China's economy and markets have been defying the laws of economics since
2009. Amid a worldwide financial crisis during that year, they managed to grow
their economy by 8.7%. But that growth was fueled by a $586 billion dollar
government stimulus package, which was followed by an additional $20 trillion
dollars in new construction spending over the next seven years.
China's economy became the envy of the world as the economy expanded through
the edict of government to build massive cities that were mostly vacant. In
fact, estimates are that 52 million homes in China are currently vacant and
90% of those empty units were purchased for investment purposes.
As investors sat on empty real estate, debt levels in the shadow banking system
rose to troubling levels. A real estate bubble of this magnitude would bring
most economies to the brink of destruction. But fear not; the megalomaniacs
in Beijing had a solution: in 2015 they created a new bubble in the stock market
to offset the fragile real estate bubble.
And to accomplish this, 40 online brokerage lenders helped arrange more than
7 billion yuan worth of loans for stock purchases.
As you can imagine, China's leverage problem quickly reached epic proportions.
Fueled by margin debt the Shanghai Composite (SSE) started 2015 at 3,234 and
hit 5,023 by June 4th; a 150% surge from the preceding 12 months, before plunging.
Shanghai Index:
With markets in free-fall, the totalitarian regime made daily policy modifications
in a desperate attempt to stop the bleeding. Surprise interest rate cuts by
the central bank, relaxations in margin trading and other "stability measures"
did little to calm investors' angst. But eventually, the central planners stepped
in and stemmed the market's decline.
However, the nation was far from out of the woods. Once a model of fiscal
prudence, China became a country swimming in debt and asset bubbles. China's
corporate debt levels are now over 150% of its GDP, and estimates of total
debt are as high as 280% of GDP.
Consumer credit has grown by over 300% in just the past six years. In October
of 2015, debt levels for consumers hit 23.5 trillion yuan ($3.41 trillion).
The expectations are that this will more than double by the end of 2020, reaching
nearly 53 trillion yuan ($7.66 trillion).
The nation has now reached a 10-year high in delinquent corporate loans. Bloomberg
reports that China has had nearly three times the number of defaults recorded
in 2015.
Even the International Monetary Fund (IMF) is beginning to wave the warning
flag that failing to act quickly to rein in corporate debt could prove detrimental
to both China's economy and the world as a whole.
Of course, supporting the rotating carousel of real estate, commodity, and
stock bubbles, while also trying to stem bond defaults, comes at a cost. All
of that debt and money creation usually results in a decimated currency. However,
China uses its currency reserves (held mostly in dollar denominated Treasuries)
to keep the value of the yuan from falling too quickly. But what had once been
China's get out of financial crisis free card--their immense foreign exchange
reserves--is dwindling at an alarming rate.
November's severe drop in reserves marked the fifth straight month of declines
and are at the lowest level since March 2011. In fact, Japan just superseded
China as the largest holder of U.S. sovereign debt.
IMF guidelines put $2.8 trillion as the minimum prudent level for China to
hold in reserves--it is closing in on that level at the current pace. The yuan
fell to an 8-1/2-year low in November and has dropped 6% against the dollar
so far this year despite the government's efforts.
Adding to pressure on the yuan is the newly elected U.S. president, Donald
Trump, who has threatened to label China as a currency manipulator on his first
day in office and impose huge tariffs on imports of Chinese goods. Pushing
even further down on the yuan are the threatened three Fed rate hikes scheduled
for 2017.
In January, Chinese citizens will get an even lower quote from Beijing for
exchanging their local currency into foreign dollars. Yes, China's government
even tries to dictate the exact value of its currency. Many believe this will
create a repeat of the market chaos that ensued at the start of 2016, as capital
outflows surge.
Scotiabank Vice President of Economics, Derek Holt, believes these fears are
warranted. He said in a recent article: "Why wouldn't they convert like there
is no tomorrow?" ... "After another year of yuan depreciation, would you keep
your life savings in a currency that is losing international purchasing power
and within a banking and shadow finance system that gets all manner of negative
headlines?"
Therein lies China's dilemma: Allow the yuan to intractably fall, which will
increase capital flight and destroy its asset-bubble economy. Or, raise interest
rates to stabilize the currency and risk collapsing asset bubbles that will
crumble under the weight of rising debt carrying costs.
China embodies a Keynesian dystopia that results from central planning gone
mad. It's mirage of prosperity should soon be coming to an unpleasant end.
The misguided belief any government can print unlimited amounts of money and
issue a massive amount of new credit; while providing the conditions that are
the antitheses necessary for viable growth, has one significant Achilles heel:
eventually, it will destroy your currency. Currency is always the pressure
valve that explodes in an economy that has reached the apogee of dysfunction.
The Red nation isn't the only offender on this front, but is certainly one
of the worst. Therefore, China and the yuan may have finally run out of time.
