China’s Government Panics: Launches Version of QE/LTRO!

The People’s Bank of China just cut interest rate last Sunday May 10^th, for the second time this year.

Apparently the succession of interest rate cuts since 2014 has hardly helped buoyed the real economy. Instead this has only been magnifying credit risks on their financial system.

As I pointed out before, in order to alleviate her intractable debt burden (now an estimated at least 282% of GDP), the Chinese government have contemplated on mimicking Western monetary policies of either Fed QE or ECB style LTRO. 

Plans have now turned into action.

From Dow Jones/Australian News: (bold mine)

China is launching a broad stimulus to help local governments restructure trillions of dollars in debts while prodding banks to lend more, as fresh data added to signs of a worsening slowdown in the world’s second-largest economy.

In a joint directive marked “extra urgent,” China’s Finance Ministry, central bank and top banking regulator laid out a package of measures to jump-start one of the government’s most important economic-rescue initiatives: a debt-for-bond swap program aimed at giving provinces and cities some breathing room in repaying debts.

Central to the directive is a bigger-than-expected plan by the People’s Bank of China that will let commercial banks use local-government bailout bonds they purchase as collateral for all kinds of low-cost loans from the central bank. The goal is to provide Chinese banks with more funds to make new loans. The directive was issued earlier this week to governments across the country and reviewed by The Wall Street Journal.

The action marks the latest in a string of measures taken by Beijing to boost economic activity, including three interest-rate cuts since November. But those steps so far have failed to spur new demand, in part because heavily indebted Chinese companies and local governments are struggling with repaying mountains of debt. At the same time, borrowing costs remain high, and low inflation makes it difficult for businesses and consumers alike to service debt. Banks are reluctant to cut lending rates amid higher funding costs and rising defaults.

The sense of urgency to resolve the country’s mounting debt problems is palpable at the government’s topmost decision-making body. The State Council in recent weeks instructed China’s top economic agencies-including the Finance Ministry, the central bank and the China Banking Regulatory Commission-to come up with a plan to help local governments cope with their debt, according to officials with knowledge of the matter.

The attempt at easing debt servicing costs via a debt swap will hardly boost economic growth on a system deeply hobbled by balance sheet impairments, instead what this will do is to buy time and worsen the imbalances (by inflating debt and misallocation of resources).

As I previously wrote:

The Chinese government fails recognize that the consequence of the previous (property) bubble has been to engender widespread balance sheet impairments in the real economy.

So foisting of credit to the financially inhibited economy via intensified easing measures will only signify “pushing on a string” or the inability of monetary policies to entice consumers to borrow and spend.

Instead, the ramifications of such policies will spillover into sectors that has previously had least exposure to credit. And this is what China’s stock market bubble has been about.

Recent credit growth has suffused to the stock market where borrowed money has ballooned and used to hysterically bid up equity prices even as the real economy has been materially deteriorating.

So the Chinese government basically adapts the current therapeutic government standard in dealing with bubbles: Do the same things over and over again and expect different results. Or solve bubble problems by blowing another bubble.

Here is an example how zero bound has only resulted to 'pushing on a string', from the same report:

Meanwhile, Chinese banks also aren’t extending new loans as much as the market expected. In April, banks issued 707.9 billion yuan ($114 billion) in new loans, down from 1.18 trillion yuan in March and below the median 950 billion yuan forecast of 11 economists polled by the Journal. M2, China’s broadest measure of money supply, was up 10.1 per cent at the end of April compared with a year earlier, below the median 12 per cent increase forecast by economists.

The steeper slowdown is forcing policy makers to devise more-aggressive measures to prop up growth if Beijing is going to reach its already-reduced annual growth target, set at 7 per cent for this year, the lowest level in a quarter century. In public, though, the Chinese government maintains a “neutral” monetary-policy stance, as the leadership doesn’t want to appear to be resorting to the old playbook of opening the credit spigot to salvage the economy.

In reality, some economists say, a new stimulus comparable to the $586 billion stimulus package launched in late 2008 is already in the making. Over the past six months, the central bank has cut interest rates three times and twice released the amount of rainy-day reserves set aside by commercial banks with the central bank. In addition, the PBOC has also provided more than $161 billion of funds to banks through a batch of tools.

The path towards larger than 2008 stimulus has been predictable, as I wrote in November 2014

In the past the Chinese government has vehemently denied that this will be in the same amount of the 2008 stimulus at $586 billion. But when one begins to add up spending here and there, injections here and there, these may eventually lead up even more than 2008

So far the recent experiment of inducing banks to buy government bonds has failed.

From the same report: 

When the bonds were first offered last month, many banks balked, saying the yields were too low compared with their funding costs. As a result, a number of Chinese regions, including Jiangsu, Anhui and Ningxia, either delayed or planned to put off their bond offerings.

In response to the new directive, the prosperous eastern province of Jiangsu this week relaunched a sale of bonds that it delayed last month. In a statement late Tuesday, Jiangsu said it was scaling back the amount on offer in the first stage, to 52.2 billion yuan, from the 64.8 billion yuan originally planned.

