Will Financial Tremors in China and Hong Kong Lead to the Big One?

Bankruptcy comes in stages. In the early stages, it is barely visible. Income does not keep pace with expenditures. The spendthrift borrows. "No problem." This is seen as a temporary anomaly. Then the borrowing speeds up, but there is sufficient capital to justify the increased debt. The accountants warn of trouble ahead. The debtor responds: "So far, so good!" "There's more where that came from!" The process continues. Then the accountants say: "The future is now." The spendthrift responds: "Eat, drink, and be merry, for tomorrow we die." —Gary North

In this issue

Will Financial Tremors in China and Hong Kong Lead to the Big One?

-Mounting Stress on China Yuan and the Hong Kong Dollar; Will the Hong Kong’s USD Peg be Broken?

-From Convergence to Divergence: China’s Stocks Leads The Rest of the World Lower as US Tests Record High!

-Will China’s Government Launch Xi Jinping Put 2.0?

-Has Financial and Economic Rescues Reached its Natural Limits?

Will Financial Tremors in China and Hong Kong Lead to the Big One?

From Turkey back to China.

Mounting Stress on China Yuan and the Hong Kong Dollar; Will the Hong Kong’s USD Peg be Broken?

After hitting a 15-month low, the Chinese yuan rallied most since January by .79% last Thursday, on rumors that US-Chineseofficials reopened doors for trade discussions.  In spite of the rally, the USD yuan firmed by .45% this week. (see figure 1, upper pane)

 

Figure 1

Like the yuan, the Hong Kong dollar’s US dollar peg has been under pressure. Hong Kong's de facto central bank, the Hong Kong Monetary Authority (HKMA), reportedly bought more than $2 billion worth of local currency to maintain a long-held peg to the US dollar leaving just $12 billion in its reserves by the end of the week.

Tremors in the yuan appear to have diffused into Hong Kong. Should the USD-HKD peg break, not only will the yuan’s fall accelerate, tensions may intensify in Hong Kong and China’s financial markets that could prick both China and Hong Kong’s property bubbles.

From Convergence to Divergence: China’s Stocks Leads The Rest of the World Lower as US Tests Record High!

 

Figure 2

Strains in the currency markets have been reverberating on China and Hong Kong’s stock markets.

The national benchmark, the Shanghai Composite (SSEC), tumbled by a staggering 4.52% this week, to hit the lowest level of the 2015 crash in January 2016. Hong Kong’s HSI sank 4.07% to a one year low.

From its zenith in January, the SSEC has lost 24.99% and posted a year to date performance of -19.3%, Asia’s worst. Meanwhile, Hong Kong’s HSI which has been down 17.92% from the January peak may likely drop into the bear market’s lair.  

Pressures on the Chinese stock market appear to have truncated the recent rally of ASEAN stocks. Excluding the Vietnamese benchmark, which closed almost unchanged (+.04%), the national indices of Indonesia (-4.83%) and the Philippines (-2.84%) led ASEAN benchmarks down.  

Only six (31.6%) of the nineteen national bourses defied selling pressures in Asia. The region’s weekly performance had an average of -1.35%.

Bank Indonesia raised rates for the fourth time since mid-May this week to stanch the hemorrhaging rupiah (-.79% week on week, -7.66% in 2018). The Philippine peso slid .55% to 53.43.

Since the January acme, the complexion of the performance of global equities experienced a radical change.

While US stocks represented by the S&P 500 (+.59, week, +6.6% year to date) continues to climb to its January highs, the MSCI World ex-US (MSWORLD), China’s Shanghai Composite and the Emerging Market iShares ETF have fallen to reach more than a year’s depths.

Convergence in global equity market performance has morphed into a divergence. Yet how sustainable can this seminal divergence be?

Have global investors been rotating into the US? If world national benchmarks have been signaling an economic downshift, will US stocks follow suit? Or will the US power the global economy higher? But how can the latter be if the trade war will remain in place or if it will intensify?

Such divergent dynamic has also emerged in parts of Asia.

With most of the region’s markets under pressure, the Pacific benchmarks of Australia and New Zealand ironically hit milestone highs.

Bifurcating markets have also appeared in India. While the Indian rupee’s free fall plumbed a fresh low, its equity benchmarks raced to landmark heights!

Will China’s Government Launch Xi Jinping Put 2.0?

The plunge in China’s stock markets should be a concern to Asia. The Middle Kingdom has significant links with latter which functions primarily as its supply chain network. China has likewise been a significant source of Asia’s financing, fund flows, and a market for tourism

In 2015, a slew of draconian measures had been implemented by the Xi administration to arrest the stock market crash.

Aside from imposing assorted bans and limits on equity sales, the government infused cash to brokers and state-owned enterprises to put a floor on the stock market. 197 people, including journalists, were reportedly incarcerated for spreading rumors. “Spreading rumors” carries a three-year jail sentence after its introduction in 2013

The Xi administration’s stock market rescue efforts had been known as the Xi Jinping Put.

Nevertheless, the SSEC still crashed by 48% in 6 months.

The crash exposes how meddling and manipulating the markets will fail to attain its intended objectives. Though perhaps China’s markets could have gone lower, the present stress highlights the fact that kick the can down the road may have reached its end.

China’s stock markets may likely bear the brunt of the accrued imbalances caused by the 2015-2016 Xi Jinping Put.

All actions have consequences.

 

Figure 3

That episode caused the Chinese government to panic!

It launched a considerable amount of fiscal stimulus (see above), accelerate interest rate cuts and infused massive amounts of credit to stabilize and insulate the economy from the aftermath of the stock market crash. According to Federal Bank of New York’s Liberty Street Economics, “In 2016 alone, credit outstanding increased by more than $3 trillion, with the pace of growth still roughly twice that of nominal GDP” (bold and italics mine)

Since the stock market crash, the bank loan share of M2 continues to bulge.

Some of the global central banks responded by implementing negative interest rates in 2016 (e.g. ECB, Bank of Japan, Denmark and Sweden).

Under introduction of the corridor system, the Philippine Bangko Sentral ng Pilipinas slashed rates to a historic low in June 2016(also partly in response to domestic downside price pressures or “disinflation”).  Remember the erstwhile BSP chief Amado Tetangco Jr’s spiel on deflation or disinflation?

If stocks continue to crumble, will the Chinese government respond in the same way as they did in 2015?

Will interest rate cuts be the next move for global central banks?

Has Financial and Economic Rescues Reached its Natural Limits?

But here is the thing.

China’s property markets continue to burn the road.

New home prices and property investment growth have rocketed at the fastest pace in 2 years which had been financed by a rapid buildup in household debt which soared 15.14% in June month on month.

So rescue operations will only accelerate the meltup in the housing market which the Chinese government has been attempting to control, although at local levels.

Figure 4

And weakness in stocks or properties may aggravate its fragile offshore dollar/eurodollar conditions in part by rekindling capital flight and mainly from growing scarcity of access to US liquidity and collateral. China’s international reserves have begun to fall again last July. [upper window]

China’s monetary system, like the Philippines, is built upon mainly forex or international assets (mostly US dollars). [lower window]

China has been experiencing tremendous economic and financial tensions. The snowballing strains appear to be spreading. It has been ventilated on the currency markets (the yuan and Hong Kong dollar) first and then has spread to the stock market. Will credit be next? Then housing?

Unless Chinese authorities will be able to pull a rabbit out of a hat soon, a major financial and economic tremblor may be upon us, with the epicenter in China.