Is China’s Coronavirus Portentous of the Year of the Metal Rat? The Pig-Rat’s Nasty Tandem

Well, to tell you the truth, in all this excitement, I've kinda lost track myself. But being this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: 'Do I feel lucky?' Well, do you, punk?—Dirty Harry (Callahan), played by Clint Eastwood

In this issue

Is China’s Coronavirus Portentous of the Year of the Metal Rat? The Pig-Rat’s Nasty Tandem

-Is China’s Coronavirus Portentous of the Year of the Metal Rat?

-Shocks from The Pig-Rat Tandem: Symptoms of the Credit Cycle

-The Metal Rat May Be Inclined Towards the USD and Less Eager on Stocks

-The Pig-Rat Tandem’s Contribution to Economic Shocks and Underperformance

Is China’s Coronavirus Portentous of the Year of the Metal Rat? The Pig-Rat’s Nasty Tandem

Is China’s Coronavirus Portentous of the Year of the Metal Rat?

How should we take the following events as a precursor to the fortunes of the Chinese zodiac year of the Metal rat?

Figure 1

Due in part to the outbreak of the deadly coronavirus, which originated in Wuhan, the capital of Hubei province, China’s major equity benchmark, the Shanghai Composite Index, plunged 2.75% on Thursday, January 23rd, posting its worst loss for the end of the lunar year in three decades. (Figure 1 topmost pane)

And as the Chinese government aims to contain the virus from morphing into an epidemic or pandemic, social activities are being stringently controlled, which included the lockdown of some cities affecting as many as 56 million people, for now.

Many have called off the lunar year celebrations. (Figure 1, middle pane)

China's government imposed travel restrictions, as well as ordered shut the nation’s 70,000 movie theaters. Disney closed its Shanghai Disneyland in response to the outbreak, and had later been joined by several branches of Starbucks and McDonald's.

Meanwhile, Hong Kong’s government announced a citywide coronavirus emergency, which suspended classes until February 17, aside from the cancellation of all official travel to the mainland.

That’s aside from the Chinese government’s latest measure of suspending all inter-provincial road passenger transport from and to Beijing. Likewise, twenty-five provinces, municipalities, and autonomous regions in covering more than 1.2 billion people have activated the Level-I alert of public health incident, according to the China Daily.

The US and French governments also announced plans to evacuate citizens and diplomats from Wuhan.

Last night, China’s President Xi Jinping warned of the “spread of a deadly new virus is accelerating”, and thus declared that following the first 1000 room hospital, a second 1,300 room, will be built in a month or less.

And exacerbating this, major East Asian benchmarks have suffered deficits from the start of the year. The worst year-to-date performers have been national bellwethers of Laos (-5.17%), the Philippines (-2.45%), and China (-2.41%). (Figure 1, lowest pane)

With New Year’s celebration virtually aborted and turned upside down, would these signify as good Feng Shui for the metal rat?

Shocks from The Pig-Rat Tandem: Symptoms of the Credit Cycle

The Chinese zodiac sign of the year of the Pig has a history of being been chain-linked to either financial or economic turmoil, as I warned last year. Superstitions have little to do it with, except as coincidence. Instead, the credit cycle embodies the occurrence of such turbulence.

To recap on the 12-year cycle of the year of the pig:

1947-1949: Precursor to the Foreign Exchange crisis

1958-1960: Economic Slump (1959- year of the pig)

1969-1971: Balance of Payment crisis

1983-1985: Debt Moratorium/ Economic recession

1995-1997: Antecedent to Asian Financial Crisis

2007-2009: Forerunner to the Great Recession

Since the Philippine independence from the US, economic turmoil has shockingly encumbered the year of the pig. Its relations per year differ though.  The year of the pig heralded the crises of 1949, 1997 and 2008. The emergence of a crisis (1983) or its culmination (1971) has also shrouded the year of the pig.

The year of the PIG hasn’t been responsible for such gamut of economic dislocations. Or it hasn’t been superstitions that have plagued the Philippine financial and economic sphere since 1946.

