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So what is really happening in China?

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China_flag1Nov. 6, 2009 (Erwan Mahe) If there is one credit situation we have been paying particular attention to, it is surely China’s! The country is the only region where the term, credit wave, has any real meaning. Unlike their less directed western peer, domestic banks apply government orders to the letters to open the main credit spigots in order to offset the collapse of world trade last year.

We have insisted at length about how such an approach simply “delays the encroaching instability”, as domestic banks fill their balance sheets with risky loans used to finance useless projects, thus, driving up overcapacity on certain sectors to alarming levels.

Officials, especially those in charge of supervising the banking system (CRBC), appear to be perfectly aware of these problems and seem disinclined to rely on a Asset Management Corporation (AMC) sleight of hand, the local bad banks set up in 1998 to sponge up $200bn of NPL dating from the boom years of 1991-1995. During this period, credit surged at an annual rate of 30%, feeding the coffers of the State-Owned–Enterprises (SOEs), which considered loans more as state-provided gifts than contractual obligations, thus, creating a real estate bubble that far exceeded real demand.

Any similarity between that situation and today’s hardly being a coincidence; let me suggest these two very interesting texts on the matter for some peaceful weekend reading:

Non-performing loan resolution in China. (Journal of Real Estate Portfolio Management, 22 Sep 2002) and

WTO and the reform of China’s State Banks, UIOWA.

While Chinese officials continue to assert that their monetary, fiscal and credit policies will remain accommodating in the coming months so as to not kill the bird in the nest, CRBC officials warned banks against any repetition of past errors and imposed stricter cross-capital rules (e.g. hybrid products.

Above all, news coming from the Middle Kingdom present a fairly surprising picture of the Chinese banking landscape, with a game of Old Maid strangely resembling that already played out by American banks with their foreign peers and investors throughout the world in 2006/2007, when they tried to unload as quickly and as discreetly as possible the toxic assets polluting their balance sheets!

Since I continue to be concerned for your leisure time, I would like to warmly recommend a work on this issue by Lawrence MC Donald, ‘A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers’. It is really worth the read!

The four major Chinese banks (ICBC, BOC, CCB and ABC), which normally write over half of all loans in China, issued just 20% of total loans in September.

As a case in point, BOC, long the leading credit issuer, saw its volume of loan activity fall from 72.2bn yuan in August to just 3bn yuan in September!

Why? The big banks have been passing the credit asset torch to smaller, local banks as well as financial services firms and rural credit unions!

Moreover, major banks have started selling loans through syndicate packages and wealth management products.

Others transferred loans at negotiated rates to direct receiver banks.

Certain sceptics claim that I am making us of this phenomenon to support my macro scenario for China (Thaler's Corner 17-08-09: Chinese Minsky ladder and a broken rung...), and they are right!

This is especially so, given the strange things occurring on the dollar interbank market in Shanghai, where local banks are effectively driving up 6-month interest rates on the dollar which, at 1.79%, is now 122 bp higher than the US Libor!

But with rates for the same period for yuan-denominated debt coming to 4.86% and local investors all betting on the appreciation of the Chinese currency against the US dollar, the inconsistency of the Chinese government’s monetary/trade/currency policy is as flagrant as ever, as it falls into Mundell’s Impossible Trinity.

And it is hardly fortuitous that this is being accompanied by a resurgence in protectionist tensions:

« China applies export restrictions - quotas and export duties - on key raw materials. These restrictions distort competition and increase global prices, as some of these resources cannot be found elsewhere. Downstream industries in China therefore have access to cheaper materials than their competitors outside China. That is not a level playing field, and the EU and U.S. have asked for consultations with China at the World Trade Organisation (WTO).”

  • China Trade Probe on U.S. Chicken Imports Enlarged

China's Ministry of Commerce announced on Nov. 5 that seven new terms would be included in the trade probe on American chicken products.
The new investigation items involve two U.S. federal government programs and five issued by state governments.
The ministry initiated the anti-dumping and countervailing investigation into American chicken products on Sept. 27. The original investigation planned to cover ten items.”

Following such a statement, we really didn’t need the new US unemployment rate figures at 10.20%. I wish everyone a good weekend nonetheless.



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