Something Might Be Going Wrong Over There …
Now it's official – even the credit rating agencies are noticing the huge credit bubble in China, which has in recent years been mainly driven by the 'shadow banking' market. Keep in mind though, the shadow banking market is still financed by the banks – it is a method by which they are escaping official credit restrictions.
Albert Edwards and his colleagues at CLSA have recently darkly muttered about an 'approaching Minsky moment' for China, as the recent surge in credit seems not to have fueled much growth – on the contrary, growth seems to be weakening seemingly in spite of vast credit growth.
Of course it is not really 'in spite', but 'because of' – the only difference to earlier phases is that this time, it is noticed right away. Instead of producing another boom-bust phase, the credit expansion now apparently produces bust exclusively – which is a strong sign that the pool of real funding in China is in trouble.
Lately there have also been stresses in the interbank market, which haven't really gone away just yet (at least we now know that there has indeed been a bank that was unable to repay its obligations, see further below).
The 5-day moving average of overnight SHIBOR as of Friday – click to enlarge.
The Telegraph writes regarding Fitch's assessment:
“China's shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned.
The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.
"The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation," said Charlene Chu, the agency's senior director in Beijing. "There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signaling," she told The Daily Telegraph.
While the non-performing loan rate of the banks may look benign at just 1pc, this has become irrelevant as trusts, wealth-management funds, offshore vehicles and other forms of irregular lending make up over half of all new credit. "It means nothing if you can off-load any bad asset you want. A lot of the banking exposure to property is not booked as property," she said.
Concerns are rising after a string of upsets in Quingdao, Ordos, Jilin and elsewhere, in so-called trust products, a $1.4 trillion (£0.9 trillion) segment of the shadow banking system.
Bank Everbright defaulted on an interbank loan 10 days ago amid wild spikes in short-term "Shibor" borrowing rates, a sign that liquidity has suddenly dried up. "Typically stress starts in the periphery and moves to the core, and that is what we are already seeing with defaults in trust products," she said.
Fitch warned that wealth products worth $2 trillion of lending are in reality a "hidden second balance sheet" for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.
This niche is the epicentre of risk. Half the loans must be rolled over every three months, and another 25pc in less than six months. This has echoes of Northern Rock, Lehman Brothers and others that came to grief in the West on short-term liabilities when the wholesale capital markets froze.
Mrs Chu said the banks had been forced to park over $3 trillion in reserves at the central bank, giving them a "massive savings account that can be drawn down" in a crisis, but this may not be enough to avert trouble given the sheer scale of the lending boom. Overall credit has jumped from $9 trillion to $23 trillion since the Lehman crisis. "They have replicated the entire US commercial banking system in five years," she said.
The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990. "This is beyond anything we have ever seen before in a large economy. We don't know how this will play out. The next six months will be crucial," she said.”
Suddenly, There's Unrest Everywhere
First Turkey, now Brazil – the masses are getting restless. In Brazil it is understandable that protests are flaring up. The country is slithering down the other side of a credit bubble mountain, something that has been reinforced by declining commodity prices and accompanied by soaring consumer prices to boot.
The Bovespa has been declining for some time now and the fall in the Brazilian real has been even worse. Brazil and a number of other commodity producing countries are so to speak twin bubble warrants. On the one hand, credit bubbles in them were egged on by the ultra-loose monetary policy in the West, which sent waves of foreign capital in search for yield flooding into them. On the other hand, China's credit bubble and the associated investment boom triggered a seemingly unstoppable upward spiral in commodity prices. All of these events have been reinforcing each other, but the root cause is the same wherever one looks: the scourge of central banking.
Now public anger is suddenly boiling over in Brazil and violent protests are erupting, a phenomenon typically associated with a souring social mood.
The Bovespa is back to where it was four years ago – only, the direction it is going in is 'South' this time – click to enlarge.
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Bank Recap Slightly Delayed
We have previously made a few remarks on Slovenia's astonishing three-card Monte, whereby the toxic assets of its banks (some 30% of their assets are reportedly non-performing) are to be transferred into a 'bad bank' owned by the government.