To give banks more incentives to purchase the bonds, the new directive from the Finance Ministry and other agencies requires localities to raise the yields on the bonds, saying the returns shouldn’t be lower than the prevailing Chinese treasury yields. At the same time, according to the order, yields on the new local bonds are capped at 30 per cent above the treasury yields. Currently, one-year Chinese treasury bonds yield about 3.2 per cent, while 10-year treasurys yield 3.5 per cent.

If banks won’t participate, then the PBOC might take the role of lender of last resort. They are likely to absorb most of the debt issuance by local government.

The Chinese government will also try to keep the stock market bubble alive in order to project C-O-N-F-I-D-E-N-C-E, and importantly, as an alternative channel for fund raising (for highly indebted firms to tap equity financing).

The noose on China’s bubble economy tightens.

As Housing Prices Crash at Record Speed, Chinese Government Bails Out Developer, Injects Liquidity

And the Chinese government declared that they would supposedly conduct reforms. But the reforms they have currently embarked on has been to save the status quo.

The Chinese government just rescued a major property developer.

From the New York Times:

Chinese banks have extended $16 billion in credit lines to shore up one of the country’s largest and most heavily indebted home builders, as pressure mounts on developers short of cash in a slumping property market.

The move by a group of mainly state-run banks to bolster the builder, Evergrande Real Estate Group, which is controlled by the billionaire Hui Ka Yan, is the latest sign of tumult in China’s sprawling housing sector.

Developers are rushing to secure financial support as sales volumes and housing prices plunge, weighed down by a growing overhang of unsold homes. The Kaisa Group, once a favorite of foreign investors, nearly defaulted on its offshore debt this year before being rescued by another developer.

Evergrande said on Tuesday that since February, it had secured new credit lines totaling 100 billion renminbi, or $16.2 billion. Those included a new 30 billion renminbi commitment on Monday from the Bank of China, which regards the developer as “its most important bankwide long-term partner,” Evergrande said in a news release.

The current measures has been meant as band-aid to a hemorrhage...

Analysts said the support from the banks — which also include the Agricultural Bank of China, Postal Savings Bank of China and the privately controlled China Minsheng Bank — would provide temporary relief but would fall short of addressing the company’s deeper problems.

Mounting debts and slumping sales “are fundamental challenges that can’t be resolved short term by government’s bailing them out on ‘too big to fail’ pretense,” said Junheng Li, the head of research at JL Warren Capital in New York.

“The company has been under financial distress for a long time,” she added.

Whether it is short term or not, resources redistributed to non-productive activities would worsen the current conditions going forward.

 

And this comes as the crash in Chinese home prices has even been intensifying.

From Investing.com (bold mine)

Property prices fell again in most major Chinese cities in February, amid continuing anxiety about the state of the country’s real estate sector. New house prices declined in 66 of 70 large- and medium-sized cities surveyed, according to China’s National Bureau of Statistics (NBS). Prices fell an average of 0.4 percent on the previous month, ending 5.7 percent lower than a year earlier, according to Reuters. It is the biggest year-on-year fall since the national survey began in 2011.

The only major cities that did not see a drop were the southern special economic zone of Shenzhen, where prices rose 0.2 percent, and the central industrial city of Wuhan, which saw no change. Prices for the secondary market also fell in 61 cities, though there were rises in five cities. The bureau blamed the sharp fall partly on February’s week-long Chinese New Year vacation, and predicted that prices would rebound this month. That did not stop the figures attracting widespread attention, however: one Chinese-language news website blared the headline: “Hangzhou house prices back to their level of five years ago?”

From CNBC (bold mine)

China new home prices registered their sixth straight month of annual decline in February, as tepid demand continued to weigh on sentiment despite the government's efforts to spur buying. 

New home prices fell 5.7 percent on year in February, according to Reuters calculations based on fresh data from the National Bureau of Statistics on Wednesday. The reading was worse than January's 5.1 percent decline and marks the largest drop since the current data series began in 2011.

Meanwhile, both Beijing and Shanghai clocked home price declines. In Beijing, prices fell 3.6 percent on year following a 3.2 percent drop in January, while prices in Shanghai fell 4.7 percent, following January's 4.2 percent drop.

So pressures from housing problems has filtered into the credit system, thereby manifesting strains in the repo markets.

The government’s response? Well, to inject money.

From Bloomberg: (bold mine)

China’s interest-rate swaps dropped the most in six weeks after the central bank took extra steps to boost liquidity to cushion an economy grappling with capital outflows and slowing growth.

The People’s Bank of China said it auctioned seven-day reverse-repurchase agreements at 3.65 percent, down from 3.75 percent last week. The central bank also rolled over 350 billion yuan ($73 billion) of loans it extended to banks via its medium-term lending facility in December, according to a person with knowledge of the matter, who asked not to be identified because the information hasn’t been made public. An unknown amount of lending was also added, the person said.

So reforms have actually been about the preserving the status quo.

The Chinese government reported that credit in February unexpectedly ballooned

From Bloomberg (bold mine)

Aggregate financing was 1.35 trillion yuan ($215.5 billion) in February, the People’s Bank of China said in Beijing Thursday, above economists’ median estimate of 1 trillion yuan. New yuan loans totaled 1.02 trillion yuan and M2 money supply rose 12.5 percent from a year earlier. 

