Tuesday, June 28, 2011

China’s Bubble Cycle: Shadow Financing at $1.7 Trillion

The US mortgage bubble had substantially been financed by Shadow Banking system, where major private financial firms arbitraged around existing regulations in complicity with regulators.

China’s bubble has been progressing with the same symptoms but with different players.

This time local government agencies have relied on unofficial sectors to fund the blossoming property mania.

From the Bloomberg

China’s first audit of local government debt found liabilities of 10.7 trillion yuan ($1.7 trillion) at the end of last year and warned of repayment risks, including a reliance on land sales.

Financing vehicles set up by regional authorities already had more than 8 billion yuan in overdue debt, while more than 5 percent of such companies used new bank borrowing to repay loans, according to the audit, posted on the National Audit Office’s website and submitted to China’s cabinet.

“Some local government financing platforms’ management is irregular, and their profitability and ability to pay their debt is quite weak,” Liu Jiayi, the country’s auditor-general said in speech published today.

Premier Wen Jiabao ordered the first audit of local- government borrowing in March, amid concern spending designed to support the economy following the 2008 global financial crisis would leave a legacy of bad debt. As much as 30 percent of bank loans are expected to turn sour and they are likely to be the biggest source of non-performing assets for the industry, Standard & Poor’s said in April.

Local governments, barred from selling bonds or borrowing directly from banks, had set up 6,576 financing vehicles by the end of 2010 to raise money, the audit showed, accounting for 4.97 trillion yuan, 60 percent of which governments have responsibility to repay. Some governments have offered illicit guarantees to such companies, while others rely on land sales to help them repay, Liu said.

UBS AG estimated in a June 7 report that local government debt could be 30 percent of gross domestic product and may generate around 2 to 3 trillion yuan of non-performing loans. Credit Suisse AG economist Tao Dong said it was the biggest “time bomb” for China’s economy.

The Austrian business (bubble) cycle seems to be buttressed by the Hyman Minsky Ponzi financing dynamics or financial instability hypothesis.

A refresher quote from Professor Minsky, (bold emphasis mine)

“Three financial postures for firms, households, and government units can be differentiated by the relation between the contractual payment commitments due to their liabilities and their primary cash flows. These financial postures are hedge, speculative, and ‘Ponzi.’ The stability of an economy’s financial structure depends upon the mix of financial postures. For any given regime of financial institutions and government interventions the greater the weight of hedge financing in the economy the greater the stability of the economy whereas an increasing weight of speculative and Ponzi financing indicates an increasing susceptibility of the economy to financial instability.”

Many who see the fallacious “global imbalances” symptom will be proven wrong once China’s bubble bursts. We will see China's currency the yuan collapse the way the Thai baht did in 1997

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