A day after I pointed out my suspicions of a possible implosion of China’s bubble economy, China’s government announced that she will be intervening to support their banking and financial system by acquiring shares of major banks through her sovereign wealth fund, Central Huijin[1].
China’s reported interventions sent the Shanghai index up 3% over the week.
Financial bailouts has not been confined to China’s stock markets, but to the real economy too, China declared another bailout package for small companies[2]. The measure includes tax breaks, easier access to loans and leniency on appraising bad loans following the reported collapse of some manufacturers in Wenzhou which has been indicative of the growing risks to China’s economy.
Resorting to emergency stabilization policies basically confirms my suspicions, China is presently suffering from either a sharp economic slowdown or in the process of a bubble implosion. The latter is where I am leaning on, but this requires more evidence.
As earlier mentioned, China’s recent strains have been representative of the unintended consequences of China’s boom bust or inflationist policies. Part of which constitutes the aftereffects of the 2008 stimulus, combined with the impact from China’s struggle to contain her inner demons—elevated consumer price inflation (CPI).
And also as previously noted, the bear market of the Shanghai index since 2007 represents a continuing dynamic of China’s massive boom bust cycle that only has shifted from the stock market to the property sector.
Slowing money supply growth from the series of interest rates increases, the hiking of bank reserves requirements and the appreciation of her currency, the yuan, has been putting financial strains on the massive misallocation of capital due to the previous policies directed at preventing a bust and the political imperatives to maintain a permanent state of quasi booms[3].
And to further give weight to my suspicions, we seem to be seeing substantial outflows of hot money which has materially reduced China’s foreign reserve accumulation. Part of this has also been been attributed to China’s declining current account surpluses[4].
For now, the continuity of the outflows is not clear and will likely depend on the scale of economic and financial deterioration.
Seen from the perspective of China’s currency, we are unlikely to see the yuan appreciate further. And contrary to public expectations, the unwinding of China’s bubble economy would lead to a depreciating yuan.
While many see the current downturn to meaningfully reduce China’s lofty Consumer Price Inflation (CPI), which gives China’s government more latitude to ‘ease’ credit or provide additional bailout measures, economic downturns do not mechanically imply a disinflation of consumer prices. This will greatly depend on the actions of the Chinese government
But more bailouts should be expected as the political objectives for the China’s ruling class ensures such course of action. China’s political stewards will work to postpone an inevitable bubble meltdown. That’s because a sharp economic downturn will likely trigger China’s version of the Arab Spring uprising or a populist upheaval that magnifies the risk of toppling the incumbent regime. There have already been snowballing accounts of protest movements[5] over the country.
Put differently, signs of accelerating stress levels in the financial sector, where loan losses from bad debts could spike to 60% of equity capital according to the estimates the Credit Suisse[6], and a slowdown in parts of the China’s economy suggests that the campaign to contain inflation will shift towards promoting inflation as evidenced by the two bailout measures unveiled last week. There will be more coming.
And like the current policymaking dilemma in the Eurozone, where Euro officials have been struggling to thresh out a “comprehensive strategy” which would ring fence the Euro’s fragile banking sector[7], and similar to the sequential actions of US authorities leading towards the Lehman bankruptcy in 2008, Chinese officials are likely to apply a whack-a-mole approach in dealing with the emergent economic strains.
Unlike in 2008, last week’s twin bailout packages have been inexplicit or indeterminate as there has been no amount specified.
In short, expect Chinese policies to be reactive until such problems will become significant enough for the government to announce a massive specific systemwide bailout program.
Dissonant Market Signals
For the meantime, the current financial and economic environment remains fundamentally a guesswork.
China and the Eurozone’s bailout has hardly boosted copper prices.
Dr. Copper, whose price action have conventionally been interpreted as exhibiting the health conditions of the global economy seems unconvinced, as the recent price performance has evidently lagged the recovery seen in global equity markets.
For chartists, the current rally appear to have forged a bearish rising wedge pattern which seem ominous for another bout of selling episode.
