Meet China's new leader
Well, attention for the
reality behind China's growth picture is finally heating up, and I would say
that's definitely a good thing. It will allow everyone to take a second look
and wonder what is real and what is not. It will also allow countries like
Australia and New Zealand to rethink their all-out economic dependency on
China. Not to mention Mongolia; Michelle Yun had this for Bloomberg:
Mongolia Mining Corp. is
betting there’s enough demand from China to support the construction of an $800
million railway that will double export capacity to the nation that counts
Mongolia as its biggest coal supplier.
Expanding transportation links
between the adjacent countries "will improve the position of Mongolia as
the leading coking coal supplier to China," Battsengel Gotov, chief
executive officer of MMC, as the company is known, told reporters in the
Mongolian capital of Ulan Bator.
Mongolia, the world’s fastest growing economy, overtook Australia as China’s biggest coking coal supplier last year, exporting 20 million metric tons of the raw material used to make steel. MMC is building a 250 kilometer (155 mile) rail to add 30 million tons of export capacity direct to China. "There’s still room for everybody in Mongolia" to mine and sell commodities, Gotov said from the company’s head office. [..]
Chinese demand has been curbed
by slower global growth and coking coal prices have fallen as much as 15
percent in the first half from the previous six months, Gotov said.
If that's not enough to make
you think, there are stories like the one that got Bloomberg banned in China
last week (by the way, in banning Bloomberg over one article the Chinese
leadership make clear they haven't yet understood that they have lost the media
battle, that bloggers will always re-post whatever is banned):
Xi Jinping, the man in line to
be China’s next president, warned officials on a 2004 anti-graft conference
call: "Rein in your spouses, children, relatives, friends and staff, and
vow not to use power for personal gain."
As Xi climbed the Communist
Party ranks, his extended family expanded their business interests to include
minerals, real estate and mobile-phone equipment, according to public documents
compiled by Bloomberg. Those interests include investments in companies with
total assets of $376 million; an 18 percent indirect stake in a rare- earths
company with $1.73 billion in assets; and a $20.2 million holding in a publicly
traded technology company.
As well as a great and long
article on Barron's by Jonathan R. Laing (available through Google News for
non-subscribers):
[..] ... old China hands like
Peterson Institute economist Nicholas Lardy [are] concerned. He points out that
last year residential construction accounted for 9.2% of Chinese GDP. Compare
that with 6% in the U.S. at the peak of its housing boom in 2006. Among major
countries, only Spain has hit that level—right before the housing collapse in
that country.
Lardy and others fear that a major
decline in residential real estate and underlying property prices could
severely damage the Chinese economy. (Average new-home prices in some 70 major
Chinese cities fell monthly in the eight months through May.) A falloff in
demand for steel, cement, and copper would lead to heavy layoffs. He reckons
that some 25% of all Chinese steel consumption goes into residential real
estate.
According to Lardy, nearly 20%
of Beijing residents own two apartments or more in the city. Thus any
precipitous slide in the property market would have a tremendous negative
wealth-effect in an economy whose consumption spending needs to be nurtured,
not impaired.
And, of course, the financial
system could suffer mightily from a real-estate slide, even with the
conservative loan-to-value ratios of most mortgages. Local governments
typically raise 30% to 40% of their annual revenues from land sales—the state
technically owns all land—to finance their operations and capital improvements.
Property also constitutes the
collateral that underlies the local government funding vehicles that borrow
from state banks to finance infrastructure projects. State-owned enterprises
and, indeed, the state-dominated banking system have all been drawn to
real-estate speculation like catnip. Fitch estimates that some 35% of all bank
loans in China are exposed to the vagaries of the Chinese property market. And
that number doesn't capture all the commercial and industrial loans that
companies borrowed ostensibly for corporate purposes and then diverted into
real-estate development. [..]
