China Economy: More Worrying Signs30 September, 2011, 13:02. Posted by Zarathustra
This is not an easy call to be made, but it does strike me that there is something wrong with the Chinese economy, even though the focus these days are mostly in Europe, as the European debt crisis is moving ever closer to a tipping point.
For China, it seemed as though a hard-landing was avoided as of 2 months ago. As it turns out, even myself was getting a little bit too optimistic. Now, the probability of a hard-landing is getting even higher than before, in my view, the only question is when, not if. Although I have not been writing very often these days about these little stories concerning failure of small and medium sized businesses, or the overhang of the local government debts problems, it does not mean that problems aren’t going away.
That is something pretty worrying, as many of these struggling business owners have been relying on the underground credit market (as I have pointed out months ago here and here), which got the funding from yield-hungry depositors withdrawing deposits from the formal banking system into these shadow banking system, and these private lenders are charging extremely high interest rates to borrowers, which are unsurprisingly unsustainable. So here comes the great escape of business owners.
We have just got yet another sub-50 HSBC manufacturing PMI reading for September. But as I have also pointed out in the latest reading of the official PMI figure, we found that the new exports order index has fallen below 50 for the first time since the recovery of the 2008 financial crisis. That points to a weakness in the global demand, which the Chinese export sector is relying on.
A few other signs which are providing some indirect clues would be from the commodities market. For instance, I have pointed out the recent weakness in copper (and it is of course melting down, falling off the cliff amid global financial chaos) could be an indication of slowing global growth (China in particular). Gold is also melting down, which is not normally a likely outcome in the risk off environment. Earlier, I hypothesized that gold price is probably just an indirect gauge of the Chinese economy as I noticed a tight correlation between gold and the Chinese Yuan with a few months of lead. As Chinese Yuan is one of the monetary policy tools the policymakers think they have, the pace of appreciation tells how confident policy makers are on growth, and the lack of appreciation signals doubts. If the economic challenges are too huge, the first step for policymakers would be to stop the appreciation, and if the situation is bad enough, I see Yuan depreciation.
Whether this hypothesis is an accurate description of the reality today will face its test in the coming months. But we are seeing some capital flight away from emerging markets, and the non-deliverable forward contract of Chinese Yuan is now pricing in a depreciation of the Chinese currency, and there are some sell-offs happening in the recently days in the currency, thus the market is already speculating on the deteriorating prospect of the Chinese economy.
The recent development in the real estate sector is also getting weaker. September and October are traditionally the strong season for real estate, but no longer. Real estate developers counting on these two months are likely to be disappointed. As I have predicted quite a long time ago in my bearish call on China, the real estate developers will be hurt first in the event of real estate market correction as they have high debts (while household debts are generally lower than the US, for instance). I have long expected the days where some developers will be running into difficulties if credit tightening continued, and the day of reckoning is coming. Even more worrisome is that some of the real estate developers are also tapping the underground credit system or shadow banking system for loans as the formal banking system has back away from them. With increasing financial pressure, we should brace for some failure of developers and more aggressive price cutting in the months ahead.
With the debt level of the economy higher than most people believe, and with asset price bubble popping, both the shadow banking system and the formal banking system will be under pressure. Thus we are seeing weaknesses in banking stocks recently, and the CDS for Chinese banks are surging, even though the problems have been very apparent for months. We will not see major banks failure in China, but the bad news for shareholders is that the equities might still be wiped out in the years to come, and that’s why I have absolutely no love for Chinese banking shares.
As time passes, what we are seeing is an increasing number of indications that the growth story of China is finished. My guess for the Chinese economy is that the long-term growth potential would slow to only 3-5% by the end of this decade, instead of 8-9%. While one Chinese economist proudly believes that Chinese policymakers have abolished business cycle, I believe one should not be surprised to see negative growth numbers in the years ahead as the economy hard lands. The only question is when hard landing would occur, not if.