With two interest-rate cuts and one reduction to the percentage of reserves banks have to set aside in the past four months, the central bank is seeking to cushion China’s slowdown. Industrial output, investment and retail sales growth missed analysts’ estimates in January and February, suggesting more stimulus is needed to boost the world’s second-largest economy.

“We see continued pretty solid core bank lending but a further slowdown in shadow banking,” said Louis Kuijs, Royal Bank of Scotland Group Plc’s chief Greater China economist in Hong Kong. “Authorities are trying to push liquidity into the system, but in terms of real economic entities, demand for credit is not very strong.”

But obviously the sponges for those credit expansion have likely been via State Owned Enterprises or politically controlled private institutions. 

As for the real economy, the disparity between credit expansion in the light of “demand for credit is not very strong”, crashing housing prices, and stagnating real economy implies that the Chinese economy has been plagued by substantial balance sheet impairments. You can lead the horse to the water but you cannot make him drink. 

However Chinese stocks continue to deviate from reality with its sustained upside move.

Of course it could most likely be that part of the credit expansion being foisted by the government to the system has been finding their way to chase yields via stocks.

So reforms has been about blowing one bubble after another. All temporary measures intended to kick the can down the road.

And naturally, because credit infused into the system will spillover to some areas of the real economy, there will be an outlet for this.  A clue to this has been that aside from retail punters, the shadow banking system have most likely been another major driver of the Chinese stock market mania.

From Reuters: (bold mine)

China's trust firms, with total assets of $2.2 trillion, are shifting more cash into frothy capital markets and over-the-counter (OTC) instruments instead of loans - blunting regulators' efforts to reduce shadow banking risk.

By redirecting money into capital markets and OTC products like asset-backed securities (ABS) and bankers' acceptances, trusts are acting less like lenders and more like hedge funds or lightly regulated mutual funds.

And the shift - a response to a clampdown last year on trust lending to risky real estate and industrial projects - means a significant chunk of shadow banking risk is migrating rather than shrinking…

Previously, people who bought into opaque wealth management products, many of which were peddled by banks but actually backed by trust assets, found themselves heavily exposed to real estate loans. Trust firms' changing asset mix means these investors may now instead find themselves exposed to high-yield corporate debt (junk bonds), volatile stock funds or risky short-term OTC debt instruments.

Oh, as for the pace at which housing prices have been crashing, they appear to be shortening the path to a Chinese recession/crisis. 

So there should be more defaults ahead.  Yet can the Chinese government fill in every defaulter's shoe? If not, market developments are likely to even deteriorate further.

As I previously noted:

Should the US housing bubble bust experience serve as a model, then a sustained housing deflation in China means that the latter's economy may fall into recession by mid 2016. 

But if the rate of the unwinding of the Chinese housing bubble accelerates, then this may shorten the time window. 

However, the Chinese government has been preemptively easing. The Chinese government has been joined by many other global central banks who appears to have also been frantically easing. 

Will such joint actions help extend or delay the process? Hmmmm.

It’s a complex world with manifold factors. But the writing is clearly on the wall.

Record stocks in the face of record imbalances at the precipice.

And once a recession/crisis has surfaced expect volatility in Chinese politics.

So what will the Chinese government do aside from reforms that has actually meant preserve the status quo?

Beat the drums of war to divert public attention from economic travails and to shore up domestic political capital, perhaps?

China’s New Stealth 500 billion yuan Stimulus Sends US Stocks to Recent Record Levels

In the Philippines, the classical Pavlovian conditioning to trigger a panic bid has been to shout G-R-O-W-T-H

In the US and elsewhere, the equivalent is for authorities to declare Q-E or S-T-I-M-U-L-U-S

So all it takes for the major US benchmarks to basically erase recent corrections is for the Chinese government to announce another system wide bailout via a QE

From Businessweek/Bloomberg:

China is providing 500 billion yuan ($81.4 billion) of liquidity to the country’s five biggest banks as Premier Li Keqiang steps up stimulus to support economic growth, Sina.com reported yesterday.

The People’s Bank of China yesterday started providing the banks with 100 billion yuan each through standing lending-facilities with tenor of three months, the news website said, citing banking analyst Qiu Guanhua at Guotai Junan Securities Co. The PBOC will complete the process today, it said.

“This is like ‘printing money’ as base money is created,” Shen Jian-guang, Hong Kong-based chief Asia economist at Mizuho Securities Asia Ltd., said in an e-mail. “The immediate impact is similar to an RRR cut of 50 basis points to all banks.” RRR is banks’ required reserve ratio; cutting it increases the amount they have available to lend.

The Chinese government earlier wavered on stimulus. Then they changed their minds and declared a ‘targeted easing’ last June with a formal announcement in July of 1 trillion yuan ($171 billion) stimulus (or QE?) via the “Pledged Supplementary Lending”.

The June-July stimulus hardly “boosted” the (really deteriorating) economy. 

It has been in stocks where the stimulus has had a positive effect. The government added spice to the stock market boom by intervening in the IPO market which has incited a debt financed retail based IPO frenzy.

