China’s First Default and Export Crash
A few hours after the close of the Friday’s trading session in Asia, news announced of the first China onshore default on bonds[1]. While the manic US stock markets seem to have shrugged this off, it is unclear if Asian markets will also disregard this.
Even worse, after the close of the trading hours in US, the Chinese government announced[2] of a steep 18.1% decline in exports!!! I would say that 18% EIGHTEEN PERCENT represents a collapse and not just an ignorable drop.
The export crash has brought about China’s trade balance into a massive deficit. Yet both the degree of export volume breakdown and the scale of deficits matches or has even been larger than during the global crisis of 2008 (see red ellipses). Whether this represents an anomaly or signs of the deepening and acceleration in the deterioration of China’s economy has yet to be established. But I suspect the latter.
Why?
Because as I have been pointing out, such is how the bubble cycle unfolds.
The first stage; financial market disruption. Then, liquidity squeeze. Lastly, either a financial crisis that brings about an economic crisis or vice versa. The Chinese markets had her financial market disruption episode in June 2013. Then the attendant spike in interest rates underscored on the liquidity squeeze which the Chinese central bank has been intensely firefighting with liquidity administration[3].
Now the real world contagion.
In 2014, we seem to be witnessing the combination of financial market disruption and real world economic problems, particularly, the first trust bailout[4] in late January, the unreported January quasi-‘bank run’ on three cooperatives which just surfaced last week[5], the reversal of the one way yuan trade[6] and now both the first default and export meltdown. In barely three months, accounts of financial-economic convulsion appear to be increasing in frequency and intensity.
Remember, Chinese ‘zombie’ non-financial companies with debt-to-equity ratio exceeding 200% have reportedly jumped from 57% to 256 from 163 in 2007 according to a report from Bloomberg[7]. This implies of the potential scale of the risks of defaults, not to mention the risks from $3 trillion of local government debt and China’s shadow banking industry estimated[8] between $7.5 trillion (JP Morgan) and $15 trillion (Fitch’s controversial Charlene Chu)
So aside from higher cost of funding which results to dislocations in economic operations and subsequently engenders an economic slowdown, a feedback loop of slowing economic growth magnifies on the debt problem by aggravating access to funding which translate to higher costs of financing.
This is why the first default has been analogized by some mainstream pundits as China’s ‘Bear Stearns moment’ as climbing rates and the risks of payment delinquency will pose as major roadblocks to interbank lending that increases default risks.
And it is important to point out that in contrast to the external account talisman that the mainstream uses to justify their worship of bubbles, in China’s case surpluses dramatically morphed into deficits. In addition, China’s record forex reserves hardly serve as an adequate shield to a DEBT problem issue.
As I have projected at the start of the year, China’s unwieldy debt conditions may trigger a Global Black Swan event[9].
Evolving events have been indicative towards such direction.
Russian Financial Markets Meltdown
And this has not just been a China affair. Financial strains in emerging markets have been sporadically spreading. While ASEAN’s pressures may seem to have eased (I say temporarily), Russia suffered a financial market meltdown last week.
It would be misguided to treat or impute Russia’s problems to entirely the Ukraine standoff. As I pointed out earlier, in contrast to mainstream understanding which views the weakening Russian ruble as foreign money instigated[10], this has been mostly a resident capital flight phenomenon[11]. The falling ruble existed even prior to Russia’s troop build up in Crimea.
The intervention by the Russian government has only aggravated such conditions. And in trying to preempt the outflows from a deepening corrosion of sentiment, Russia’s central bank Bank Rossii hiked interest rates by 150 basis points. The result has been a horrific (12%) one day crash in stock market, bond markets and even the ruble[12]. All the stock market gains accumulated from June of 2013 vanished in just one day. Russia’s stocks as measured by the MICEX closed the week down 7.29% which means about 40% of the losses have been recovered. Dead cat’s bounce, perhaps?
And all it takes is for political maelstrom to expose on the real issues: DEBT.
And again despite the huge forex reserves of both China and Russia, worsening credit conditions have overwhelmed or negated any so-called advantages.
And to put into perspective from the heavily biased reporting seen in most of mainstream media about the geopolitical impasse between the US and Russia, under the previous terms and agreement by Ukraine and Russia, Russian troops “has been allowed to keep up to 25,000 troops on the Crimean Peninsula”[13]. Now whether troops operating outside the bases are legitimate or not is subject to anyone’s interpretation.