These episodes shared some common denominators: credit expansion. Its ramifications were price inflation, economic slump, recession or a financial crisis or a combination thereof.

Some had external influences. Domestic origins were responsible for the others. 

Beware the Year of the Pig! Unblemished Record of Economic Turmoil Since 1947! February 3, 2019

There had been no let down from the year of the Earth Pig. Credit strains intensified in the banking system.

Figure 2

Exhibiting signs of tightening financial conditions, the Philippine yield curve INVERTED for the FIRST time since at least 2000!  (Figure 2, upper pane)

Such historic and seismic activities, but had largely been unnoticed by the public, had been reflected in the banking system’s liquidity conditions as manifested by the BSP’s KPI of cash-to-deposits, as well as, the liquid assets to deposits ratio. (Figure 2, lower window)

Tighter financial conditions likewise spiked Net NPLs to multi-year highs! (Figure 3 upper window)

Figure 3

The BSP response has likewise been monumental!

Aside from the massive downside adjustments of 400 bps in the banking system's Reserve Requirements Ratio, resonating its response to the 1997 Asian Crisis, not only did it join the global central banks in paring down its policy interest rates, but most importantly, it rekindled its nuclear option of monetizing public spending to unprecedented levels!

As ramifications to an economic downturn, global central banks eased in a panic to lower rates at levels last seen during the Great Recession that sparked a massive risk-on on financial assets in 2019!

And that’s not all.

Not only has the BSP engaged in stealthy rescue measures, but they even transcribed it in a report!

In its 2018 Financial Stability Report, the BSP acknowledged the massive buildup of such imbalances. (p. 19) [bold and underline added]

If there are risk issues to raise, it will have to be the prospects of managing liquidity. Aside from simply having more loans versus deposits, using liquid assets as a source for funding more earning assets needs our attention. However, the bigger issue will be that continuing on the path of being a bank-based financial market means that the provision of credit will require taking on mismatches in tenor and in liquidity. As more credit is dispensed, such mismatches will only increase.

Sadly, mainstream institutions have either dismissed or repressed this.

And in the face of increasing leverage, the BSP also raised concerns about the capability of its platform to handle payments and settlements of the Financial System. (p. 29 to 30)

Developments in the clearing and settlement space are unfolding at two distinct levels. At the most basic, the amounts processed for payments are significant, of the order of 15 times that of the resources of the banking system or of the economy (Figure 3.13). This highlights the substantial amount of (gross) liquidity needed to support financial market activity. This point is not trivial because it means that the magnitude of settlement/pre-settlement risk may be a much bigger concern than credit risk.

It also suggests why unwinding failed transactions can have broad system-level implications. Despite institutionalizing the delivery-versus payment protocol, the system remains vulnerable because a single bilateral failed trade may require a network of unwinding. Unfortunately, such data is not easily accessible and the extent to which these “settlement fails” represent a possible systemic risk—not just in size but more so in terms of interlinkages that can spillover to the rest of the economy—is not readily determinable, at least at this time. In general, payments system data remain largely untapped and not having even a cursory view of the dynamics of the payments network leaves financial authorities blind to their possible consequences. This is a major concern

Unfortunately, with its complete dependence on such platforms and the absence of causal factors, the BSP provides no concrete solution to these substantial risks!

So the risk baton will be passed over by the Earth Pig to the Metal Rat.

The Metal Rat May Be Inclined Towards the USD and Less Eager on Stocks

Philippine risk assets likewise generated positive returns in 2019, the year of the Pig.

Saved by massive end session pumps, the main equity benchmark eked a meager 4.68% returns in 2019, the second positive return in six outings for the year of the pig since 1959.

Aside from Philippine Treasuries, the peso surged 3.7%.

Will such positive returns continue in the year of the Metal Rat?

Figure 4

In looking at patterns, positive returns might be the result of the alternating performances of the equity benchmark of the year of the rat since 1960. But such gains were accrued following negative returns from the year of the Pig.

But what if this year’s outcome will come in the shade of 2007-2008’s two-year boom-bust cycle? Or, this year’s positive may lead to negative returns in 2020.