This paucity of the initial stimulus to the real economy plus perhaps a –1.82% slump in the Shanghai index yesterday may have prompted for the new government support. The rationale could be if stocks come unglued and confidence falls apart in the face of fragility from an overdose of debt, misallocated resources and a fumbling economy, then a crisis may just emerge, so actions must be taken.

And in perspective if we add June and yesterday’s announcement this will constitute 43% of the 2008-9 stimulus at $586.  So if the QE lite installments will be continued this will eventually lead to the size of 2008-9.

The last major stimulus in 2008-9 spawned a debt monster. This has been manifested by the fantastic growth in the banking sector with banking assets now significantly above or higher than US counterparts.

But with the debt monster flailing, the Chinese government thinks that they must continue to feed on it in order to keep up with those targeted statistical 7.5% data for political reasons. This is regardless of whether policy induced diversion of wealth to unproductive activities will mean a further draining of the real economy which has already been burdened by too much debt and malinvestments

So this is basically doing the same thing over again and expecting different results. That’s the way of politics.

And unlike the Philippines where monetary authorities have been panicking to tighten, for the Chinese government, the panic has been to stoke more credit expansion.

Yet here is the intraday price response by the S&P and Australian dollar:Japanese yen pair, according to the Zero Hedge.

Like the Philippines, US stocks has become a one way street.

Profit taking is now considered taboo and thus corrections have become shallower which reinforces the manic phase.

Governments around the world continue to use asset markets as signal channeling tool to impress upon public that everything has been A-okay. This by sustaining the invisible transfer of resources to the government’s favored parties, Wall Streets of the world, elites, cronies, the bureaucracy and the welfare-warfare state.

Unfortunately the real economy is guided by the law of scarcity, which means such illusions won’t last.

As Chinese Developers’ Debt to Equity Soar, Hope Becomes Part of the PBoC Strategy

Interesting ironies developing in the Chinese economy.

First, credit woes has been spreading to reflect on slackening demand for properties.

From Bloomberg’s Chart of the Day: (bold mine)

China’s largest property developers risk missing their full-year sales targets as tighter credit and an economic slowdown cut demand for real estate, fueling concern the industry will struggle to repay debt.

The CHART OF THE DAY shows the 13 biggest developers that provided full-year sales targets achieved 49 percent of those goals by the end of July, the weakest level in at least two years, according to data compiled by Bloomberg. The ratio of debt to equity on a Bloomberg Industry gauge of 84 Chinese property companies has climbed to 128 percent, the highest since at least 2005 and almost double the Bloomberg World Real Estate Index’s 76 percent.

New-home prices fell in July in almost all cities that the government tracks, while sales of residential units slumped 28 percent from the previous month, as China’s broadest measure of new credit sank to the lowest since the global financial crisis. Moody’s Investors Service and Standard & Poor’s said this month some smaller Chinese developers may default in the second half amid falling sales and shrinking access to credit.

So slumping property demand expressed through falling prices has begun to impair on the balance sheets of property developers. This should amplify credit risks as debt servicing burden increases in the face of falling sales compounded by tightening access to credit.

In another Bloomberg article, the Chinese central bank, the People’s Bank of China has reportedly been challenged by the current predicament. (bold mine)

Rising stress in China’s $6 trillion shadow banking industry is testing central bank Governor Zhou Xiaochuan’s resolve to limit monetary easing as risks to the government’s growth target climb.

In the past three months at least 10 trusts backed by assets spanning coal mines in Shanxi to forests in Fujian have struggled to meet payments, sparking protests by investors outside banks that distributed their products. A slump in new credit in July underscored strains on the industry that funded as much as half of China’s recent growth, presenting Zhou with a choice: ease policy to avert a slowdown, or hold the line…

Apparently, the PBoC toes the same line with her contemporaries who has assumed the de facto policy guidepost on bubbles: “We recognize the addiction problem but a withdrawal syndrome would be more catastrophic”. 

So PBoC launched ah ‘targeted easing’ stimulus…

While the People’s Bank of China hasn’t changed its benchmark lending and deposit rates for the past two years, local media reported last month it had extended a 1 trillion yuan ($163 billion), three-year loan to a state development bank to support the funding of government-backed housing projects. It recently granted a 20 billion yuan re-lending quota to some regional bank branches to support agriculture, according to a statement on its website yesterday.

And as an offshoot to their previous undertakings of stimulus and other interventions, the consequences are now the PBoC’s headache:

Local-currency bank loans’ share of aggregate financing -- which includes bank lending, off-balance sheet loans, and bond and stock sales -- fell from 70 percent in 2008 to 51 percent in 2012 as shadow banking surged along with government-led efforts to stimulate the economy.

In the first seven months of 2014, the share of bank loans recovered to 56.7 percent, according to calculations based on PBOC data. In July, bank loans exceeded aggregate financing as other forms of credit shrank.

China’s debt-to-gross-domestic-product ratio was about 250 percent at the end of June, up from about 150 percent before the government rolled out its stimulus campaign in 2008, according to research by economists at Standard Chartered Plc.

