{"id":39300,"date":"2013-06-25T23:04:26","date_gmt":"2013-06-26T03:04:26","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=39300"},"modified":"2013-06-26T11:10:13","modified_gmt":"2013-06-26T15:10:13","slug":"chinas-growth-story-ends-with-a-whimper","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/06\/25\/chinas-growth-story-ends-with-a-whimper\/","title":{"rendered":"China\u2019s Growth Story Ends With a Whimper"},"content":{"rendered":"

By MoneyMorning.com.au<\/span><\/a><\/p>\n

The Chinese model of economic growth is flawed. It has wasted resources on an unprecedented scale. Empty cities, excess industrial capacity and sour construction loans litter the country. New lending yields less and less incremental growth. And the very worst construction projects aren\u2019t producing enough cash to service debts.<\/p>\n

The Chinese economy<\/strong>, like most others, rests on a shaky foundation<\/a> of credit. The country has completed the largest building boom in history \u2013 a boom dependant on unsustainable growth in the supply of money and credit.<\/p>\n

It\u2019s important to understand that there are effectively two governmental factions in China: one that\u2019s interested in power, control and stability and one that\u2019s interested in getting rich no matter the consequences.<\/p>\n

With China\u2019s late 2008 surge in bank lending, the second faction\u2019s priorities \u2013 construction and industrial activity of all kinds \u2013 won out. But ever since inflation heated up, threatening social stability, the first faction grew more concerned about its hold on power.<\/p>\n

Because of concerns about social stability, China\u2019s central bank, the People\u2019s Bank of China<\/a> (PBOC), started tightening liquidity to the official banking system. Such tightening had the potential to spark a panic in real estate and banking a few years ago.<\/p>\n

No panic ensued\u2026<\/p>\n

No Panic in China\u2026Yet<\/h2>\n

Instead, overstretched borrowers and local governments migrated to off-balance sheet structures within the \u2018shadow\u2019 banking system. The loans that funded busted projects were, in many cases, not rolled over during China\u2019s credit tightening phase of 2010-11.<\/p>\n

Shunned from the banking system, stressed borrowers were desperate to find new sources of funding. They found high-interest, short-term funding from \u2018trust\u2019 companies. As part of the shadow banking system, trust companies match savers looking to earn high interest rates with desperate borrowers.<\/p>\n

At the end of 2012, borrowers scrambled to secure loans from trust companies. According to the PBOC, trust loans rose 679% in the year ending December 2012, to 264 billion yuan ($42 billion). High-interest rate trust loans now make up 16% of China\u2019s entire pool of financing. Trust loans, like payday loans in the U.S., have short maturities. Short-term trust loans amount to an estimated 50% of Chinese GDP, so liquidity crises can quickly spiral into solvency crises.<\/p>\n

Local governments are big trust loan borrowers. They\u2019ve reverted to bad, old infrastructure spending habits. The late 2012 revival in infrastructure spending may have been cut off when liquidity to fund trust companies dried up. Some trusts could be on the verge of defaulting\u2026<\/p>\n

Trusts rely on funding from the official banking sector, and in recent weeks, the PBOC has directed the banks to ration credit to shadow banks. \u2018The [PBOC] has made it clear that it intends to penalize those aggressive lenders and crack down on the potential for moral hazard,\u2019<\/em> writes Credit Suisse analyst Dong Tao in a June 20 note. \u2018Some small-medium-sized banks have deployed an excessive amount of liquidity into high-yield\/high-risk assets [like trust loans]\u2026 counting on the central bank\u2019s rescue in case that liquidity gets tightened.\u2019<\/em><\/p>\n

The central bank told banks to look elsewhere for liquidity. \u2018To us, this is a sign of brinkmanship,\u2019 <\/em>Tao concludes.<\/p>\n

When the Chinese banks <\/strong>looked for liquidity outside the cozy confines of the PBOC, they found it scarce and expensive. The banks demanded higher interest rates to lend to each other.<\/p>\n

When one bank fears another bank might have exposure to dodgy trust companies, it now demands a high interest rate to compensate for risk. The Shanghai Interbank Offered Rate (SHIBOR) \u2013 the rate banks charge each other for loans \u2013 spiked dramatically.<\/p>\n

SHIBOR rates have fallen a bit since the PBOC injected some liquidity into the system. But the PBOC issued a terse memo on liquidity management practices to the banks on June 24. Credit Suisse\u2019s Tao explains:<\/p>\n

\u2018We take this as a gesture from the central bank that \u2018teaching a lesson\u2019 is probably over, but it could tighten the liquidity again should it feel banks are misbehaving.\u2019<\/em><\/p>\n