Compared to the year of the Pig, the average USD peso has generated strong returns in the year of the Rat. The average USD peso has been up in four of the five years, with an average gain of 17.8%.

Or how about the last appearance of the metal rat, which was in 1960? 

The Pig-Rat Tandem’s Contribution to Economic Shocks and Underperformance

The big jump of the USD-peso and the crash of the equities in 1960 and 1984 had mainly been a consequence of economic shocks.

As noted last year, 1983 was the year the Philippine Government declared a debt moratorium (debt default)!

Figure 5

From Wikipedia: The country was hit hard by the second global oil crisis of the decade, in 1979. And when the US Federal Reserve raised interest rates in the early 80s, the Philippines’ debt ballooned rapidly, pushing the Philippine economy towards an economic nosedive by 1983 (bold italics added)

In the meantime, 2020’s predecessor, the year of the metal rat in 1960, almost shared a similar economic fate.

Aside from the former Philippine President Carlos P. Garcia’s January 26, 1959 SONA, which indicated pressures arising from credit-fueled inflation and a growth slowdown or stagflation, I excerpted Messrs Dohner and Intal from an NBR paper (p.180): “Philippine trade and industrial performance have been determined by a system of protection initiated in 1950. To deal with external imbalance, the Philippine government began licensing imports, in amounts determined by essentiality of the product. The incentives created for domestic production of these goods led to rapid industrialization and growth during much of the decade, but the growth rate had slowed appreciably by 1959.” (bold added)

The Philippines used to be ahead of its neighbors. However, the cumulative effect of such shocks or dislocations resulted in the reversing their relative financial and economic status.

According to the ADB: (bold added)

The Philippines has frequently suffered from periodic macroeconomic instabilities (Figure 3.21). The instabilities often resulted from persistent fiscal and current account deficits, over-borrowing and over-lending activities in the banking sector, and excessive exposure to short-term external debt. These often depressed investor confidence and led to capital flight, sharp currency depreciation, and economic recessions. Sharp monetary contraction and high interest rates to stave off currency depreciation and inflationary pressures during these crisis periods aggravated the economic downturn. The 1984–1985 economic collapse cost the Philippines a decade of potential economic growth and development. Major recession or low growth episodes occurred in 1960, 1970, 1982–1985, 1991– 1993, 1998, and 2001, and were associated with the macroeconomic instabilities in the last five decades. Indeed, these periodic and frequent downturns largely explain why the Philippines lagged behind many of its regional neighbors.

Asian Development Bank Philippines: Critical Development Constraints 2007, ADB.org

And yet the pig rat tandem played critical roles or have been associated with most of these shocks, as indicated in the underline texts.

And let us not forget, a cauldron of miasmic events for 2020: the Taal eruption in the Philippines, which may still be ongoing, the bushfires of Australia, the flare-up of the US-Iran conflict, a Trump impeachment trial and now the outbreak of the coronavirus of China…for January alone!

What a close for the year of Earth Pig! What an inaugural for the year of the Metal Rat!

As SFPD Inspector Harry Calligan in the 1971 film Dirty Harry asked, “Do I feel lucky? Well, do you?”

Attachments area

Headline of the Day: More on China's Sunshine Industry (Build and Demolish)

When a local government demolished an unoccupied newly built building last year, I wrote about China's sunshine industry:

Since "build and they would come" didn't work, so might as well just build THEN demolish as a circular economic growth model. Neat!

Well the above headline reveals of more signs of 'economic' activities based on 'build and demolish'

To quote En.people.cn (image/headline theirs)

More than 100 high-end villas are razed to the ground without permission from local authorities in Heyuan City, south China's Guangdong Province. The real estate developer who built these luxury houses said the houses were pulled down due to a tight budget. The demolition fees were worth some 120 million yuan ($18.5 million). The high-end houses started construction in 2004, covering an area of 60,000 square meters.

Do you know that Shanghai was once an Almost Free City-State?