What makes this so astonishing is that the banks also belong largely to the government, so the government is transferring bad loans from itself to itself. One wonders how exactly that is supposed to alter the situation. Moreover, the question 'where is the money to recapitalize the banks going to come from?' sort of suggests itself. The idea is apparently to sell the banks once they have been cleaned up. In principle not a bad plan.
However, it turns out now that the plan is hitting a few snags, one of which is that the 'government may have underestimated the problems'.
“Slovenia's ring-fencing of billions of euros of bad debt racked up by state-owned banks may be delayed by an audit expected to show the country has underestimated its economic problems.
Transfers of the debt to a 'bad bank' – called The Company for Management of Bank Claims – are due to start this month, and the entity has scheduled its first news conference for Tuesday. But the audit ordered by the European Commission to uncover the extent of the non-performing loan problem is expected to delay the start of the cleanup until July.
The government aims to absorb 3.3 billion euros of loans that turned sour after a real estate bubble burst, putting Slovenia at risk of becoming the euro zone's euro zone's next bailout recipient.
That is less than half of the 7 billion euros the Bank of Slovenia estimates to be the true scale of the problem loans – a figure analysts say may also be too low as it was calculated earlier this year before the country's recession deepened.
"This has been the experience with other euro periphery economies, and the macro backdrop in Slovenia is getting worse than expected," said Timothy Ash, an analyst at Standard Bank. Getting a clearer picture via audit may delay the cleanup.
[...]
Along with the transfers, Slovenia also has to pump 900 million euros in the top three banks by the end of July to bring capital ratios into line with European requirements.
An EU official told Reuters the credibility of the Slovenian cleanup was more important than its speed, adding the external audit of banks should be completed in weeks, though the country had not yet chosen the auditor.”
25 Years of Real Estate In One Chart
There is good news. This is likely my shortest rant ever.
Freddie Mac recently released the 2013 First Quarter Refinance Report. My attention was drawn to one chart. More specifically, the blue line in the chart.
Boom and bust in mortgage finance … – via Freddie Mac – click to enlarge.
It may just be a coincidence but whoever created this chart used the time period that covers exactly the reign of Chairmen Greenspan and Bernanke. Real estate investors should look back and realize that they could not have asked for anyone better than these two.
A Market Mover
Monday's action in the stock market confirmed once and for all that the great mass of traders in the market aren't exactly the brightest tools in the shed. In fact, we suspect that most of the action is driven by algos anyway, which these days are inter alia scouring press reports for 'market moving news'. These programs appear about as effective in interpreting 'news' as a fence post. For instance, a report in the FT about 'QE tapering' that regurgitated the same stuff everybody must have heard 50,000 times by now, shaved off 150 points from the DJIA intraday, in spite of the fact that the author was not Hilsenrath and therefore was only speculating. Besides, who cares? After all, stocks are rising because the future is so great we'll all need to wear shades.
Earlier on, a buying stampede was set into motion after the release of the Empire State Survey, the headline reading of which came in 'better than expected' (surprise, economists guessed wrong again).
So what excited the market so much about this survey? It really can only have been the headline, because the innards of the report read as though the region was hit by an earthquake.
To Intervene or Leave Them Be, That is the Question
The G8 decided not to make any big decisions regarding Syria over the weekend, allegedly because Vladimir Putin was strongly against anyone interfering there. This in spite of the media intervention promotion machinery swinging into action, at least partly.
“The Times warns that "standing by as Syria burns is now untenable" and that it is time for world leaders to end their posturing and make a decision on arming the country's rebels.
The paper argues that providing "moderate" rebel leaders with the means to defend themselves is the least bad option after what it calls "two years of drift".
Others are not so sure if that's a good idea. In fact, it is a good bet that the appetite for intervention is extremely low everywhere, especially among voters.
“The Daily Telegraph concludes that the political spirit to intervene is weak, because Britons are haunted by memories of the intractable nature of the violence in Iraq and Afghanistan and are anxious about enduring austerity at home.
Most find it baffling, it says, that Mr Cameron could even countenance involving himself in such a mess.”
What Are They Thinking?