And because of too much partying (debt financed asset boom), signs of hangover has emerged:

Shadow-banking assets jumped more than 30 percent in 2013 to 38.8 trillion yuan, according to Barclays estimates.

Trust defaults have escalated in recent months as the economy’s momentum stalled. At least 15 trust products have been reported to have repayment difficulties this year, according to UBS AG, citing media accounts and company disclosures. Local governments are working to avoid defaults, brokering deals between corporates and banks and leaning on lenders to provide bridge loans or take over shadow credit, Wang Tao, chief China economist at UBS, wrote in a July 10 note.

China Credit Trust Co. last month delayed payments on a 1.3 billion-yuan high-yield trust product backed by coal-mining assets in Shanxi after the borrower failed to raise funds to repay investors, according to a company statement. That triggered protests outside the Shanghai branch of the Industrial & Commercial Bank of China Ltd., which sold the product, according to local media reports.

Chinese debt woes hasn’t just been from the context of statistics, these are symptoms of a much larger disease, misallocation of capital. Therefore, working to avoid defaults by shifting productive capital to survive zombie companies simply will add to the present dilemma which means it won’t last.

And clearly hope has become part of the PBoC strategy. 

The hangover effects appears to have even spread to the mutual fund sector

From the South China Morning Post (bold mine)

The mainland's shadow banking woes have spread to the mutual fund sector, fuelling fears that defaults and frauds could spread in waves despite Beijing's efforts to deleverage an economy facing the risk of a hard landing.

Two recent scandals were fresh signs that nearly 1.5 trillion yuan (HK$1.89 trillion) of capital raised by the subsidiaries of mutual fund houses is exposed to risks due to the absence of an efficient monitoring system.

Earlier this month, Shanghai Goldstate Brilliance Asset Management, an alternative investment arm of Value Partners Goldstate, announced a 600 million yuan real estate fund would not be able to pay interest to investors, indicating the product would fail amid a weakened property market.

At the same time, Wanjia Win-Win, a subsidiary of Wanjia Asset Management, said it had uncovered fraudulent actions by a partner, Shenzhen Jingtai Fund Management, in the operations of a real estate fund started in June…

About 70 alternative investment companies have been set up by mainland mutual fund houses, with total assets under management of about 1.5 trillion yuan.

And because of the constrained access to credit, credit starved entities has been loading up from foreign sources

From the Wall Street Journal Real Time Economic Blog (bold mine)

Both disclosures offer insight into a recent surge in foreign lending to China as tighter lending conditions there and low global interest rates push more Chinese companies to borrow offshore. According to the latest data from the Bank for International Settlements, outstanding foreign loans to China rose 38% on year in the first quarter of 2014 to a record $795.7 billion, a fourfold increase since 2010.

Of the 25 countries whose banks report lending data to BIS, the biggest surge in new loans in the year ended March 31 — $50 billion — came from banks based in the United Kingdom, a group that includes HSBC and Standard Chartered, both British-domiciled banks with most of their assets in Asia. French banks were the second-largest source of new credit, extending $20.6 billion in new loans to China. Japanese banks were third, raising their exposure by $15.8 billion over the same period.

The rapid growth in credit to China left British banks as China’s largest foreign lenders, with a record $221.2 billion in outstanding loans to China. U.S. banks were second with a record $86.5 billion and Japanese banks third, with a record $77.4 billion.

So ‘misery loves company’ has been transmitted through foreign financial institutions. Aside from PBoC stimulus, Chinese (private and hybrid) firms continue to survive because of access through the global chase for yields. Yet this underscores the elevated risks of contagion

And of course, junctures in the credit markets will filter down into the real economy which will have a feedback mechanism: credit problems will hurt the real economy and the real economy will aggravate on credit woes.

And the stimulus have yet to weave its magic as shown in the above chart. According to the WSJ Real Economic Blog

The latest figures out of China indicate recent stimulus attempts have yet to relieve distress in lending and real estate markets.

So how should stocks respond to a slowing economy, to a decline in earnings and rising credit risks?

In the case of the Chinese stocks, since the targeted easing last June PLUS the recent massaging of IPOs the Chinese equity benchmark has been significantly been UP!

So are stocks about fundamentals as textbook says? The answer is it depends on the type of fundamentals. Post Lehman crisis, "fundamentals' have been determined largely by central bank subsidies to financial markets and secondarily government policies.

The Pre-Lehman crisis world illustrates the disconnect between stocks and the real economy or what has been a parallel universe!

Don't worry, risks have all vanished, central banks has assured that stocks have been bound to rise forever!

Hong Kong Dollar-US Dollar Peg Under Pressure

The Hong Kong US dollar peg appears to be under pressure.

The Zero Hedge writes (bold and italics original): "Yesterday saw something quite unusual in the New York trading session. The Hong Kong Monetary Authority bought $715 million (selling HKD) in the FX markets to manage its currency peg, injecting the money into the banking system (and expanding its balance sheet) to prevent HKD from rising above its permitted range. HKMA projects its balance sheet to grow to the end of July, but as Simon Black (of Sovereign Man blog) notes, this could well be the start of a bigger shift - an end to the US Dollar peg..."The US is no longer the undisputed superpower it once was. The US dollar is dragging them down. Hong Kong is easily strong enough to stand on its own." HKMA's balance sheet is surging - HKD demand pressuring peg, thus buying USD (and selling HKD) to manage peg..."