Austrian economist Dr. Richard Ebeling narrates of Shanghai's laissez faire capitalism experience at the Northwood University blog: 

China’s impressive modernization since the death of Mao Zedong in 1976 and the end to the destructive madness of the Cultural Revolution has been epitomized by the dramatic growth of the industrial and port city of Shanghai, with its majestic skyline of impressive futuristic skyscrapers. It is forgotten that Shanghai already was a commercial and industrial center before the Second World War, built on the principles of laissez-faire capitalism.

Following the Chinese-British War of 1842, several ports along the China coast were opened to Western merchants. In these “treaty ports,” portions of the cities were recognized to be under European jurisdiction. Known as “concession” areas, the European powers administered these areas according to Western principles of the “rule of law,” with recognition and protection of property rights, personal freedom and civil liberties.

By the end of the 19th century, Shanghai had become the most important of the treaty ports. Indeed, it was the industrial, commercial and cultural center of modem China until the Japanese occupation of the city in December 1941, following the attack on Pearl Harbor.

Shanghai an Almost Free City-State

The Western-administered portions of Shanghai were divided into two districts: the French Concession and the International Settlement. A Consul-General appointed by Paris administered the French Concession.

But the much larger International Settlement was administered by a Municipal Council composed of fourteen members elected by the permanent foreign residents of the city, with the franchise based on being a “ratepayer,” i.e., a tax-paying property owner within the boundaries of the International Settlement. By the 1930s, around 90,000 Europeans and Americans lived in Shanghai.

Hence, Shanghai’s International Settlement was almost an independent “city-state” based on the nearly unhampered principles of free trade and free enterprise under the protection of the Western Powers (which ended up meaning mostly a British and American military presence).

In general, the economic policies of Shanghai’s International Settlement followed the ideas of Adam Smith’s system of natural liberty and laissez faire. The Municipal Council limited itself primarily to three functions: administration of justice; police protection of individual liberty and property; and the undertaking of a limited number of “public works,” such as construction of roads, traffic control (administered by Sikh policemen brought by the British from India), harbor patrol, and the dredging of the Whangpoo River that connects Shanghai with the mouth of the Yangtze.

Read the rest here

China’s Property Bubbles Intensifies

So the ‘silent stimulus’ recently implemented by the Chinese government (including the hiding, editing censoring of statistics) aimed at attaining statistical growth goals has only been further inflating property bubbles. 

China’s credit fueled property bubbles may have entered a blowoff phase, notes the Bloomberg:

Home prices in China’s four major cities rose the most since January 2011 last month, raising concerns that a lack of new property curbs is allowing a bubble to form.

New home prices climbed in 69 of the 70 cities the government tracked in September from a year earlier, led by 20 percent increases in the southern business hubs of Shenzhen and Guangzhou, the National Bureau of Statistics said in a statement today. Prices in Beijing rose 16 percent and advanced 17 percent in Shanghai, the biggest gains since the government changed its methodology for the home data in 2011.

Premier Li Keqiang has come up with no additional measures to rein in property prices since his predecessor Wen Jiabao stepped up a three-year campaign in March to cool the housing market, ordering the central bank to raise down-payment requirements for second mortgages in cities with excessive cost gains. Some Chinese cities are facing increasing pressure to meet annual home-price targets they set earlier this year and to cap gains at the growth rate of local disposable incomes.

Bubbles are a function of inflationism, and in China’s case, compounded by financial repression, viz keeping capital markets underdeveloped or limiting options for the citizenry to invest their savings in order for the government to tacitly capture them.

Previous property curbs has failed and will continue to fail because of the political incentives driving China’s politics.

Political careers of local government officials have been mainly dependent on the goals set by the national government. Thus, for local government to meet such statistical ‘growth’ targets, they resort to circumventing these regulatory hurdles by using local government financing units (LGFU) through the private sector, who partly bankroll these property projects via the shadow banking industry.The national government has accused many local governments of statistical manipulation. Yet if the LGUs indulge in them why not the national government?

Add to these the barrage of stimulus employed unannounced by the national government.

More signs of credit expansion fueling China’s bubbles, from the same article…

Domestic loans to developers jumped 50 percent last month from a year earlier, according to Shanghai-based advisory firm CEBM Group, which calculated government data.