And considering the newly announced expansions of QE measures by the European Central Bank (ECB)[8] and the Bank of England (BoE)[9] as well as the soaring money supply aggregates in the US (which is a fundamental reason why the US is unlikely to fall into a recession unless an external shock occurs like that of China), the same essence of skepticism can be construed to the underperformance of gold prices.
While threats to[10] and actual imposition of various trading curbs on the commodity markets are currently being waged by global authorities, the effects of these are likely to be short term. The greater and more lasting impact would emanate from the large scale redistribution schemes of bailouts, taxations and inflationism.
Nonetheless, the unfolding events in China poses as a black swan event that could undermine the current rally.
Thus, we should closely observe the developments in China and how Chinese and global authorities will react to the unfolding developments.
Grandiose Plans and Promises Meant To Be Broken
To repeat, the current state of the markets appear to be driven by the spate of newly implemented political programs such as QEs, bailouts (Drexia[11]) etc..., as well as, promises for a political resolution on what has mainly been a politically induced problem for the China, the Eurozone and the US.
The current European based QEs may not seem as large as the previous which, in my view, could be a source of liquidity strains on the financial markets starving for sustained massive injections of money or inflationism.
It would be interesting to see if the flurry of news of actual and proposed bailouts will succeed in the restoration of confidence (which means reduced market volatilities highlighted by a fortified upside trend) or if such narratives will be reinforced by concrete actions such as the recent ratification[12] of the European Financial Stability Fund (EFSF) or recently announced QEs by the ECB and the BoE. Again, size matters.
So far some stories or plans may just end up in the shelf or in the trash bins signifying another failed attempt at propping up a highly fragile and tenuous system.
In the Eurozone, a proposal being floated to ring fence the region’s banking system will be through the conversion of the EFSF into an insurance like credit mechanism, where the EFSF will bear the first 20% of losses on sovereign debts, but allows the banks to lever up its firepower fivefold to € 2 trillion[13]
Yet the lack of real resources, insufficient capital by the ECB, highly concentrated and the high default correlation of underlying investments could be possible factors that could undermine such grandiose plans. Besides, such plans appear to have been tailor fitted to reduce credit rating risks of France and Germany aside from allowing the ECB to monetize on these debts[14].
Again given the complexities of the system, it would be difficult to conceive how these centralized plans would ever succeed.
At the end of the day, the final intuitive recourse, like in most of our history, would be for political authorities to engage in inflationism.
[1] See Black Swan Event: Has China’s Bubble Been Pricked?, October 9, 2011
[2] Bloomberg.com China Offers Help to Small Companies Amid Wenzhou Risks, October 14, 2011 SFGATE.com
[3] See China’s Bubble Cycle Deepens with More Grand Inflation Based Projects, June 2, 2011
[4] Danske Bank China: FX intervention eased substantially in Q3, October 14, 2011
[5] See Does Growing Signs of People Power Upheavals in China Presage a ‘China Spring’? September 26, 2011
[6] Bloomberg.com Chinese Banks’ Bad Debt May Hit 60% of Equity Capital, Credit Suisse Says October 12, 2011
[7] Bloomberg.com Europe Crisis Plan Wins Global Backing as G-20 Urges Action, October 15, 2011 Businessweek.com
[8] See European Central Bank expands QE to include Covered Bonds, October 6, 2011
[9] See Bank of England Activates QE 2.0 October 6, 2011
[10] See War on Commodities: Eurozone Threatens to Impose Derivative Trading Curbs, October 15, 2011
[11] See Reported Bailout of Belgium’s Dexia Spurs a fantastic US Equity Market Comeback October 5, 2011
[12] See Slovakia ratifies Euro Bailout Fund (EFSF), October 14, 2011
[13] Reuters.com G20 tells euro zone to fix debt crisis within weeks October 15, 2011 Hindustantimes.com
[14] Das Satjayit A Psychiatric Assessment of the Eurozone's Leveraged Bailout Fund, October 5, Minyanville.com
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