Sovereign Man's Simon Black also suggest that this could represent a speculative attack on the peg: "The reasons are unclear, though it’s entirely possible that investors are attacking the peg, similar to what happened to the pound back in the 1990s. We could be in the early stages of such an assault." (Mr. Black’s article is a recommended read)

The HKD-USD peg basically means that Hong Kong's has been importing the US Federal Reserve's monetary policies. 

As I wrote back in 2009: Since the Hong Kong currency has been pegged to the US dollar it implies that Hong Kong has essentially been importing its monetary policy. Yet, the inflationary path undertaken by the US government suggest that Hong Kong is equally importing inflation-hence the rapid monetary expansion that has been fueling booming property and stocks.

And fuelling asset bubbles has indeed been the case.

Hong Kong’s Hang Seng Index approaches the 2010 highs but has been still about 20% off from the 2008 highs. Hong Kong’s valuation has been about 39 times historic earnings  according to this Bloomberg report!

And cognizant of risks of property bubbles, Hong Kong authorities imposed additional property curbs in 2013. A 15% flipping tax was first reportedly introduced in November 2010 as with doubling of stamp duties. Eventually the Hong Kong government introduced a 15% tax on foreign purchase according to a report from Bloomberg

Recently such restrictions appears to have been eased, perhaps in conjunction with the recent loosening of China’s monetary policies.  

[As a side note: the Chinese central bank the PBOC have launched a 1 trillion yuan ($171 billion) stimulus (or QE?) via the “Pledged Supplementary Lending" (PSL) which has spurred the  recent surge in China’s stocks. This fills in the gap—”this implies a Xi-Zhou PUT (from China’s President Xi Jin Ping and PBoC governor Zhou Xiaochuan) in motion”—of my Sunday’s commentary]

The ramifications of the present easing has been a dramatic resurgence in Hong Kong New Residential loans and to accelerated record loans to the private sector.

As I also noted in the past, Fed inflated bubbles has impelled and fostered recent outcries against growing inequality that has led many Hong Kong residents to embrace populist anti-market politics and which has partly ushered in a welfare state: "The point is that not only has the easy money policies of the US Federal Reserve been blowing Hong Kong’s bubble cycles, at worst such policies have been gnawing at Hong Kong’s relative free market environment by whetting or stoking on populist anti-market sentiment and the promotion of the mixed economy-welfare state. In short, bubble policies function like a political Trojan horse for destabilization"

And this is why the HKD-USD pegged is numbered. 

Again from my 2012 article: Hong Kong authorities should deal with the US dollar peg rather than intervene in the marketplace. Perhaps they should consider the proposal, which I earlier noted here, by Prof Joseph Yam, the former head of the Hong Kong Monetary Authority (HKMA), who is also one of the architects of Hong Kong-US dollar peg through a monetary board, to alter Hong Kong’s monetary system by shifting from US dollar peg towards China’s yuan or through a basket of other currencies. They could also consider Yuanization or using mainland currency by scrapping the Hong Kong dollar altogether.

The recent pressure on the HKD-USD peg suggest that markets, rather than HK authorities, will determine when this untenable relationship ends.

Will the current currency speculation break the peg? Or will a bursting bubble do the job?

China Bubble: No Money Down Housing Proliferates, Echoes US Subprime Loans

In desperation to sell an oversupply of properties, Chinese developers have evaded regulations to offer "no money down" housing loans which the Bloomberg associates with the risks of US subprime loans

China’s home buyers are being offered no-money-down purchases in an echo of the subprime lending that triggered a U.S. economic meltdown and the global financial crisis.

Deals skirting government requirements for minimum 30 percent down payments have emerged this year from Guangzhou and Shenzhen in the south to Beijing in the north as real-estate sales slump, according to state media and statements by government agencies and developers.

Loosening down-payment requirements could erode China’s financial stability by adding to risks for property companies, lenders and an economy already heading for the weakest growth in 24 years. Government warnings to consumers indicate that officials will strive to limit such arrangements, a sign of stress in a property market with a glut of homes.

Well, this has not just been an exclusive Chinese affair, Sovereign Man’s Simon Black points to the same financially destabilizing risks of NO money loans down in the Philippines.

Going back to China, the earlier stimulus of “additional spending on railways, upgraded housing for low-income households and tax relief for struggling small businesses” plus the central bank, the PBOC’s calls for “nation’s biggest lenders to accelerate the granting of mortgages” or the political way to solve debt problems with even more debt, appears to have delayed an economic meltdown as banking loans and money supply growth recovered in May.