[..] ... the central bank, the
People's Bank of China, is sitting on $3.2 trillion in foreign reserves (mostly
earned from China's positive trade balance with the U.S.) that could be
deployed to head off any bank run or other financial emergency. Chinese
national debt, as officially reported, sits at around 50% of its 2011 GDP of
$7.3 trillion, compared with a U.S. debt-to-GDP ratio of more than 80%.
But appearances can be
deceiving, says Victor Shih, a political scientist at Northwestern University
who has a host of sources inside and outside government in China and has
burrowed deeper than most other Western observers in all manner of government
reports, corporate financial statements, bank filings, and bond prospectuses.
His conclusions are several.
First, when one tallies up all the liabilities direct and contingent of the
Chinese central government, indebtedness of the state-controlled banking
system, various government entities like the Ministry of Railroads, state-owned
enterprises, local government loan investment vehicles, and considerable
cross-holdings of bond debt by SOEs, China's government debt-to-GDP triples to
about 150% and is rapidly rising.
Secondly, nonperforming loans
in the financial system are dramatically higher than officially reported,
because the banking system, under orders from authorities, masks that total by
sedulously rolling over bad loans. For example, even the $500 billion of bad
loans hived off by authorities to facilitate the initial public offerings of
the giant state banks Bank of China, China Construction Bank, Industrial &
Commercial Bank of China, and Agricultural Bank of China now sit chastely in
various asset-management companies, mostly bereft of any write-downs or of
substantial recoveries.
Peril for China's banking
system lies, ironically enough, in a liquidity crisis that might ultimately
expose many of the rotten loans like so many stinking, beached whales. Any
faltering in the China growth story could cause corporations and investors both
on the mainland and offshore to run down their renminbi balances through simple
balance transfers and clever invoicing to move funds offshore. There was such
an outflow in the latest monthly figures for April, when some $11 billion worth
of renminbi left China in excess of the sums flowing in from overseas as a
result of the nation's continuing positive current-account balance and foreign
direct investment.
Capital flight by corrupt
party members and other wealthy Chinese could also shred China's vaunted safety
net of $3.2 trillion in foreign-currency reserves. Northwestern's Shih
estimates that the top 1% of Chinese households have amassed liquid and
real-estate wealth of as much as $5 trillion. The gambling mecca of Macau and
leaks in the banking systems afford plenty of ways to get money out of the
country.
But that's all still frankly a
bit beside the point that should by now be made. Which is, how does the Chinese
economy finance itself?
Well, here's one way, as
reported by Zhang Yuzhe, Zhang Bing, Shen Hu, Wen Xiu and Zheng Fei at Caixin:
The Zhejiang government is
scrambling to settle a credit crisis threatening banks and financial
institutions that altogether issued about 6 billion yuan in loans to scores of
companies. Sources say 62 companies, from furniture makers to import-export traders,
have been affected to varying extents by the collapse late last year of
Hangzhou-based property developer Tianyu Construction Co. Ltd.
The companies were financially
linked to Tianyu through a province-wide, reciprocal loan-guarantee network.
Tianyu's sudden failure raised the specter of a domino effect of defaults
taking down every network participant and devastating their lenders.
"After Tianyu went
bankrupt, banks in Hangzhou started calling in loans to other firms guaranteed
by Tianyu," said the owner of a company tied to the network. "That
had a ripple effect and affected a number of other companies." [..]
Guaranteeing loans for each
other has long been common in Zhejiang, said a risk officer at a major bank.
Neither is there anything unusual about credit crises and subsequent government
bailouts in the province.
The city of Shaoxing, for
example, rode to the rescue in 2008 following the failure of a local
petrochemical firm called Zhejiang Hualian Sunshine Petro-Chemical Co. Ltd.
Hualian Sunshine borrowed more
than 8 billion yuan from eight banks and let a number of enterprises use that
borrowed money to guarantee their own loans. Together, the network's
participants borrowed more than 100 billion yuan, said an Industrial and
Commercial Bank of China official.
"Zhejiang's business
owners were spoiled by easy access to credit, especially in 2008 and
2009," said a credit manager at one bank. "Back then, they could
always get loans using land as collateral and could always make money by
investing in property."
