10/13/2011 6:11 PM ET|
China faces its own debt bomb
The country let the money gush to keep growth going despite the 2008 global financial crisis. The bills are coming due now, and alert investors may profit.
What if your country's financial powers plowed $30 million into bank stocks and investors yawned?
That's exactly what happened in China on Oct. 10. Central Huijin, which is the domestic arm of China's sovereign wealth fund, bought $30 million in shares of China's biggest banks. The stocks moved barely 2% -- amazingly little, given that shares of Chinese banks were down 30% for the year. And the wider Shanghai Composite Index, which had closed at a 30-month low the day before, squeaked out just a 0.2% gain.
China's investors have seen this all before (in 2008), and they're determined to wait for the big payoff when China dumps real money into stocks or -- more likely -- reverses policy at the People's Bank and starts cutting interest rates.
Until Beijing shows the markets that it's serious about turning the money taps back on, with something like the volume that it did in 2008, investors look like they plan to sit on their cash. There are reasons, after all, that China's Shanghai stock market is down 22.6% -- in bear market territory -- from its November 2010 high to the close on Oct. 12, and why the Hong Kong market is down even more, at 26.3%.
China's investors have at least an inkling of the dimensions of the problem. They know that $30 million is a laughably small gesture and are waiting for the big money. It will flow, and when it does, China's stocks will rally hard. And while we're getting closer, I think we're still months from the day that China turns the spigot on.
To understand what's happening now in China's financial markets, you need to understand how 2011 is both similar to and different from 2008.
When the money gushed
In 2008, while the global financial system was reeling from the shock waves of the Lehman bankruptcy, China pumped $600 billion into its economy. And that was only the money officially authorized by the central government. Beijing leveraged that stimulus by encouraging local governments to go on an infrastructure spree to finance roads, airports, factories, rail lines and other projects.
Local governments in China have very limited sources of tax revenue, so to finance all these stimulus projects, local governments borrowed. To make that borrowing possible, Beijing kept interest rates low and encouraged the state-controlled banks to lend first and ask questions, well, never.
China escaped 2008 with just a scare -- even as the rest of the world fell into recession. For all of 2008, China's economy grew by 9%, the lowest rate of growth since 2003. But the end of 2008 was much scarier than that annual number suggests. In the fourth quarter, year-to-year growth dropped to 6.8% and sequential growth -- that is, from the third quarter to the fourth quarter -- was either only barely positive or slightly negative.
Of course, that looked pretty good in comparison with the annualized 6.3% drop in U.S. gross domestic product in the fourth quarter of 2008.
As China moved into 2009, the economy revved up again, with growth rates rising from 6.2% in the first quarter to 7.9% in the second quarter, and finishing at 8.7% for the year as a whole. Growth in 2010 soared to a too-hot-to-handle 10.4%. The Chinese government has spent 2011 trying to slow the economy and get inflation, which hit 6.4% in June, under control. In the second quarter, economic growth slowed to 9.5%. In August, inflation dipped to 6.2%.
All's well, then, right?
Not at all. China is suffering a massive debt hangover at its big state-controlled banks, at local governments, and in what has become a massive unofficial financial sector.
China's big bank woes
Let's start with the banks themselves. Officially, they look reasonably solid. Not stellar, mind you, but solid. According to banking regulators, China's banks had an average Tier 1 capital ratio of 10.1% at the end of 2010. That compares with an average of 12.3% for the world's 100 largest banks by market capitalization, Bloomberg calculates.
But as the euro debt crisis has amply demonstrated, Tier 1 capital ratios can be wildly deceptive. The ratio is supposed to compare risk-weighted assets (loans, for banks) to the bank's own capital. In Europe, Tier 1 ratios were distorted because bank regulators decided that sovereign debt (the bonds of countries including Greece and Portugal) should be considered risk-free. That had the effect of driving up Tier 1 ratios.
In China, the distortion comes from the huge volume of loans to big, state-owned companies. Bank regulators have given these loans low risk ratings, even though many state-owned companies are marginally profitable at best and manage to pay interest on their loans only by taking out new loans.
A way to correct for that distortion is to compare total equity with total assets (loans). So China's biggest bank, Industrial and Commercial Bank of China, had an official Tier 1 capital ratio of 9.82% at the end of June, but, The Wall Street Journal calculates, its ratio of total equity to total assets was just 5.77%. In comparison, the Journal notes, the total-equity-to-total-assets ratio at Bank of America (BAC, news), not the strongest of U.S. banks, was 9.8%.
