Earlier we brought you the latest note from Art Cashin, who highlights mounting concerns in China.
Cashin was riffing off his colleague UBS colleague Andy Lees, who has one of the gloomier notes about China we’ve seen in a long time.
In addition to talking about drought, the end of productivity growth, water depletion, and a looming demographic crisis, Lees highlights the state of the banking system.
Unfortunately there is yet another area of concern starting to build in China, that of its finances. We have heard the recent stories about companies using letters of credit to import copper or soybeans and then using the proceeds to support other debt, but this is just the tip of the iceberg. You may recall back in 2006 Ernst & Young issued a report that China’s bad debts may be as high as USD900bn, outstripping the country’s massive foreign exchange reserves at the time. Aside from large banks, the estimate includes bad loans in state investment companies, credit cooperatives, and other vehicles set up by the government to dispose of the loans. At the time the government dismissed this as fantasy and Ernst & Young were forced to withdraw the report, presumably if they wanted to continue lucrative business in the country. Fitch, PriceWaterhouse and McKinsey Global Institute subsequently issued reports, which although not quite as extreme nevertheless made similar observations and suggested that the problem was significantly worse than Japan’s 15 years earlier. Fitch said official NPL’s were USD206bn with another USD270bn problem loans plus another USD197bn in NPL’s that have been taken off the bank’s books and with the management agencies, which are not treated as NPL’s, but are future liabilities on the government. That USD673bn it said was a very conservative estimate due to the quality of accounting etc, and was therefore not credible. It said in reality the figures would be far higher and “Given the weakness” already discussed, we believe Chinese banks remain acutely vulnerable to an economic slowdown”. You cannot prepare to deal with a loan situation as bad as China’s. You simply keep cycling as fast as possible and hope something turns up.