A residential land parcel in Beijing sold at a record price 73,000 yuan ($11,980) per square meter (10.76 square feet) on Sept. 4, according to Centaline Property Agency Ltd. Sun Hung Kai Properties Ltd. (16), Hong Kong’s biggest developer by market value, bought a site in Shanghai for 21.8 billion yuan in an auction the next day, a record price in that city, Centaline said.

“Developers have been able to access cheaper liquidity, which financed their land acquisitions,” ANZ’s Liu said. “Homebuyers dashed into the market fearing that home prices will rise further given the high land prices.”

For the fifth month in a row, the eastern city of Wenzhou was the only one to post a decline, with prices dropping 1.7 percent from last year.

Existing home prices rose 18 percent in Beijing last month from a year earlier, leading the gains, followed by a 14 percent increase in Shenzhen and 12 percent in Shanghai, according to the data.

The Chinese government recently surpassed their statistical objective growth threshold of 7.5% with a 7.8% 'growth' for the third quarter. 

Curiously the pace of growth in the broad sector has been nearly ‘identical’ to their reference points.

This from another Bloomberg article 

Gross domestic product rose 7.8 percent in the July-September period from a year earlier, the National Bureau of Statistics said today in Beijing, matching the median estimate in a Bloomberg News survey. Industrial production advanced in September by 10.2 percent, in line with projections, while retail sales gained 13.3 percent…

Industrial output growth compared with August’s 10.4 percent.Retail sales compared with a median estimate of 13.5 percent expansion and 13.4 percent in August.

Fixed-asset investment excluding rural households, a key force behind growth, grew 20.2 percent in the first nine months of the year, compared with the median estimate of 20.3 percent from analysts and a 20.3 percent pace in the January-August period

Let see: Industrial output 10.2 vis-à-vis 10.4. Retail 13.5 relative to 13.4. Fixed asset 20.2 against 20.2. Given the booming and highly volatile property sector, in my view, I’d smell something fishy with the seemingly placid numbers which assumes that general economy has been growing at steady pace.

Yet more credit inspired statistical economic growth from Financial Times: 

A surge in lending by banks and other financial institutions at the start of this year is one of the main explanations for the upturn in Chinese growth. Total social financing – China’s widest measure of credit – rose 52 per cent year-on-year in the first five months of 2013, an astonishingly fast pace.

So whether in the US, Japan, Europe or China or elsewhere, governments have been pushing debts to their critical limits in order to attain temporal statistical growth. 

Along with the momentum or yield chasing inspired private sector, governments have been funneling resources into speculative-capital consuming activities.

Yet every action has a consequence. Spurious or artificial growth financed by unsustainable will eventually face a day of reckoning. The $64 gazillion question is: when?

And another thing… as China’s bubbles intensify, Hong Kong and Singapore’s luxury rental market has shown signs of a slowdown: are these signs of a reprieve before the next leg up or are these initial signs of a coming reversal?

Chinese Government to Crack Down on Fake Statistical Data?

More reasons to distrust statistical economic and financial figures from the Chinese government.

From Bloomberg:

China’s statistics-bureau chief said the agency has “zero tolerance” for falsified data after it publicized cases of manipulated local numbers and the customs bureau cracked down on fraudulent export invoices.

Incidents exposed by the agency are isolated and won’t affect the broader quality of data, Ma Jiantang, head of the National Bureau of Statistics, said today in Beijing at an “open day” attended by officials, journalists and school students.

China’s government has struggled to win the trust of investors and economists for data ranging from gross domestic product to trade. Li Keqiang, who became premier this year, said in 2007 that GDP figures were “man-made” and “for reference only,” according to a WikiLeaks cable.

Ma said that his agency has gained better control over the numbers through a direct reporting system that limits local officials’ ability to manipulate the numbers.

When political careers of the local authorities depends on the boosting of growth statistics then the natural consequence—or reaction by local leaders to the incentives provided by the political system—would be to fuel localized bubbles or to manipulate statistics or a combination of both as previously discussed. 

