7/15/2013 6:15 PM ET|
Perfect storm gathering in China?
The slowing of the world's second-largest economy is sending shock waves around the globe. Here's what investors need to watch for as they try to stay out of the storm's path.
I can see a potential perfect storm brewing in China that could -- please note that "could" -- send chaos sweeping over global financial markets and economies.
I can see the conditions for the storm in place -- just as during hurricane season we can see a tropical depression building in the warm waters between Africa and South America. The question now, as with any hurricane, is whether that depression will build into a weak storm -- a Category 1 that lashes countries in its path with rain but doesn't result in much damage -- or escalate to a Category 4 or 5 that leaves a wide swath of destruction in its path.
And, of course, there's the important question of which countries lie in the storm's most likely trajectory.
At this point, I'd say the storm brewing in China is likely to rise to a Category 2 and cause damage to China's economy and stock market, as well as to stock markets and economies dependent on China's economy for growth, including commodity economies such as Australia, Brazil and Canada; Asian trading partners such as South Korea, Malaysia and Indonesia; and global export economies such as Germany.
Beyond that? Well, the timing of this storm adds to the possibility of it rising well above a Category 2, and the vulnerabilities of China's banking system say a Category 3 is well within the odds. For the storm to climb beyond that to the perfect storm level isn't impossible, but given the still rudimentary connections between China's banking system and global financial markets, the global economy would have to be very unlucky for this storm to inflict significant damage on markets and economies outside my list.
Eyeing the weather map
At this point, I'd say cut back on exposure to the markets and economies that are most likely to take a hit from even a Category 2 storm. And watch the weather map carefully to see how the global financial weather develops over the rest of the summer.
The starting point for watching the buildup of China's potential perfect storm is the country's July 15 report that second-quarter GDP came in at 7.5%. First-quarter growth had come in at an annualized 7.7% rate, (barely) above the official government target for the year of 7.5%.
As I've written before, the readings pointed to rough weather ahead. In June, to take one instance, China's exports fell by 3.1% year over year. That was the first drop in exports since the beginning of 2012 and the biggest monthly drop since October 2009.
There are good reasons to believe the data pointing to a slowdown in growth. For example, the European Union, China's biggest trading partner, is in recession. And, most importantly for storm watchers, the People's Bank of China engineered a cash squeeze in China's banking system designed to get credit growth under control.
In the week that ended June 21, the People's Bank produced a liquidity crunch by refusing to inject significant cash into the banking system, sending interbank lending rates (the interest rate that banks charge each other on short-term loans) to double digits. The overnight rate climbed to 28% intraday on June 20. When the bank did start to inject cash into the system, the overnight repurchase rate fell to 5.83% by June 26. But that still left the interbank rate about twice as high as normal. And when the People's Bank did inject cash, it didn't treat all banks equally. Most of the liquidity went to the country's five biggest state-owned banks. Midsize banks still reported a cash crunch.
Engineering a soft landing
This engineered cash crunch is a key source of energy for a developing storm in China.
First, the move makes capital scarcer and more expensive, and that's likely to lower growth in the economy.
Second, while the People's Bank did move to expand liquidity again, it didn't completely reverse its policy. Big banks got cash, and other parts of the financial system were left in a crunch. Since the big state-owned banks lend primarily to big state-owned enterprises, this has left small and midsize companies, which depend on the shadow banking system for capital, facing an extreme cash crunch.
And third, the policy suggests that the government in Beijing might be willing to accept lower growth -- even growth below the target growth rate -- in order to get China's shadow banking sector under control. Fitch Rating's analyst Charlene Chu estimates that a third of all outstanding credit in China is held in channels outside of loans from regulated banks.
The calendar also contributes significantly to the energy driving the development of a storm in China. The second-quarter numbers released July 15, showing that growth had slowed to 7.5%, don't include the entire effect of the ongoing credit crunch. Many of the effects of the June move by the People's Bank are still working their way through the economy, so we still don't know how hard the People's Bank actually stepped on the brake.
For example, we do know that second-tier Chinese banks have faced higher borrowing costs and, as the cost of buying credit default swaps to insure against the chance that loans would go bad have climbed, second-tier Chinese banks have had trouble borrowing funds from Asian banks outside China.
In other words, second-quarter numbers on growth are only the beginning of the story and not the end. Investors, traders and speculators looking at the second-quarter data can't be sure how low growth will go in the next quarter or for the rest of 2013.
Watching China's biggest companies
That doubt has been exacerbated recently by confusing statements by officials ranging from Finance Minister Lou Jiwei to Premier Li Keqiang that mentioned 7% growth as if it might be a new target. Officially, the government's economic growth target for 2013 remains at 7.5%, and China's official Xinhua News Agency corrected Finance Minister Lou's quotation mentioning 7% growth in a July 12 story. But the "accidents" have made markets wonder if the Chinese government is setting up expectations for lower than 7.5% growth -- without a big government effort to stimulate the economy to get growth above target again.
Investors, traders and speculators will be able to get a better read on the dimensions of the China story over the next few months by watching what happens to big Chinese companies that run into trouble.
China faces massive overcapacity in key industrial sectors (China's steel industry is running at just 80% of capacity, for example) that makes it impossible for companies in such sectors as steel, solar, shipbuilding, aluminum and automobiles to make a profit. China Confidential estimates that 75% of the companies in Chinese heavy industries face overcapacity in their sectors. Companies in these sectors survive only because local government officials need the jobs that these state-owned enterprises produce and because they have access to capital from state-owned banks. If state-owned banks stop providing unlimited loans, some companies in these sectors will go belly up (whatever that means in China, since the country does not have a working system for handling formal bankruptcies).
