After three consecutive devaluations to the yuan totalling a 4.5% drop in value, today the People’s Bank of China, the central bank, stayed the course. The long view sees this as a small correction in the long march of 1.3 billion-strong population to modernization and prosperity. Yet, the last 12 months have issued clear signals of more trouble ahead.
Falling Economic Growth in China
John Ficenec, the Telegraph Media Group, 17 Aug 2015
The Daily Telegraph, UK, 25 august 2015
Each event taken in isolation can be explained away. However, seen as a whole economic and financial events taking place over the last year in China are gaining a cumulative force.
- The population is ageing. The one child policy lowered birth rates artificially mirroring population stabilization in western economies undergoing prolonged periods of economic growth.
- Commodity prices are falling globally due to slowing demand from China (see Falling Economic Growth chart).
- Real Estate sales have slumped. Ghost cities are reported built as Potemkin villages fanning growth.
- The market entered a bubble-crash cycle in June 2015 likely to extend over months if not more than a year based on the 2008 precedent. Circuit breakers on trading at +/- 10% will only prolong the crash.
- Currency devaluation adds downward pressure. The yuan lost 4.5% of its value in three days mid-August 2015 and may not stabilize until it reaches levels 10 or 15% below its 2015 peg of 6.3 yuan against the US dollar.
- Illegal capital flight out of country is peaking. Currency devaluation will drive it higher.
- The debt to GDP ratio is 282%. It takes three dollars of debt to create a dollar of growth. The real number may be higher. Credit debt is reported as growing 25x since year 1999. There is no accounting of how much of that debt is foreign exchange denominated.
- A credit crunch would trigger bankruptcies in state-owned corporations and lending institutions. Leveraged borrowing could spiral out of control exposing circular capital flows and the real extent of general indebtedness.
- Currency devaluation and deflation would deal a severe blow to indebted companies and individuals while draining government reserves.
- Withdrawal of Chinese money from foreign positions and dumping foreign properties might be triggered by borrowers looking to raise cash.
- Chinese students may be called back home.
- Political stability would be threatened should economic conditions be seen to spiral out of control.
This is a long list of worst-case scenarios. Standing alone none of these presents more than a temporary setback. However, there is a knockout punch poised to explode should two, three or more of these events occur in combination.
Chenggong “ghost town”
ChinaFotoPress/ChinaFotoPress via Getty
We are already seeing linkages between real estate, the stock market and the move to float the yuan in the currency markets. Whether in the UK or Argentina, all previous attempts to peg currencies have ended in failure. China cannot hold out much longer. Once the yuan enters the free markets managing its valuation will require much greater exertion from the government. That ability may be curtailed if government industries and institutions are mired in debt.
The extent of leveraged borrowing is not known, but it is considered to be serious. If the central planners turned to the markets to finance corporations facing falling demand and difficulties servicing debt; and if the market bubble was sustained by leveraged buying and government liquidity; then a circular arrangement is in place between: (1) the government; (2) government backed corporations, banks and lending institutions; (3) private wealth and (4) the heavily regulated market amounting to a kind of pyramid scheme poised to implode.
The prospect of decreasing growth in China after 30 years of spectacular increases in GDP will magnify any weak government decisions taken in times of accelerated growth. There is a line of economic analysis that posits upside gains turning into downside risks in times of falling GDP. The mechanism links falling GDP with growing debt: As GDP falls, governments borrow to make up the difference rasing debt levels.
As a result an urgent need for rebalancing is put into play in order to avoid a debt-induced crisis. According to Michael Pettis:
Beijing must continuously choose between a rising debt burden, rising unemployment, or rising transfers of wealth from the state sector. All of its policy options boil down to one or more of these three. So far it has mostly chosen the first, but this can only go on until the country reaches debt capacity limits.
7 SEPT 2015
News of some 200 arrests of people making public their views about the China stock market crisis is a bad signal to send west. Any indication that draconian measures are still in the mix in Chinese society carry the potential to raise suspicions and spook investment.