But so does interpretative conundrum apply to the historical attachment of Crimea with Russia. Crimea had been a part of the Russian empire in 1783 way until the General Secretary of the Communist Party in Soviet Union ‘Ukrainian’ Nikita Khrushchev transferred in 1954 “the Crimean Oblast from the Russian Soviet Federative Socialist Republic to the Ukrainian Soviet Socialist Republic” notes the Wikipeida.org[14]. Ukraine became independent[15] from the Soviet Union following the latter’s dissolution in 1991.
So the Crimean political crisis is a complex issue being oversimplified by media.
I would like to also further note intervention has been a two party affair. Early February news leaked of the hacked phone conversation between US Assistant Secretary of State Victoria Nuland and US Ambassador to Ukraine Geoffrey Pyatt in actively plotting over the ouster of the previous Ukraine leadership[16] and of the prospective instalment of their candidates.
And Ms. Nuland also reportedly confirmed according to UK’s Guardian “that the US had invested in total "over $5 billion" to "ensure a secure and prosperous and democratic Ukraine" - she specifically congratulated the "Euromaidan" movement[17].”
So the pot calls the kettle black.
The Contagion Link
Going back to economics, in terms of trading linkage, ASEAN represents the fourth largest trading partner of China[18] (left window). The EU has been both the largest trading source for China and Russia. China is the second biggest trading partner of Russia[19] (right window). So a China and a Russian economic downturn imply that the biggest damage will be on the EU.
And that’s just the context of trade and doesn’t cover capital flows.
The implication of China’s export meltdown is that the global economy may have taken a sharp downturn in February. This will be reinforced by Russia and all other Emerging Markets (Turkey, Brazil, India, ASEAN and etc…) recently hit by the yield spread disorderly adjustments.
And as of December 2013, according to the Philippine National Statistics office, China has been the largest source of Philippine imports[20] and the second largest export market[21].
And as I previously mentioned US and European banks have intensely increased bank lending to emerging markets[22].
So should China and or Russia’s financial-economic turmoil escalate, the idea that the ASEAN or the Philippines will be immune from this will just seem utterly delusional. Or the fugazi.
[1] See China’s First Onshore Default! March 7, 2014
[2] Bloomberg.com China’s Feb. Exports Unexpectedly Decline in Blow to Confidence March 9, 2014
[3] See PBoC Injects 255 Yuan to Calm Debt Jitters, Asian Stock Market Celebrate January 22, 2014
[4] See China Rescues Troubled Trust Product January 28, 2014
[5] See China’s Bear Stearns Moment? First Bond Default Looms March 6, 2014
[6] See Has the Falling Yuan and Tumbling Chinese Stocks Been Signs of Capital Flight? March 3, 2014
[7] Bloomberg.com Zombies Spreading Shows Chaori Default Just Start: China Credit March 7, 2014
[8] See Global Markets: How Sustainable is the Recent Risk ON? February 17, 2014
[9] See Will China Trigger the Black Swan Event in 2014? January 20, 14
[10] See Behind Russia’s Central Bank’s “Unlimited Intervention” January 31, 2014
[11] See Emerging Market Turmoil: The Fallacy of Foreign Currency Reserves as Talisman February 3, 2013
[12] See EM Crisis Over? Explaining the Meltdown in Russian Financial Markets March 4, 2014
[13] Voice of America Russian Forces in Crimea: Who Are They, Where Did They Come From? March 5, 2014
[15] Wikipedia.org Ukraine independence
[16] Euronews.com US embarrassed by apparent hacked phone call dismissing EU on Ukraine February 7, 2014
[17] The Guardian Ukraine crisis is about Great Power oil, gas pipeline rivalry March 6, 2014
[18] Wikipedia.org List of the largest trading partners of China
[19] Wall Street Journal Lawmakers Pass Russia Trade Bill November 16, 2012
[20] Philippine National Statistics Office External Trade Performance: December 2013
[21] Philippine National Statistics Office Merchandise Export Performance : December 2013
[22] See Emerging Markets: Why Adjustments For Relative Yield Spreads has been Disorderly February 17, 2014
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