More Signs of Big Trouble in Big China as Loans Sharply Contract

Oops. More signs of big trouble in China as demand for credit substantially shrink.

From Bloomberg,

China’s biggest banks may fall short of loan targets for the first time in at least seven years as an economic slowdown crimps demand for credit, three bank officials with knowledge of the matter said.

A decline in lending in April and May means it’s likely the banks’ total new loans for 2012 will be about 7 trillion yuan ($1.1 trillion), less than the government goal of 8 trillion yuan to 8.5 trillion yuan, said one of the officials, declining to be identified because the person isn’t authorized to speak publicly. Banks are relying on small- and mid-sized companies for loan growth after demand from the biggest state-owned borrowers dropped, the people said.

The drying up of loan demand attests to the severity of China’s slowdown and may add pressure on Premier Wen Jiabao to cut interest rates and expand stimulus measures. The economy may grow in 2012 at its slowest pace in 13 years, a Bloomberg News survey showed last week, as Europe’s debt crisis curbs exports, manufacturing shrinks and demand for new homes wanes.

Press officials at the People’s Bank of China and the three largest lenders -- Industrial & Commercial Bank of China Ltd., China Construction Bank Corp. (939) and Bank of China Ltd. (3988) -- declined to comment. Press officials at Agricultural Bank of China Ltd. (601288) weren’t immediately available.

New bank loans last month dropped 33 percent from March to 681.8 billion yuan, missing the 780 billion yuan median forecast of economists surveyed by Bloomberg News. A third of April’s new credit was also so-called discounted bills, or short-term loans often used by banks to pad the total figure.

Worsening Situation

This month may be worse. The four biggest banks -- which account for about 40 percent of lending -- had advanced only 34 billion yuan as of May 20, Liu Yuhui, a director at the government-backed Chinese Academy of Social Sciences, said in an interview this week, without saying where he got the data. The lenders may rush to boost credit in the last few days, mainly through short-term notes, he said.

China hasn’t officially announced the quotas set for each bank or the total loan target for 2012.

In the past three episodes where China’s credit growth materially shrank during the last 3 years, the Shanghai index, on a time lag, experienced severe downside contractions.

While history may not repeat, however if the marked sluggishness in China’s credit markets are indeed manifestations of a deepening slowdown (or worst a bubble bust) then we can’t discount the same pattern from happening again—liquidations from bad loans, which may spillover to the equity markets, will mean higher demand for cash.

Again, reports like these, along with China’s considerable reduced demand for commodities and a sharp slump in the recent factory activities, have prompted many to anchor their hopes on a on a massive scale of stimulus from the Chinese government.

Again this will be an issue of available private sector real savings to draw from, the scale and timing of any forthcoming stimulus and of the markets response to these.

In reality, what ‘stimulus’ can do will be to temporarily mask the underlying imbalances and to defer on the day of reckoning. However short term benefits will always have long term costs: accrued imbalances worsen overtime. This should translate to a bigger intensity of a crisis when it inevitably arrives. [I am not saying this is happening today, as this has yet to be established, and vastly depends on the abovementioned conditions]

We must remember that inflation is a policy that will not last. Either the Chinese government accepts this fact or if not eventually suffer from a monetary crisis. Yet considering that China has been building up massive gold reserves and has taken steps to make her currency, the yuan, a foreign reserve currency, the latter seems less likely the option.

Also China’s slowing economy comes amidst the seething Euro crisis and the seemingly diffident (for now) US Federal Reserve, whose Operation Twist comes to an end in June which means a lot of uncertainty on the global financial markets which has been highly dependent on central banking steroids.

Like it or not, fact is, we are navigating in treacherous waters

Gold Fundamentals Remain Positive

``Gold, on the other hand, is a much-needed safeguard against the barbarism of monetary authorities. Historically, the international monetary system, imposed after World War II by the Bretton Woods agreements, gave the dollar a central role. It was considered "as good as gold" because it was the only currency that maintained a link with the yellow metal. Gold thus acted as economic actors' safety valve against American monetary authorities' abuse of inflationary expansion.” Valentin Petkantchin Gold and the Barbarians

I have always emphasized that gold has proven to be quite a reliable thermostat of the global equity markets[1].

Gold has not escaped the short deflationary episode in 2008 nor has it eluded the recession in the early 2008. Thus gold, as we have repeatedly argued here[2], isn’t likely to function as a deflation hedge for the simple reason that gold isn’t part of the incumbent monetary architecture unlike during the Great Depression days of the 1930s. In short comparing gold in the 30s and gold today would be like comparing apples to coconuts.

The implication of this is that a sustained fall in gold prices could suggest of contracting money supply or a resurfacing of recessionary (deflationary) forces. Thus, a sustained fall or a dramatic collapse of gold prices should be mean alarm bells for us.