We recently wrote about the fact that France is currently jeopardizing transatlantic free trade negotiations over the bizarre 'cultural exception' for the movie and music industries. Now the German press has also caught on to this and seems just as perplexed as we are.
For instance, Der Spiegel writes:
“It's the country that brought us "Amelie" and silver screen greats like Catherine Deneuve and Gerard Depardieu. But its insistence on its "cultural exception" could derail the planned start to talks to create the world's largest free-trade area between the European Union and the United States — an initiative that has been strongly promoted by Germany and Chancellor Angela Merkel.
EU trade ministers are expected to finalize the scope of negotiations at a meeting in Brussels on Friday. A unanimous agreement is required in order for talks to get the green light at next week's G-8 summit in Northern Ireland. But speaking to members of parliament on Wednesday, French Prime Minister Jean-Marc Ayrault said his government would exercise its veto if audiovisual media like the Internet, video on demand, television and film aren't removed as negotiating areas.
"France will oppose the opening of the negotiations if culture and cultural industries are not protected, are not excluded," Ayrault told parliament, describing the issue as "critical," according to French news agency AFP.
The French fear Hollywood dominance of the European film industry, despite a European Commission compromise that would ensure that the current system of subsidies in France and many other countries could remain in place. It would also protect French radio quotas that 40 percent of music played on French radio stations be in the national language and that the same percentage of programs on television be French productions.
[…]
Germany, which had previously sided with France, switched its position earlier this week, abandoning its objections. The EU has has proposed setting "concrete redlines" to protect European policies promoting culture.
But according to the Süddeutsche Zeitung, negotiators representing Britain in the trade agreement have said they might reject talks if the European Commission caves to French demands.
One of the key demands in entering into a trade agreement has been that conditions not be placed prior to negotiations, and US negotiators are already warning that France could be opening a Pandora's box. The Süddeutsche cited German government officials as saying the French demands would destroy the possibility of a broad free-trade agreement.
Theory of Interest and Prices in Paper Currency Part III (Credit)
In Part I, we looked at the concepts of nonlinearity, dynamics, multivariate, state, and contiguity. We showed that whatever the relationship may be between prices and the money supply in irredeemable paper currency, it is not a simple matter of rising money supply à rising prices.
In Part II, we discussed the mechanics of the formation of the bid price and ask price, the concepts of stocks and flows, and the central concept of arbitrage. We showed how arbitrage is the key to the money supply in the gold standard; miners add to the aboveground stocks of gold when the cost of producing an ounce of gold is less than the value of one ounce.
In this third part, we look at how credit comes into existence (via arbitrage, of course) with legitimate entrepreneur borrowers. We also look at the counterfeit credit of the central banks (which is not arbitrage). We introduce the concept of speculation in markets for government promises, compared to legitimate trading of commodities. We also discuss the prerequisite concepts. Marginal time preference and marginal productivity are absolutely essential to the theory of interest and prices. That leads to the last new concept resonance.
An Interesting Technical Backdrop
Over the weekend we had a very interesting meeting with friends who are working in various capacities in the financial industry, and one of the topics that briefly came up for discussion was crude oil.
The main reason to talk about crude oil these days is its stubborn refusal to go lower. There is a fairly widespread anecdotal consensus that prices will – nay, must – come down. In fact, only very recently the US Energy Information Administration (EIA) opined that the sharp increase in US domestic production portends lower prices in the future. It presumably had to point to the future because it is definitely not producing lower prices in the present. In fact, Monday's close in spot WTI at just above $97/bbl. was right at the upper end of its multi-month range and only a hair away from what would be a noteworthy technical breakout. This is evidently not what the consensus would expect, especially in view of the fundamental data accompanying this show of strength.
West Texas intermediate crude oil, spot. Closing right at multi-month resistance
Failed Projections or Just Another Government Lie? You Judge!
Boy, were they wrong!
Not so long ago, the Congressional Budget Office (CBO) said it expected the U.S. government to register a budget deficit in the current fiscal year of $642 billion.
But hold on a minute…
The budget deficit so far (as of May 31, 2013) has already hit $626.3 billion, and we still have four more months to go in the government’s current fiscal year!