China's other big banks show similarly low total-equity-to-total-assets ratios: China Construction Bank (CICHY, news), 6.28%, Bank of China (BACHY, news), 5.83%, and Agricultural Bank of China, 5.14%.
China's banks could buttress their capital by retaining more earnings, but the banks currently pay out most of their earnings as dividends to other state-owned companies or to the government itself.
The other option is raising capital in the financial markets. Lots and lots of capital. Estimates of how much start at $131 billion over six years to meet stricter capital rules -- according to one industry regulator who gave that figure, anonymously, to Bloomberg -- and then grow to include an additional $185 billion to keep the bank's capital ratios steady as the economy expands and credit demand grows.
Looking at those numbers, you can understand why the market wasn't impressed by Central Huijin's $30 million capital infusion.
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"China faces its own debt bomb"
Its about time they got a little of what they've been doing to us! Hope it blows up big and all the American companies that have moved over there feels the blast by loosing everything they've invested in China!!
Economists have been predicting this "doomsday" scenario for more than 40 years (basically ever since we went off the gold standard), but the cycle just keeps moving on because all money is relative. The world banking system has been playing musical bonds so long that nobody really knows who owes what to whom because the whole thing is a spaghetti mess that supposedly at some point traces back to a hard asset. The wierd part about it all is if you were to start unravelling the spaghetti, you would likely find that China owns a big chunk of the US, the US owns a big chunk of Europe, and Europe owns a big chunk of China. The game of kick the can goes round and round, and eventually inflation is ackowledged and prices get adjusted to the new standard. BTW, Japan used to hold China's place, but they made the mistake of trying to cash out of the game and got spanked when people found out what they actually owned.
As WOPR said (the computer running NORAD in "War Games"), "An interesting game Doctor Falken, the only winning move is not to play". I think I'll stick to chess.
Jim, You always leave me hanging. So what should investors do if China and USA are in trouble.
Too funny. Didn't China tell us to fix our debt problems awhile ago? I think China should clean up their own debt mess first.
This just reaffirms my belief that greed isn't good and we need another system of financing simply because this way is broken and isn't going to be easily fixed. I do see this is what happens when you give too much power to a few bankers in America's case, or the government in China's case. You get bad financial decisions.... And they go from bad to worse.
Fortune cookie reads:
Who seeks more than he needs, hinders himself from enjoying what he has. Seek what you need and give up what you need not. For in giving up what you don’t need, you’ll learn what you really do need.
A joyful heart makes a ; A sad heart makes . All the days of a poor person are wretched, but contentment is a feast without end.
Who is rich? Those who are happy with their portion .
China .. has inflation in food prices and deflation in industry assets, with over extended debtors and a shadow banking system. Maybe America has more in-common with China than most people recognize. Investors looking for central banks to bail out quazi-private banks .. sounds a lot like a liquidity trap where nobody is willing to make the bold move to break the vicious cycle.
Come-on Congress: pass a jobs bill .. before Bangladesh is the financial capital of the world.
I can also see more Chinese investment money making its way to the United States. They buy more than just Treasuries.
I stated a few years ago that China and its Government ran Bank is the "big target" of the private sector economic hit team to bring down. And well they just sold off 30% to Doemstic interests, it won't be long before somethig comes along and they have to sell off more, rinse and repeat here....
The fact that soo many people are unaware there are Trillionaires in the world, leads me to assume, they are not getting what's going on outside of their personal everonments or they don't care...
It's time for Americans to stop sitting on high on their hogs and try to save what future there is left...
and now China comes tumbling down...
Well officially that's every major country in the world that has had a financial meltdown, What's next?
Will America be called to pay up on it's bills that have been foolishly sold off over years? We don't have the money, what do we do? Do we have any thing else we can sell? What else is worth anything in America besides the land, resources and well I hate to say it, the People...
Social Security Number = Value to the United States > I shudder to think of what is to come...
You mean all the American companies that still employ most of us and most us have our retirement savings invested in?
Population of US is around 312 million. Aproximately 83.3 million are under the age of 18.
That puts the adult population at around 230 million. Aproximately 3 million people are millionaires. In 2009, 7.2 million adults were under correctional supervision in US with over 2 million in prisons. Aprox 5 million people are on welfare. Aproximately 5.6 million people are unemployed and gainfully seeking employment. In 2009, 71 million people didn't pay any federal tax and 30.5% of them made over $50,000. The Organize people want to say they are part of the 99%. Some are in prison or on parole or on welfare and others are millionaires. It is quite a diverse group.
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