All of these will experience financial disorder and turmoil at some point but for now, let’s take a quick look at just one of those, China. I’m a long time China bear in that I’ve never bought into the “China will save the world,” view that some have promulgated over recent years. Yes, China has kept pricing low and created demand for exports but actually, it takes a very long time to transform an economy and China now is running straight into problems resulting from its credit boom.
While analysts have been lowering Chinese growth estimates those estimates are coming down from a very high level. Current estimates of 7% growth are still too optimistic. Is China turning into Japan? That’s the new topic. Chinese debt stands at $30 Trillion, up $9 trillion since 2008 and debt is 200-300% of GDP counting Shadow Banks. If the average interest rate is 7% (banks 6% shadow banks 10%), the economy would need to grow 21% in real terms to service the debt and that’s not happening.
Since that cannot happen, banks cannot make loans without injections from PBOC. A fundamental problem is 100% of new credit goes to rollovers. This creates a Zombie economy effect with no credit demand. Steel demand is down, electricity is down, cement demand is down and growth is likely to be sub-zero this quarter. The economy is not growing.
Moreover, there is massive overcapacity in petrochemicals, construction machinery, steel, cement, aluminium, and housing. The housing excess is extreme with 70 million units of new housing in the pipeline. It will take years of growth to fill capacity.
Aluminium official said privately debt Is $1 trillion, profit 20 billion. Local governments force mills to open because smelters cannot make payments, banks have NPLs. Smelters are capital, not labour intensive.
The consumer sector is tracking close to 0% growth as well, average days of clothing inventory is 174 days, electronics 123 days. Consumer companies on the China exchange decline in gross revenue is 2% for the year, 6% third quarter.
QE3 created a flow of speculative money into China. That tap is shut off and capital flight is accelerating and is a growing problem. Policy now is not about jobs but about keeping money flowing and all capital is used to avoid defaults. We may therefore happily anticipate more defaults, a substantial devaluation, more anti-corruption raids, (especially in financial services), and a clamping down of foreign influence. The consequent demand shock will continue to ripple out. Be prepared not to be surprised by China and if you have money in there I’d mostly be getting it out.
As China comes closer to a crash landing, the China-dependent EM economies are rapidly faltering. Brazil will suffer sequential years of GDP decline for the first time since 1930-1931. In fact the China-led global commodities and industrial production boom is cooling so fast that global CapEx in mining and energy, materials processing, manufacturing and shipping is on the verge of a huge downward correction. That will also hit the high end machinery and engineering exporters like Germany and the US, creating a further negative loop in the gathering deflationary crisis.
These ricocheting impacts from the China implosion will drive the dollar still higher. That’s because Chinese companies have borrowed something like $1.5 trillion in external dollar markets, and the EM economies which boomed from the China trade also borrowed trillions in dollar markets, owing to the cheap dollar interest rates manufactured by the Fed, and the global scramble for “yield” by dollar based money managers.
The flood of cheap dollar based capital which flowed into China and the EM appeared to fuel economic miracles in countries like Indonesia, Brazil and Turkey. Unfortunately, the financial boomerang is flying back at them at devastating speed. As China and the EM struggle against global deflation, their economies are faltering and exchange rates are sinking. Accordingly, they are desperately trying to hedge their immense dollar exposures, a process which drives the USD steadily higher.