From another Bloomberg article: (bold mine)

Local-currency loans were 870.8 billion yuan ($140 billion), the People’s Bank of China said on its website yesterday, higher than 42 out of 43 analyst estimates in a Bloomberg News survey. M2, the broadest measure of money supply, rose 13.4 percent, compared with a median projection for 13.1 percent…

Aggregate financing, China’s broadest measure of new credit was 1.4 trillion yuan in May, matching the median analyst estimate in a Bloomberg News survey. The figure, which includes bank lending, corporate bond issuance and shadow-banking products like entrusted loans, compared with 1.55 trillion yuan in April and 1.19 trillion yuan in May last year. 

New yuan loans accounted for 62.2 percent of aggregate financing in May, up from 50 percent in April and 56.1 percent a year earlier, central bank data show.

Chart of China’s M2 and New Loans can be seen here.

Despite the rhetoric to control the shadow banks, the Chinese government continues to flush the system with liquidity. In mid-May, the PBoC injected 44 billion yuan ($7.1 billion). Yesterday the central bank added 104 billion to the interbank system for the 5th consecutive net weekly injection. This is a sign of how worried authorities are with the financial-economic system

While favoring the formal banking system, growth in May loans reveals that credit activities in shadow banks continue to swell.

So obviously all these measures have been meant to buy time. 

Today, Chinese equity markets as represented by the Shanghai Composite Index had been jubilant—as they have been up by about 1% (specifically .93%) on reported economic improvements.

From Bloomberg:

China’s industrial output rose 8.8 percent in May from a year earlier and retail sales gained 12.5 percent, the National Bureau of Statistics said on its website today.

Fixed-asset investment excluding rural households increased 17.2 percent in the first five months of the year, the Beijing-based agency said.

What you see depends on where you stand.

Fixed Asset investment has still been declining but yielded better than expected ‘forecast’

Industrial Production remains stagnant 

It's only retail sales that has shown slight improvement

Except for retail sales which looks like a dead cat’s bounce, both industrial production and fixed investment hardly points to a ‘recovery’. Recovery has been more a wishful thinking.

Nonetheless, in today’s credit addicted world, governments aim to keep the unsustainable party going by spiking the punch bowl with even more toxic credit, China's political response has been no exception.

China’s Central Bank Launches Targeted Easing

Earlier today, I pointed to the plummeting real estate activities and to the spreading commodity rehypothecation financing woes. Here I mentioned: 

So how will the Chinese government deal with hissing credit bubble? Well, in the same way almost every government deals with the addiction problem: give them more of the substance which they have been addicted to: credit

From CCTV.com

The Chinese government’s central bank, the PBOC officially announced ‘targeted’ easing directed at institutions lending to the rural economy

China’s central bank is easing monetary policy for lenders focused on small firms and the farming economy. The PBOC is cutting the reserve requirement ratio by 50 basis points for some lenders, effective from June 16th.

The triple R cut applies to banks whose new loans to the farm sector last year exceeded 50 percent of total new lending. An additional requirement says that outstanding loans to the farming sector must be more than 30 percent of total outstanding loans.

This means the targeted RRR cut covers around two thirds of city commercial banks, 80% of rural commercial banks and 90% of rural credit cooperatives. The RRR cut will also apply to financial services companies like leasing firms and auto financing firms to lift domestic consumption.

The problem with so-called targeted easing is that once money has been released into the system no one can know or control where it flows. This has been the reason why China’s shadow banking has ballooned. Government controls on local government lending produced offspring called Local government financing vehicles (LGFV) and eventually to illicit loans by State Owned Enterprises in behalf of local governments.

Shadow banks really signifies a regulatory arbitrage response to the highly regulated banking and finance system dominated by the state or State Owned Enterprises and most importantly to the credit boom initiated by the PBOC and from the Chinese government’s 2008 stimulus program ($586 billion). 

The likely scenario from this rural based loans will be that credit issued by accredited banks will end up again in the shadow banking sector. Such will most likely signify attempts to prop up zombie companies. 

So more resources will likely end up with non-productive activities that will persist to drain on the economy’s real savings.

Because of this China’s Shanghai index jumped 1.08% today

Oh by the way, despite tumbling property markets, China’s official inflation rates jumped in May.

From CTV.news.ca

Higher food prices have pushed China's inflation to a five-month high of 2.5 per cent.

Data released Tuesday showed consumer inflation in May picked up from the previous month's 1.8 per cent. The increase was driven by a 4.1 per cent rise in food prices.

Inflation still is well below the ruling Communist Party's 3.5 per cent target for the year, leaving room for interest rate cuts or other measures to stimulate the slowing economy if needed.

The above chart shows that May’s inflation increase has been a four month high.

This also reveals of the developing deadly cocktail mix of stagflation and bubble bust at work.

Today’s rescue also shows how the Chinese government will try to resist a collapse (kick the can) which exposes on the government’s priority which is that of political convenience first and social welfare last. Thus, goodbye reforms.

And this also shows how stock markets have been addicted to stimulus

Note to email subscribers. If I am not mistaken this blog’s Feed Burner services delivers only a maximum 3 blog post per day. Since I made six posting for today you are likely to receive only the latest three. Anyway here are the links for today’s post

Graphic of the Day: The Militarization of the US Local Police

Venezuelan Hyperinflation: Prostitutes as Currency Traders

China Bubble Bust: Land sales in a free fall, Rehypothecation Woes Spread

Quote of the Day: The IMF Gets It Wrong (again)

CNN Money: Market Emotion Now Registers EXTREME GREED

Chinese government bails out real estate markets in 6 cities; Growing Signs of Panic?