Since the beginning of the U.S. government’s current fiscal year 2013, which began in October of last year, the government has posted a budget deficit in six out of the past eight months.
The Department of the Treasury just reported the U.S. government registered a budget deficit of $139 billion for the month of May. The federal government took in $197 billion and paid out $336 billion for the month. (Source: Department of the Treasury Financial Management Service, June 12, 2013.)
Comparing it to last year, May 2013’s budget deficit was 11% higher than that of May 2012.
'Recession to End in 2014'
Bloomberg has published an article about Spain's economy which has the timing of latest postponement of economic recovery as its subject. The article is entitled “Spain Recession Seen Ending by 2014 as Austerity Eases”.
From this title we conclude that the authors mistakenly believe that the recession is the result of 'austerity', i.e., the fact that the markets have forced Spain's government to rein in its deficit spending ever so slightly. Therefore, they appear to believe that as soon as the government will be in a position to spend more money it doesn't have, everything will be fine again.
This is a misconception on several levels. For one thing, the recession is the result of the previous unsustainable inflationary boom, which expressed itself in one of the biggest housing and credit bubbles ever. Few comparable examples exist, although housing bubbles have become a global phenomenon due to the vast money printing orgy that has been raging worldwide since the year 2000. Capital malinvestment in Spain reached such gargantuan proportions that the workout is especially painful. Moreover, the bust has struck just as Spain's demographic picture is worsening markedly, as pointed out by economist Edward Hugh, who lives in Spain.
Japanese Investors Refuse to Obey
It seems everybody has embarked on yen carry trades with the exception of the one constituency that happens to command one of the largest pool of investable funds in the world: the Japanese themselves.
One of the major ideas informing so-called 'Abenomics' is the mercantilistic fallacy that 'imports are bad and exports are good' and that therefore, one of the shortcuts to prosperity is the weakening of one's currency. In order to get the yen to weaken, BoJ governor Kuroda has promised to increase the production of yen from thin air. This idea meets with resistance from private sector borrowers and lenders in Japan: the former don't want to take on new credit, the latter continue to decrease their outstanding stock of fiduciary media. You can lead the horse to the water, but you can't make him drink. In Japan, the horse has been stubborn as a mule for decades.
How It All Started
Once upon a time, consumers were happily driving Toyotas. Depending on their needs and resources, some had economy models, some more upscale models. They were very affordable and consumers were quite comfortable with the car payments. However, the dealers, manufacturers, finance and other related companies felt they were not making enough money, so they dreamed up a grand scheme. Here is how it works.
The manufacturers would start making more upscale Lexus. The dealers would steer all the tire kickers to the latest and greatest Lexus models. The finance guys would create these no payment loan programs so that anyone could upgrade from a 10 year old Toyota to a brand new Lexus. The back room bankers would package all these loans and sell them to suckers all over the world, while the blind Federal Reserve Chairman mumbled about how no supervision was needed because the banks could regulate themselves. Compounding the problem, the prices of these Lexus cars were jacked up sky high because of the pseudo demand created by irresponsible financing.
That was in the past. The story today has a new twist. Any sensible Government and policy maker can see that the simple solution is to let the repo men take the Lexus so the consumers can go back to the Toyota, something they can comfortably afford. Instead, this Government chooses to take all the wrong actions. Well, we know where this story is going, so before I bore everyone to death, here is the solution.
A Proposal
We Need the Feds
Just like the RTC era, we need an agency that can override all State and local authorities so that we can have ONE uniform solution across the nation.
Selected Indicators
Below are several indicators relevant to the stock market that we have discussed in past updates, some of which we haven't looked at in a while.
Notable divergences are in evidence almost regardless which indicators one cares to examine. As mentioned in the previous credit market update, the Citi economic surprise index for Europe is actually converging with European stock market indexes at the moment (the former is rising while the latter are declining), but the same can not be said of the US. This is the most extreme case of 'bad news is good news' we can remember having seen in a very long time. Quite often such divergences are closed rather rapidly, so clearly it is also a case of 'caveat emptor'.
Citi's economic surprise indicator for the US versus the SPX – the gap continues to remain extremely wide – click to enlarge.
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