China Rongsheng Heavy Industries, among China's biggest shipbuilders, is a highly visible test case. Rongsheng is among the roughly one-third of China's 1,600 shipyards with no new orders. The company has 15 billion yuan in loans that come due this year. Net debt is now 168 times shareholder capital. Overdue receivables have climbed by 68 times since 2011. Not surprisingly, the company has applied for government help. The company is theoretically private but Jiangsu province owns a 48% interest. Will Beijing and the province let Rongsheng and its 6,500 jobs go under?
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Worried about China, Jim? I agree.
I'm even more worried too many politicians, industry chieftains, and globalists in this country want to make us more like them.
Just saying. Now back to the usual irrelevant distractions.
So what, the US Steel Industry is running at just 15% of its 1975 capacity too!
All sorts of commentary suggesting this or that will delay the end of QE is plain out- stupid. Of course it will end and business platforms living on Kool Aid and skeleton staff will go... POOF. The history books will call this experiment- Downsizing II, the drowning of America in fake indenture debt. You should see direct comparisons to the onset of 1983 when 99% of businesses used the same basic Business Plan and by year-end, 99% of them were terminally wounded, dead, merged or acquired in pieces. What the ridiculous drug addict Ivy League crowd did this time was to create globalization AND then Quantitative Easing to fund the corp corpses. Putting college degrees in executive roles straight out of college must be banned and promised compensation to personnel prioritizes above executive anything. It will take decades to correct this.
Should have thought of that possibility before you moved there!
I don't care what country it is, the start of any market or financial crisis, (outside of events, of course, like 9-11) ALWAYS seems to start with the banks, savings and loan, or some other financial related institution. In our recent time, Greece, Italy, Spain, Portugal, Ireland (by the way, haven't heard a peep (relatively speaking, to amounts of other financial news) about the bank situations in Europe in months. I guess everything is worked out and just fine over there now. /s) Not to mention our own crisis starting to play out in 07, (the inception, which of course, was taking place long before that) and is still playing out 6 years later.
It was true in the 1920's and 30's, it was true in the 1980's, and it was true in the 00's. What is it about the relationship between the banks and governments that they seemingly can NOT come up with a set of rules and regulations that keeps a fairly even keel on one of the most important foundations of any nation?
Nothing is perfect. I understand that. Things change. I understand that. But it seems that we have enough past history to at least have some basic economic understanding of where things start to go off the rails. It is almost as if (and no, I'm not a conspiracy nut) it is either planned, or the signs are purposely ignored. As much as I like to call the government an idiot, I have to believe that there are at least a few smart people there that actually do have the best interest of the country at heart. However, I don't think it coincidental that we (and other countries) seemingly repeat the same destructive patterns over and over again, every few decades or so.
I have a degree in business. I've studied economics for a long time. I keep my ears and my eyes focused on the markets and economic conditions. I read the news and keep up with current events. I read blogs and the attendant associated articles, like this one, on a daily basis. And yet, I have no logical reason why nations keep making the same mistakes over and over, other than the one that we are all guilty of: We're human.
China is a bellwether for the economic and financial systems of the world: trying to maintain the unsustainable with the untenable; trying to maintain infinite growth with finite and declining resources.
The form of capitalism we have come to know requires continuously increasing supplies of ever CHEAPER energy to maintain growth. Even steady state energy input will not work. In attempt to make up for the lack of cheap energy, we have substituted monetized debt and infusions of money printing.
This will not work and the end result will be far far worse than if we had simply taken our lumps for a completely unrealistic living standard. That is, unless you have a spare planet or two we can pilfer as we did this one.
All of the world's economies are based on a house of cards invented by the TBTF US financial enterprises that have relegated fiat currencies to the opiate of the masses. This will continue as long as then central banks keep printing more paper based on debt instruments with shrinking returns. However, like Japan, the other world economies are going to run out of ammunition and the house of cards will finally come crashing down on everyone. All of the CDS, MBS and other paper is tied in a huge gorgon knot that will finally get so tight that nobody will be able to untie it.
this wave of milking the common man around the globe is done, we must work for the next "harvesting" in about 30 years.
Prob, investors will seek to work with India and that region next.
One world , one people , all slaves to the top ^
I'm commenting, even though I don't understand the entire article. Is Jim saying that one country goes under or even performs under, and the rest of the world weathers the storm? If China is a leg we stand on, then that's pretty pathetic.
Bring work back here.
Jim, are you still with the forecast you made in late June?
And, yes, the current sell-off will end.
U.S. stocks will find a bottom at the April low of 1,542 on the Standard & Poor's 500 Index () or at the February low of 1,488. I'd vote for either the February low or the 200-day moving average at 1,446. With the index at 1,592 at the close on June 21, 1,446 is an additional 9.2% lower and would bring the total drop from the May 17 high to 13.3%.
You guys must hate save, cut and paste! I am beginning to wise up to the 'experts' but there will always be new investors out there who trust what you write.
China mostly is a provider of goods and services to the rest of the world. They are not much of a user of the goods and services at least not yet. That mean that if China is starting to see a reduction in out put most likely the receiving counties have already experienced the slow down. So point is that China will not hurt us nor other counties more than what we have already been experiencing.
China has for the past 5 years been already losing work to counties such as Viet Nam, South American countries and of course India. The trend will continue and perhaps for China's sake by that time it's people will be more affluent and become more users of products vs. only producers of products.
All this may not be a bad thing for any one country but clearly it does continue to change our, USA, standard of living.
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Reviewing overnight developments:
- Asian markets ended lower. Japan's Nikkei -1.0%, Hong Kong's Hang Seng -1.8%, and China's Shanghai Composite -2.9%.
- Participants received several economic data points:
- China reported a trade deficit of $22.98 billion (surplus of $14.50 ... More
- Participants received several economic data points:
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