The reciprocal nature of the
guarantee network stripped real bank loan guarantees of any value, argued
another banker. The system has made all its participants mutually vulnerable to
an economic downturn, he said. Now that property development can no longer
guarantee profits, the banker said, borrowers and guarantors are in trouble
together.
Cash flow at some enterprises
has fallen to dangerously low levels, said a bank loan officer, so that they've
been forced to survive on credit. Many ran out of cash after pouring money into
speculative property investments, he said, which flopped after the central
government imposed real estate development restrictions in 2010.
An executive at Hangzhou
furniture manufacturer Rongshi Group is among those faulting the banks, which
have called in his company's loans. "Most banks care only about how to get
themselves out of the mire," he said. And without a broad solution for
companies and banks "no one will escape."
Right, that's a circular
Ponzi--meets-creative-accounting scheme, in which companies simply guarantee
each other's loans, use the loans to speculate, and in the end there's zero
collateral for a zillion yuan in credit .
There's another twist to this:
[..] Zoomlion, the concrete
and industrial machine giant is seeking Rmb140bn ($22.5 billion) in fresh
credit, fuelling fears the company is at the centre of a growing debt bubble.
Zoomlion only has a market capitalization of $12.5 billion and is one of the
most shorted stocks on the Hong Kong market with over 30% on loan at any one
time to short-sellers. [..]
Zoomlion has an interesting
business model, it is similar in many of ways to Caterpillar, except whereas
Caterpillar report falling sales, Zoomlion reports astounding sales growth with
a fivefold increase in revenue since 2007. Zoomlion customers sometimes buy ten
concrete mixers when they planned to initially by one or two. They have a
perverse incentive to buy more than they need because these concrete trucks are
purchased via finance packages supplied by Zoomlion.
Then the machines can be
garaged and used as collateral to borrow further funds from other lenders.
Zoomlion continues to grow while cement sales have plunged. In May, cement
output increased 4.3% YoY, down from 19.2 per cent recorded last year. Zoomlion’s
new debt of $22.5 billion buys roughly 900,000 trucks which could produce
enough concrete (at six loads a day) to build over thirty Great Pyramids of
Giza a day .
Every sector is infected with
these kinds of perverse business practices, steel traders used loans meant for
steel projects to speculate in property and stocks , it has been common
(apparently) for steel traders to secure loans to buy steel then use this same
steel as collateral to borrow funds to invest in property development and the
stock market. In many ways this is the steel version of the Zoomlion model. A
fundamental foundation of any lending market is the ability of the lender to
ensure title and guarantee ownership of collateral. [..]
The current political
leadership of China represents the greatest looting of a country by the
political class ever seen in history. In the Hurun Report released in March
2012—the richest 70 members of the government have a net worth of $89.8
billion, an average of over $1 billion each. This compares to $7.5 billion for
the 660 for the US government, an average of $11 million each.
So on the one hand, we have
companies guaranteeing each other's debt (loans), and on the other hand, we
have companies buying excessive numbers of equipment, which they pay for with loans
provided by the suppliers on condition excessive numbers are bought.
That equipment is then used as
collateral to secure more loans. Large parts of these loans are then used to
speculate in real estate markets. In both instances, and don't let's forget the
overlapping ones where both schemes are combined, we are talking about
absolutely virtual money. Are these incidents perhaps? I find that hard to
believe in view of how Chinese society is organized: major profits will attract
major attention, a pyramid of perfect dimensions.
Charles Ponzi, eat your heart
out. You may have been a fine crook, but you never even dreamed of operating on
this scale. When these guys are done, they’ll leave nothing but a shell of a
country behind. The Chinese elite has amassed far more in wealth than all the
country's vaunted foreign reserves put together. That is something people all
over the world need to very seriously think about.
For now, though, the only true
Chinese leader is Pon Zi. Whose inevitable successor will be Domi No.
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