As a side note, not all recessions have been deflationary as alleged by some, and this has been evident in the stagflation era of the 70s (see figure 4).

Figure 4: Economagic: Stagflation

In the 70s, even as the S&P 500 (green line) fell, the consumer price (blue line) index continued to surge. Meanwhile, precious metals (red line) peaked amidst the 1980 recession.

But of course, like money, gold is also subject to demand and supply balanced by prices. Thus given the 10 successive years of gains, gold is certainly not immune to plain vanilla profit taking.

The point is—we should ascertain if any fall in the price of gold constitutes structural or countercyclical forces at work.

Monetary Disorder Remains The Dominant Theme

When we learn that China intends to issue 1 trillion yuan ($151 billion) this year[3], the the Central Bank of Ireland is financing €51bn of an emergency loan programme by printing its own money[4] and that the US monetary aggregate M2 has been surging by biggest weekly amount since 2008[5], we don’t seem to see any substantial or structural changes that should impact the long term price trend of gold materially.

In short, global central banks continue to pump money like mad, and this should be bullish for gold.

Figure 4: St. Louis Federal Reserve: Bank Credit

To add, as I have rightly been predicting[6]; the steep yield curve would influence the US credit markets positively, though at a time lag, as I previously wrote “the US yield curve cycle has a 2-3 year lag period from which we should expect it to generate “traction” by the last quarter of 2010.”[7]

And they seem to performing as expected (see figure 4), as the US credit market appear to show signs of improvements.

The risk here is that with record “excess” bank reserves or banks' base-money holdings minus required reserves that is either held in their vaults or on deposit with the Federal Reserve, given the fractional reserve system, these reserves can multiply credit and money supply that may amplify or accelerate the rate of inflation.

In other words, even what may be read as a positive ‘economic’ sign could represent a prospective hazard—an offshoot to the previous policies.

Thus, the recent volatility in gold prices for me would account for profit taking and certainly not a reason to see a reversal.

Yet part of the recent fall in gold prices has allegedly been traced to a speculator-trader, who massively levered up on huge (long- short) gold positions, which turned out to be unprofitable and had been forced to liquidate.

The ensuing liquidation resulted to what the Wall Street Journal reports as the biggest single reduction ever[8]in gold contracts.

So with the possibility that this event may have already passed and or could have been discounted, gold could regain its lustre over the coming sessions.

Gold And The Web Enabled Middle East Political Revolutions

Friday’s huge rally in gold, which media attributed to Egypt’s worsening political crisis and had likewise been adduced to the heightened risks of a regional political upheaval—where dictatorships and the entrenched aristocracy appear to be facing a comeuppance from the long disgruntled populace, a revolution apparently enabled by the web[9] and partly triggered by surging food prices—appear more like rationalization.

Figure 5: Bloomberg[10]: Political Tremors In The Middle East

Although, stock markets in the Middle East had indeed been rattled by such fears (see figure 5).

Perhaps the embattled aristocracy could be scrambling to safekeep their wealth overseas by buying gold for laundering purposes or for absconding it, similar to reports where the First Lady of the deposed President of Tunisia was alleged to have fled with 1.5 tonnes of gold (worth $55 million)[11].

The spike in oil prices should be more of a natural side effect over concerns of supply side disruptions once political standoffs become exceedingly violent. But given that the political turmoil account for as domestic issues, I am sceptical over the prospects of prolonged violent stalemate.

For me, these so-called uncertainties are icing in the cake for gold.

Yet in my view, we should see these ongoing revolts as positive.

People appear to be emboldened in asserting their sovereignty over an increasingly derelict political structure built upon vertical hierarchies predicated on central planning and or political-economic fascism.

In short, the web has functioned as a pivotal instrument in counterbalancing or levelling or reducing the concentration of political power to a few or to the once powerful elite. The likelihood is that the rule of autocrats will be diminished, unless governments would be successful in introducing and imposing controls and censorship on the cyberspace.

With over 2 billion people now wired or connected online or “With the world's population exceeding 6.8 billion, nearly one person in three surfs online”[12], add to that the 5 billion mobile phone subscriptions or about 73% of the global population, it’s no wonder how the political playing field is being reconfigured to adjust to these new realities.

Governments in the future are likely to be more attuned to the public and would likely shed a lot of bureaucratic fats.

And these ongoing revolutions represent the aforementioned structural adjustments in the political process. Hopefully, these people power revolts will be alot less bloody than their counterparts in the early to mid 20^th century.

And if there should be any major force that could influence the current trend of gold it would likely be gold’s reversion to the new monetary framework which will likely be brought upon by people’s realization and intolerance of the abuses of central banking system.

So I unlike those who see a surge in the “event risks” from the current string of upheavals in the Middle East as a reason to sell, I see gold rebounding from these uncertainties, fed by the inflationism in central banks and eventually a rally in most of the global equity markets, including the Phisix.

