says Macquarie Economist

Contrary to popular belief, the Chinese housing market is not in the midst of a massive bubble, says Larry Hu, head of China economics at Macquarie Securities Ltd., according to Bloomberg. Rather, he contends that skyrocketing housing prices in China’s largest cities are the result of a shortage of supply coupled with consistent demand growth and immigration.

China’s largest cities have experienced drastic surges in housing prices in recent years. According to the New York Times- which reports that “China is in the midst of a dizzying housing bubble”- Shanghai’s average housing price has jumped by one-third in the space of a year, with Beijing and Guangzhou seeing similar increases. Shenzhen, another major Chinese city, has experienced a stunning 60% spike in housing prices within the past year.

At the same time, long-term housing loans (including mortgages) doubled their share of total official bank lending this year, growing from 20% at the beginning of the year to 40% in August, fueling fears that Chinese property is one of the biggest bubbles in history.

However, Hu notes, many smaller cities have not experienced similar housing price gains.“The difference between over investment versus mismatch is the single most important thing to keep in mind when thinking about China’s property sector, as these two views have vastly different implications for investment and government policy,” he wrote.

Hu also observes that larger cities have consistently experienced net immigration with only a limited supply of property entering the market, which leads him to declaim, “this is not a bubble; this is a shortage of supply.” Broadening the scope of focus to include smaller cities yields the surprising insight that housing has become more affordable at the national level, due in part to rising incomes.

As for the largest cities, Hu notes that continued migration into urban areas has maintained a steady floor on housing demand. At the same time, he believes that market-cooling measures imposed by municipal governments ought to mitigate at least part of the risk.

Since September 30, as many as 22 of the largest Chinese cities have passed market-tightening regulations such as raising the down payment on homes to around 30%, raising taxes on additional property purchases, and restricting non-residents from buying property. Such moves are likely driving the decline in China’s home sales that occurred in the first two weeks of October.

References:
http://www.bloomberg.com/news/articles/2016-10-17/what-bubble-china-s-home-prices-driven-by-demand-investment-mismatch

http://www.scmp.com/property/hong-kong-china/article/2029342/chinas-home-sales-decline-governments-market-cooling

http://www.nytimes.com/2016/10/17/business/international/china-home-price-bubble.html?_r=0

http://blogs.wsj.com/chinarealtime/2016/10/12/early-look-chinas-economy-appears-stable-but-watch-the-housing-bubble/

US Stocks Slump On Weak Chinese Export Data

US stocks have slumped following worrying news out of China that its exports in September had fallen 10% year-on-year, marking the sharpest drop since February. Chinese imports also fell 1.9% in September, after rising 1.5% in August. The steep decline in exports was greater than forecast, intensifying long-standing concerns about the slowing growth of the world’s second-largest economy and reflecting weak global demand for goods, which, in turn, bodes ill for global economic growth.

“Weaker-than-expected Chinese trade readings have increased concerns that the pace of global growth will slow further,” said Dennis DeBusschere, a macro research analyst at Evercore ISI, to the Wall Street Journal.

The Dow Jones Industrial Average fell 45.26 points, or 0.25%, to 18098.94 points. The S&P 500 dropped 0.3%, or 6.63 points, to 2132.55, while the Nasdaq Composite Index fell 0.5%, or 25.69, to 5213.33.

Traders sought refuge in government bonds, the yen, and gold, as Treasuries rebounded from a four-month low. The yield on benchmark 10-year Treasuries fell 3 basis points, or 0.03%, to 1.739%, reflecting higher demand. According to Bloomberg, the US Treasury sold $12 billion of 30-year debt on Thursday. Conversely, raw materials and energy stocks fell out in anticipation of weakening demand.

The weak data coming out of China has precipitated some doubts as to whether the Fed will indeed raise interest rates by its December meeting, though the market-implied probability rate of such an eventuality is still 66%. The consensus among traders and investors is that the Fed will proceed with raising the interest rate, despite the news.

“It’s going to take some pretty lousy data to persuade the Fed to not raise rates,” said Art Hogan, of Wunderlich Securities to Bloomberg. “The Fed’s letting us know that December is something they have to be talked out of, not into.”

References:

http://www.wsj.com/articles/global-stocks-down-after-weak-china-export-data-lower-oil-1476344506

http://www.bloomberg.com/news/articles/2016-10-12/dollar-near-6-week-high-versus-yen-after-minutes-crude-declines

http://www.forbes.com/sites/timworstall/2016/10/13/china-export-fall-knocks-global-stock-markets-because-of-what-it-says-about-the-global-economy/#52b4b7c633aa

http://www.marketwatch.com/story/us-stocks-open-lower-following-china-trade-data-2016-10-13?siteid=bnbh

Oil Prices Surge Following OPEC Production Cap

Oil prices surged following news that the Organization of Petroleum Exporting Countries had agreed to cut production and cap output. The international oil benchmark Brent crude rose 6% to nearly $49 a barrel on the back of the announcement.