This serves as the difference between China's top-down politics relative to the Philippine Pork Barrel based system--where the latter's political power are attained by buying votes directly or indirectly from the electorate and from other political constituencies using earmarks (Pork), while the former gets appointed to local posts by meeting national targets.

And political leaders resort to, as well as, contribute and participate in the China’s shadow banking system via the local government financing vehicles (LGFV) to finance local projects. Off balance sheets now play a big role in China’s credit system (Business Insider)

Stephen Green of Standard Charter estimates at least 10,800 operational LGFVs from which only 800-900 LGFVs have financial statements on publicly issued debt.

Nomura economics estimate total LGFV debt at the end of 2012 at RMB19.0trn (37% of GDP), which included RMB14.3trn of interest-bearing debt. From 2010-12, LGFV debt rose by 39%, which implies total government debt of RMB31.7trn accounts for  61% of GDP at end-2012. (FT Alphaville)

Yet if many local governments have been notorious in the manipulation of statistics in response to the political system’s incentives, then why should we trust the central-national government when the same incentives influence the national leaders? 

For instance, Chinese Premier Li Keqiang has a self-imposed quota for economic growth which is at 7.5 percent. Today Premier Li says this quota has been surpassed 

From another Bloomberg report: (bold mine)

Chinese Premier Li Keqiang said the nation’s economic growth exceeded 7.5 percent in the first nine months of the year, a sign the government will next week report success in arresting a two-quarter slowdown.

Gross domestic product “maintained a fairly high growth rate of over 7.5 percent” in the first three quarters, Li said today in a speech at the East Asia Summit in Brunei. He said earlier today at an Association of Southeast Asian Nations summit that the economy has “shown stronger momentum of steady growth” in recent months, with indicators that reflect market expectations, such as the Purchasing Managers’ Index (SHCOMP), improving.

China previously reported expansion of 7.6 percent in the first half and Li’s government introduced measures including faster railway spending and tax cuts to defend a 7.5 percent goal for the full year. The National Bureau of Statistics reports third-quarter growth on Oct. 18, with the median estimate of 33 analysts surveyed by Bloomberg News for a 7.8 percent pace, up from the second quarter’s 7.5 percent.

At the end of the day, China’s economic growth has been all about meeting political objectives as measured by statistics whether from the national or the local level. 

Thus government activities will focus on attaining statistical growth at the expense of real economic growth. 

And these will likely be achieved by serially blowing bubbles and or by statistical manipulation via hiding, censoring and deleting of data which doesn't conform with the administration's goals.

China’s Replica of Paris is a Ghost Town

China’s real estate industry has the propensity of imitating famous European architectures. 

From the Reuters:

Tianducheng, a gated community near Hangzhou, capital of coastal Zhejiang province, boasts its own Arc de Triomphe and rows of European-style villas to attract China's newly wealthy.

"(It) can house up to 100,000 people comfortably," said Lu Xiaotian, a director at the Zhejiang Guangsha Co. Ltd, the estate's developer.

Unfortunately, the European fashioned gated community has reportedly been a ghost town.

Some pictures courtesy of Business Insider

See more pictures here

The above is just one of the numerous ghost projects epitomizing the Chinese government’s assimilation of policies that promotes “abolishing slumps and thus keeping us permanently in a quasi-boom” grounded on the misinterpretation of Say’s law of “supply creates its own demand” or from a rigid adaptation from Kevin Costner’s Field of Dreams, “if you build they will come”. This also signifies as an example of wastage of capital from centrally planned projects.

Incidentally the developer, Zhejiang Guangsha Co Ltd is a publicly listed company at Shanghai, which represents a “province share holding system” or largely a local state owned owned enterprise (SoE) with private sector facet. 

Many private companies are vehicles used by the local state to promote the political objectives of the national government, as well as, the career goals of local politicians. Thus as previously discussed, the interests of the private sector and the state has been complexly interwoven. Yet the same sectors have acquired huge debts from boondoggles as the above that has put the Chinese economy in jeopardy or has raised the risks of a China bubble bust with far reaching ramifications.

The sustainability or viability of these massive credit fueled “build and they will come” social projects have recently been under intense scrutiny by the national government and by the markets.

Interesting times indeed.