---

[1] See Gold As Our Seasonal Barometer, February 23, 2009

[2] See Gold Unlikely A Deflation Hedge, June 28, 2010

[3] People’s Daily Online Central bank to print 1 trillion yuan in paper currency, January 20, 2011

[4] Independent.ie Central Bank steps up its cash support to Irish banks financed by institution printing own money January 15, 2011

[5] Durden, Tyler M2 Surges By Biggest Weekly Amount Since 2008 As It Hits Fresh All Time Record, Zero Hedge, January 27, 2011

[6] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010, See What’s The Yield Curve Saying About Asia And The Bubble Cycle?, January 17, 2010

[7] See Trigger To The Inflation Time Bomb, October 7, 2010

[8] Cui Carolyn and Zuckerman Gregory Small Gold Trader Makes Big Splash, Wall Street Journal, January 28, 2011

[9] See The Web Is Changing The Global Political Order, January 29, 2011

[10] Bloomberg.com Bloomberg GCC (Gulf Cooperation Council) 200; The Bloomberg GCC 200 Index is a capitalization weighted index of the top 200 equities in the GCC region based on market capitalization and liquidity. The index was developed with a base value of 100 and is rebalanced semi-annually in April and October.

[11] MoroccoBoard.com Tunisia: Ex First Lady Absconded With 1.5 T Of Gold Bullions, January 17, 2010

[12] Physorg.com Number of Internet users worldwide reaches two billion, January 26, 2011

Trick Or Treat: The Federal Reserve’s Expected QE Announcement

``But on the other hand inflation cannot continue indefinitely. As soon as the public realizes that the government does not intend to stop inflation, that the quantity of money will continue to increase with no end in sight, and that consequently the money prices of all goods and services will continue to soar with no possibility of stopping them, everybody will tend to buy as much as possible and to keep his ready cash at a minimum. The keeping of cash under such conditions involves not only the costs usually called interest, but also considerable losses due to the decrease in the money’s purchasing power. The advantages of holding cash must be bought at sacrifices which appear so high that everybody restricts more and more his ready cash. During the great inflations of World War I, this development was termed “a flight to commodities” and the “crack-up boom.” The monetary system is then bound to collapse; a panic ensues; it ends in a complete devaluation of money Barter is substituted or a new kind of money is resorted to. Examples are the Continental Currency in 1781, the French Assignats in 1796, and the German Mark in 1923.-Ludwig von Mises, Interventionism: An Economic Analysis, Inflation and Credit Expansion

What I think would be the most important driver for the global financial markets over the coming weeks would be the prospective announcement by the US Federal Reserve’s Quantitative Easing version 2.0 on Wednesday.

The Gist of QE 2.0

I do NOT share the view that QE has been FULLY factored IN on the financial markets for the simple reason that estimates of the scale and duration and or terms have been widely fragmented. And there hardly appears to be any consensus on this.

The QE 2.0, in my analysis, is NOT about ‘bolstering employment or exports’, via a weak dollar or the currency valve, from which mainstream insights have been built upon, but about inflating the balance sheets of the US banking system whose survival greatly depends on levitated asset prices.

And all talks about currency wars, global imbalances and others are most likely to be diversionary ‘squid’ tactics to avoid the public from scrutinizing on the Fed’s arbitrary actions.

I see the ongoing QE 2.0 as heavily correlated with the legal issues surrounding the ownership[1] of many mortgage securities that has plagued the industry over the past few weeks.

Of course, it is also possible that Federal Reserve Chairman Ben Bernanke and company maybe pre-empting the results of the midterm elections, which they might think, could upset the current policy directions directed at providing subsidies to the banking system. The possibility of Cong. Ron Paul taking over the banking committee in Congress, they might see as a potential risk that could disrupt the viability of the banking system.

More Evidence Of Inflation

Yet there is hardly any convincing evidence that the US will likely succumb to another recession even without QE 2.0.

Even the credit markets have been saying so as we earlier pointed out[2].

Figure 2: Improvement On US Credit Markets (charts from St. Louis Fed)

For an update (see figure 2): Bank Credit of All Commercial Loans seem to be picking up momentum anew (top window), even Individual loans at ALL commercial which have recently skyrocketed, seem to be in a short pause but still looking vibrant (bottom pane) while Commercial and Industrial Loans of ALL Commercial banks seem to be bottoming out (mid window).

Figure 3: US Monetary Aggregates Points To Inflation (St. Louis Fed)

And even US monetary aggregates[3] appear to be saying the same story: MZM (upper window) and M2 (mid window) have recently been exploding skywards, while the M1 multiplier, a former favourite tool of permabears which tries to measure velocity of money, appears to be emerging fast from a bottom. And this is even prior to the Fed’s supposed renewed engagement with QE.