The Chinese government appears to be conducting a stealth bailout of localities affected by the rapidly unfolding periphery (rural areas) to the core (large cities) dynamic of the boom-bust cycle.

Writes Sovereign Man’s Simon Black (bold mine)

According to the Chinese financial publication Securities Daily, emergency real estate rescue packages have been launched in large cities such as Wuxi, Nanning, Hangzhou, Tianjin, Tongling and Zhengzhou in the last month alone. 

“Zhengzhou created a mortgage guarantee policy to win back banks’ confidence” according to the story.

Further, “if a borrower does not fulfill the loan repayment obligations as agreed in the contract, the guarantee institutions will have to repay the housing loans…”

What a surprise– a government guarantee.

The market is imploding and defaults are going through the roof. Property vacancy rates in Zhengzhou are an astounding 23%. So the government is putting taxpayers on the hook.

The article goes on: “A legislative affairs official of Zhengzhou revealed to the media that this was the first time for Zhengzhou to carry out such individual housing loans guarantee policy.”

In other words, the government is panicking.

Home sales in China fell last month by 18%, in no small part due to tightening credit conditions.

Developers have tried to pick up the slack and liquidate inventory by offering no money down deals… their own desperation tactic.

But it’s not working.

Over the May 1-3 holiday weekend, new home sales across China’s 54 largest cities were 47% lower than last year.

The national government in China has all but capitulated, and they’ve turned the reins over to local governments to ‘fix’ the problem.

This has been a long time in the making.

According to data from the US Geological Survey and China’s National Bureau of Statistics that was compiled by the Financial Times, in just two years (2011 and 2012), China produced more cement than the United States produced in the entire 20th century.

Much of this development came from centrally planned monster infrastructure projects– bridges to nowhere, zombie train stations, and infamous ghost cities.

So much excess inventory has built up, a major slowdown was inevitable.

This is a huge issue for China given that housing sales comprised nearly 12% of GDP last year.

Even President Xi Jinping recently stated that his nation must adapt to a ‘new normal’ of slower economic growth.

And like the butterfly that flaps its wings, a slowdown in China has substantial effects on the rest of the world.

Please read the rest here.

Some comments

1. So in addition to the PBoC’s implicit stimulus, I wrote why these bailouts aimed at “kicking the can” will buy only limited time yesterday. (bold original)

What they are really doing is to buy time from a devastating meltdown. Yet by doing so, they will increase the magnitude of a disorderly market clearing as resources continue to flow into speculative capital consuming ventures.

The decline in property prices has been manifested by a slowdown credit expansion. This simply means that the diversion of something for nothing bubble activities will materially decline. And a lot of the unproductive bubble projects will continue to surface as debt delinquent entities.

And demand that has emerged from the bubble boom will equally subside which should aggravate the surpluses.

And as the property sector slows, all other industries attached or that has emerged out of the bubble will also be significantly affected. There will be a contagion.

And feedback loop between problematic debt and the rapidly slowing economy enhances the risk of a credit event—a Black Swan moment.

If China’s bubbles has overwhelmed her residual real savings (which have been sunk into capital consuming speculative projects as embodied by vacant properties and ghost projects), then the policies to “kick the can down the road” will buy limited time.

This also means that throwing money into the system will extrapolate to the law of diminishing marginal returns—more debt produces lesser growth, but on the other hand, amplifies systemic risks.

2. I previously dealt with the illusion or the myth of infrastructure spending or “centrally planned monster infrastructure projects”. Here is a slice. 

The fundamental reason why Bastiat argued against the age old economic myth is that resources used by the government will always have to be taken away from somewhere: particularly resources (savings) or output (income) of non-political economic agents. The result will be a NET transfer of resources from productive agents to unproductive agents. Costs are not benefits.

Public choice theorists would further expand on Bastiat’s opposition, noting that “costs are diffused, while benefits are concentrated”. 

Bridges to nowhere have been the same infrastructure problem bugging the US.

3. More and more bailouts will mean more and more resources being transferred in support of unproductive activities. This also means goodbye reform agenda. Thus President Xi is correct when he says that the world should expect a ‘new normal’ of slower economic growth. 

4. “Substantial effects” extrapolates to transmission mechanism via economic and financial markets. This implies a short-lived EM stock market rally which will likewise affect US and Europe as global economic growth declines. This also posits rising risks of a global Black Swan moment.

Oh, substantial effects may also postulate into amplified tensions over territorial disputes. 

Anti Chinese riots in Vietnam claimed 1 life with 90 injured yesterday.  The riots has not been exclusive to Chinese companies but was anti-Asian in nature. From the CNN: “the arson was indiscriminate, with Korean-, Taiwanese- and Japanese-owned properties also torched by the angry mob.”

This implies the rise of protectionism which means decreased economic activities, deterioration in social order or peace and stability and greater risks of violence and an outbreak of military conflict.

Yet for the don’t worry be happy crowd, stock markets will keep roarin’.