The PBOC, in other words, will ensure liquidity is sufficient to allow for an orderly deleveraging of unviable shadow banking entities. But the deleveraging (credit contraction) process will not be stopped.<\/p>\n

A state-sponsored contraction of China\u2019s shadow banking system is bad news for property developers. The second Chinese government faction \u2013 the faction of speculators and crony politicians making money from the bubble \u2013 has no interest in ending the status quo: It financed projects through entities called local government financing vehicles (LGFVs). These are joint ventures between local governments and property developers.<\/p>\n

Local governments own the land. There are no real property taxes in China, so local governments earn tax revenue by selling land into these joint ventures. Then, they get a piece of the proceeds from development.<\/p>\n

Loans to these LGFVs are in a sort of netherworld. The Chinese banks think they are going to be \u2018money good\u2019 because they are quasi-government entities. But a study of LGFVs conducted by banking regulators a few years ago discovered that a staggeringly high number of these LGFVs couldn\u2019t generate enough cash to service their debts. Some estimate that up to half of these loans could go bad.<\/p>\n

Everyone expects that the government will bail out LGFVs when they default, after losing funding from the trust loan market. But the central government may not ride to the rescue. Political leaders concerned with stability and inflation seem determined to purge excesses. The will to reform and restructure will be tested, because the bubble\u2019s excesses were staggering\u2026<\/p>\n

Short selling legend Jim Chanos is a vocal bear on China. He famously described the country as stuck on a \u2018treadmill to hell.\u2019<\/em><\/p>\n

In other words, Chinese leaders feel the need to sustain frantic levels of construction and infrastructure activity for fear that the economy would crash without it<\/a>; yet more and more construction results in lower and lower incremental returns on investment.<\/p>\n

Chanos illustrated the scale of China\u2019s new office and residential apartment construction; it\u2019s so enormous that it\u2019s hard to grasp: 31-32 billion square feet of new office space was constructed in just 18 months after China\u2019s 2008 bank-funded wave of stimulus. To put the number into perspective, it\u2019s equivalent to a 5-by-5 office cubicle for every man, woman and child in China.<\/p>\n

The Biggest Myth of Them All<\/h2>\n

Chanos thinks the biggest myth of all about the China investment story is the myth of limitless urban migration. This myth involves 15-20 million people per year moving from rural areas to urban areas. But the migrants into cities are among the lowest-wage workers, and, ironically, many have migrated simply to construct the very condos that they can\u2019t afford.<\/p>\n

Another myth Chanos busted is the idea that most Chinese real estate investors are all-cash buyers \u2013 or at the very least invest with hefty down payments. But much of this \u2018all-cash\u2019 buying is funded by loans sourced elsewhere, such as loans drawn from corporate credit lines.<\/p>\n

Whatever the source of down payments for real estate, the bottom line is that Chinese banking system assets grew at 25% per year and the shadow banking system grew at 10% per year. Thirty-five percent credit growth never ends well, but it\u2019s fun while it lasts.<\/p>\n

Everything in China is about making the GDP number. Politicians are fixated on the result, rather than how they get there. But GDP \u2013 adjusted for wasteful, uneconomic projects \u2013 will ultimately be much lower. We\u2019ll see how much lower when the government recapitalises the Chinese banking system \u2013 both official and shadow banks.<\/p>\n

By the end of the banking system restructuring, China\u2019s reputation will have taken a big hit\u2026<\/p>\n

The biggest construction project in history will have ended; the supply of newly printed yuan, printed to fund the banking system restructuring, will have ballooned; the savings of a hardworking population will have been wasted on boondoggles; and China\u2019s growth <\/strong>story, as its population follows Japan into an aging demographic cycle, will end with a whimper.<\/p>\n

Dan Amoss<\/strong>
\nContributing Editor, Money Morning<\/em> <\/strong><\/p>\n

Publisher\u2019s Note<\/em>: This article first appeared in The Daily Reckoning USA.<\/em><\/a><\/span><\/em><\/p>\n

Join Money Morning on Google+<\/span><\/a><\/strong><\/p>\n

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\"\"<\/a> \"\"<\/a> \"\"<\/a><\/div>\n

\"\"<\/p>\n","protected":false},"excerpt":{"rendered":"

By MoneyMorning.com.au The Chinese model of economic growth is flawed. It has wasted resources on an unprecedented scale. Empty cities, excess industrial capacity and sour construction loans litter the country. New lending yields less and less incremental growth. And the very worst construction projects aren\u2019t producing enough cash to service debts. The Chinese economy, like … <\/p>\n

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