What all these seem to be pointing out isn’t what the mainstream and the officialdom has been looking at: we seem to be seeing are convergent signs of emergent inflation!

You have seen the actions US credit markets and US monetary aggregates, now the actions of the financial markets.

Figure 3: EM Equities, US Bonds and Commodities In A Chorus

We have argued that the convergence between rallying US bonds and a bullmarket in gold and or commodity markets would seem incompatible, from which the incoherence the markets would eventually resolve.

We seem to be seeing clues of this happening now, of course, going into our direction.

And deflationistas, whom have adamantly argued that bonds will likely benefit from a so-called liquidity trap, and have used the deflation bogeyman as justification for more inflationism, appear to be on the wrong the trade anew.

As one would note in Figure 3, emerging market equities (MSEMF or the MSCI Emerging Market Free Index), the CRB or a major commodity benchmark, a bellwether of Treasury Inflation Protection Securities or TIPS (iShares Barclays TIPS Bond Fund) and 10 year US Treasury Yields appear to be in a chorus.

What all these (credit market, monetary aggregates, financial markets) seem to be indicating isn’t what the mainstream and the officialdom have been looking at. (They’ve been fixated with employment figures).

Instead, what we seem to be seeing is a convergence of surging inflation worldwide!

And this is even prior to the Fed’s coming actions.

Not only that.

Last week, the US government sold $10 billion of 5 year Treasury Inflated Securities (TIPS) at minus .55% or negative interest rates for the first time in US history[4]!

TIPS investors don’t just earn from coupon yields, they earn from the adjustment of the securities’ par value[5] along with that of the consumer price index (CPI) thus giving protection against inflation as measured by CPI (which I think is vastly underreported).

This only means that the aggressive bid up of TIPS, which has led to a milestone of negative interest rates, represents a monumental swing in investor sentiment towards a deepening recognition of our transition to an inflationary environment which over the recent past had only been a fringe idea!

And this, in essence, would validate our 2009 prediction that inflation will be a key theme for 2010[6]!

And this also means that the premises of deflationistas are being demolished or dismantled as inflation expectations emanating from central bank policies deepens.

What To Expect

So how does QE 2.0 translate to the actions in the Financial markets?

If the Fed announcement should fall substantially below market expectations (perhaps $ 1 trillion or less) then we are likely to see some downside volatility which should prove to be our much awaited correction.

Yet any substantial volatility in the financial markets would translate to the Fed likely upping the ante on the QE 2.0. Remember falling asset prices would pressure the balance sheets of the banking system, and thus, would prompt for the Fed to make additional injections.

However, given the penchant of the Fed to resort to shock and awe, I wouldn’t be surprised if the FED would equal or go over the previous $1.75 trillion[7] monetization of treasury and mortgage related securities in 2009.

Of course, the other important aspect would be how other central banks would react to the Fed’s actions. We cannot take the Fed’s action as isolated.

If Bank of Japan and Bank of England would augment the Fed’s QE 2.0 by increasing its exposure on its current programs, then we should expect money flows into emerging markets to expand significantly. And this should go along with commodity prices and commodity currencies.

From the current market actions, we seem to be witnessing the early stages of a crack-up boom.

I remain bullish on equity markets, which I see as protection or serving as insurance against the currency debasement programs being undertaken by central banks to promote covert political agendas.

For Emerging Markets and Philippine stocks, we should remain exposed to commodities, energy and property issues.

[1] See The Possible Implications Of The Next Phase Of US Monetary Easing October 17, 2010

[2] See The Road To Inflation, August 29, 2010

[3] M1: The sum of currency held outside the vaults of depository institutions, Federal Reserve Banks, and the U.S. Treasury; travelers checks; and demand and other checkable deposits issued by financial institutions (except demand deposits due to the Treasury and depository institutions), minus cash items in process of collection and Federal Reserve float.

The M1 multiplier is the ratio of M1 to the St. Louis Adjusted Monetary Base.

MZM (money, zero maturity): M2 minus small-denomination time deposits, plus institutional money market mutual funds (that is, those included in M3 but excluded from M2). The label MZM was coined by William Poole (1991); the aggregate itself was proposed earlier by Motley (1988).

M2: M1 plus savings deposits (including money market deposit accounts) and small-denomination (under $100,000) time deposits issued by financial institutions; and shares in retail money market mutual funds (funds with initial investments under $50,000), net of retirement accounts.

St. Louis Federal Reserve, Notes on Monetary Trends

[4] Financial Times, US Treasury sells negative-rate bonds, October 26, 2010

[5] Investopedia.com Treasury Inflation Protected Securities - TIPS

[6] See Following The Money Trail: Inflation A Key Theme For 2010, November 15, 2009

[7] The Economist, A roadmap for more Fed easing, December 4, 2009