Everyone’s suddenly wary about China.Copper has been plunging on fears about a slowdown, while the Shanghai Composite continues to plunge to new lows for the year.
This more and more people are eyeing China and the increasing possibility of a hard landing.
Bank of America cautioned investors to be wary of China in a presentation earlier this week, and a Bloomberg poll recently concluded that nearly half of respondents foresaw Chinese growth to slow to less than 5% in the next two years, with nearly 60% certain this would happen in the next 5 years,
We analyse why everyone’s suddenly up in arms about China.
HSBC's preliminary China PMI fell from 49.9 to 49.4 from August to September, suggesting a big drop-off in Chinese growth. This was also a major concern cited in a Goldman desk note circulated this morning.
A huge underground banking system is emblematic of an aversion to private companies and a poor understanding of banking in general.
China has publicly admitted to a $470 billion-large underground banking sector, though in reality it could be much larger.
The official banking sector charges state-owned companies far lower rates than private companies, 7.2% versus 36-60% respectively. It's no surprise that private banks turn to large companies for funding at lower rates.
Nine large business owners from Wenzhou province walked away from their underground loans when they found they didn't have the money to pay creditors. It will likely prove difficult to even locate the offenders.
Perpetrators of a Ponzi scheme kidnapped the wife of the head of a Bank of China branch after the bank noticed money missing from more than 40 savings accounts.
Free cash flow (essentially, the cash companies have beyond maintaining their asset base) is hugely negative, meaning that firms have little money to spend beyond their current investments.
Hot money -- though a 'wild card' -- also looks to be dropping off significantly, reducing cash available in the short term.
Source: Bank of America
Real estate trust funds -- a last resort for borrowers -- accounted for about 50% of new loans to developers over the past year, according to a Bloomberg report. Junk bonds for Chinese home builders fell by 19% in the second quarter marked a 19.9% drop, the biggest quarterly decline since Q4 2008.
The Basel Committee on Banking Supervision is about to add the BOC to its list of 'systematically important' banks. This will allow it cheaper access to funds, but also require the bank to conform to keep higher capital reserves than it currently maintains. This could further increase funding costs as the bank becomes 'too big to fail.'
In a note we reported on yesterday, Citi's Shuang Ding wrote, 'Investment boom during 2008-10 pushed investment/GDP to a record high -- The ratio reached 48.5% in 2010, unprecedented in recent history of China and major world economies.'
But with nearly half of China's GDP invested, this situation is unsustainable. The marginal product of investment has gone down the tube since the financial crisis began, suggesting that public spending needs to reined in to maintain efficiency.
According to Bank of America, infrastructure spending as a percentage of GDP was flat from 2009 to 2010, as infrastructure growth fell off sharply during the same period.
The central government extended huge loans to local governments during the recession, and are now facing the consequences. Local government obligations to GDP rose to 63% in 2010. The central government created financing vehicles to fund projects and alleviate local government concerns, but even these are facing problems. One such vehicle recently attempted to default in Yunnan province.
Source: Bank of America
The Justice Department, FBI, and SEC are investigating accounting irregularities at top Chinese companies.
The Justice Department revealed that it is working with the SEC and FBI to investigate accounting fraud at Chinese firms listed on U.S. exchanges, according to Reuters. The SEC has been investigating the matter for over a year.
'Not having proper accounting and reliable audit review for publicly traded companies with operations in China is just not acceptable. We have to find a path to resolution of this issue,' said Rober Khuzami, head of enforcement action at the SEC.
And a bipartisan bill in the Senate could punish China for currency manipulation and trade manipulation.
A bill in the house right now could alter trade law in order to compensate for what these Senators believe is currency manipulation on the part of the Chinese.
It would also slam them for excessive domestic subsidies, violations of labour and environmental standards, and flouting of trade regulations.
President Barack Obama, however, is against the bill.
Because China is unwilling to admit to underground banking activities and prefers to cover up deficiencies in their banking sector, it's hard to make predictions about China's future financial health.
Even if the indicators are pointing to a soft landing, investors are likely to doubt professions of fiscal stability due to the opacity of the Chinese government.
A Goldman note circulated about China this morning suggested that Chinese stocks could see a major sell-off over its uncertain economic future. With the market already in 'attack mode,' the note's author reported seeing shorts laid out for Chinese equities.
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