November West Texas Intermediate crude futures jumped 4.7%, or $2.11, to trade at $46.78 a barrel. US stocks also closed higher overall following the surge in oil prices, with the Dow Jones Industrial Average closing up 110.94 points, ExxonMobil Corp. shares jumping 4.40%. Moreover, the S&P 500 index finished up 11.44 points, or 0.5%, at 2,171.37, while the energy sector jumped 4.3%. Oil prices settled up 5.3% at $47.05 on Wednesday.

The energy ministers from the major oil exporting nations struck the deal during talks held in Algeria in order to limit crude production and reduce the oversupply. The formal details of the agreement will be finalized at the OPEC meeting in November.

The deal stipulates a 700,000 barrel reduction of oil output per day overall, though some OPEC nations will cut their production more than others. Iran, for instance, will be allowed to increase its output. Oil production will be limited to a range of 32.5 million to 33 million barrels per day, down from August’s output of 33.2 million barrels.
“Opec made an exceptional decision today,” Iran’s Oil Minister Bijan Zanganeh said, according to the BBC.

Goldman Sachs expressed skepticism that the deal would successfully limit oil production in the long term, in a note that the investment bank circulated to investors. Goldman said that it would not revise its forecasts for WTI at $43 per barrel by the end of this year and $53 a barrel in 2017.

“If this proposed cut is strictly enforced and supports prices, we would expect it to prove self-defeating medium term with a large drilling response around the world,” Goldman’s analysts said.
Goldman also noted that “compliance to quotas is historically poor, especially when oil demand is not weak,” and that other oil exporting nations not beholden to the quota had increased oil production beyond analysts’ expectations.

References:

http://www.cnbc.com/2016/09/28/goldman-sachs-opec-production-cut-deal-doesnt-change-oil-price-forecasts-through-2017.html

http://www.marketwatch.com/story/us-stocks-close-higher-as-oil-jumps-2016-09-28?siteid=bnbh

http://www.marketwatch.com/story/oil-futures-rally-on-report-of-opec-output-cap-agreement-2016-09-28?siteid=bnbh

http://www.bbc.com/news/business-37502538

http://money.cnn.com/2016/09/28/investing/oil-surges-after-opec-informal-meeting/

The BIS Warns of Record-High Banking Stress in China

The Bank for International Settlements has recently released a quarterly report warning that China’s “credit to GDP gap” has reached a record 30.1%, indicating that the world’s second-largest economy faces mounting debt and credit pressures. According to the BIS, levels elevated beyond 10% signal high banking strain in an economy. In the United States, for instance, readings surpassed the 10% threshold in the lead-up to the financial recession.

The elevated credit to GDP gap suggests excessive credit growth in China and the possibility of a financial implosion. Should such an event occur, the repercussions would greatly damage the global economy. According to the Telegraph, “outstanding loans have reached $28 trillion, as much as the commercial banking systems of the US and Japan combined. The scale is enough to threaten a worldwide shock if China ever loses control.”

China’s total debt has reached 255% of GDP, having ballooned by 107% in the past eight years, and continues to grow, while corporate debt alone has hit 171% of GDP. Though China’s leadership has promised to limit debt growth, it has been hardpressed to follow through on its pledge given that debt has sustained the nation’s economic growth. Government spending on infrastructure and real estate has also proven to be less productive and failed to contribute meaningfully to GDP.

Some analysts have taken to prescribing bank recapitalization and reducing reflexive stimulus spending to artificially sustain growth on the part of the Chinese government. China’s central bank issued a statement earlier this year averring that investors would be able to maintain reasonably high levels of capital in the event of a serious banking shock. The fear, according to the Telegraph, is that a surge in capital outflows may force the central bank to sell off foreign currency to bolster the yuan, “automatically tightening monetary policy” and sparking a vicious cycle.

Significant doubts remain as to whether the government can extricate the nation from its precarious situation, though state control of the financial system may conversely prove to partly mitigate the risk of a banking crisis.

References:

http://www.mauldineconomics.com/outsidethebox/does-it-matter-if-china-cleans-up-its-banks

http://www.bloomberg.com/news/articles/2016-09-18/bis-warning-indicator-for-china-banking-stress-climbs-to-record

http://www.telegraph.co.uk/business/2016/09/18/bis-flashes-red-alert-for-a-banking-crisis-in-china/

http://www.businessinsider.com.au/this-early-warning-indicator-of-looming-financial-risks-is-flashing-red-for-china-2016-9