Eastern Monetary Drought

Smug Central Planners

Looking back at the past decade, it would be easy to conclude that central planners have good reason to be smug. After all, the Earth is still turning. The “GFC” did not sink us, instead we were promptly gifted the biggest bubble of all time –  in everything, to boot. We like to refer to it as the GBEB (“Great Bernanke Echo Bubble”) in order to make sure its chief architect is not forgotten.

To be sure, he does admit right away that there are “costs” associated with this, without going into too much detail about them. He also points out to his fellow panelists that when your stock market is more overvalued than at the peak in 1929 (showing them a chart virtually all of Wall Street has tried to studiously ignore for the past three or four years), you have no business worrying about bubbles elsewhere. Perhaps you should be more concerned about your own.

Let us take a brief look. This is a lengthy video, and the part we are referring to begins at 48:52. Here is a direct link with the start time embedded, alternatively you can look at the version of the video embedded below, by navigating to the 48:52 time stamp on your own.

Fang Xinghai opines on the US stock market bubble and the supposed invincibility of China’s financial system

What Fang didn’t mention: in the process an ever larger debt pile is built up, even while the ability to service this debt is weakened concurrently, as more and more loss-making zombie undertakings are kept afloat alongside a shrinking number of viable investments.

We also believe that people tend to underestimate the strong entrepreneurial spirit of the Chinese citizenry; moreover, it may well be that aggregate statistics are not truly doing the size and power of China’s economy justice. There are undoubtedly many great things happening in China, where hundreds of millions of people have achieved a decent living standard after being mired in poverty for decades. These favorable factors provide an overarching backdrop for a positive long-term outlook, but they are probably not really relevant to the situation currently at hand.

USD-CNY weekly over the past five years.

When the currency weakened in 2015, markets all over the world came under pressure. The renewed weakness this year is once again associated with problems in emerging markets that are now beginning to spread inward to the developed market “core”. - Click to enlarge

Crunch Time in China?

With another major centenary approaching – namely the centenary of the founding of China’s Communist Party in 2021 – it was apparently decided to act counter-cyclically by tapping on the monetary brakes just in time. The chart below was recently shown in a Zerohedge article about well-known China bear Kyle Bass. It illustrates that slowing money supply and credit growth in China are slowly but surely having an impact on more and more economically weak undertakings, as corporate bond defaults continue to surge:

China onshore bond defaults since 2014

The numbers are still small in absolute terms given the size of China’s economy, but the recent wave of defaults is nevertheless a noteworthy development. - Click to enlarge

We admit we have no idea how many more times this rabbit can be successfully pulled out of China’s hat, so to speak. After all, we cannot measure the state of the country’s pool of real funding, but this accumulated pool of real capital is what makes seemingly successful interventions even possible. It therefore also represents the limit to what can be done (“political will” alone is not enough).

For the near term outlook one must consider various monetary data in China. Recently the PBoC has eased monetary conditions by lowering minimum reserve requirements (MRR) again, but this is partly a function of the ongoing, slow drain in China’s foreign exchange reserves (the PBoC uses MRR to partially “sterilize” foreign exchange inflows). Interestingly, despite the decline in forex assets, the central bank’s balance sheet continues to grow.

China forex reserves and PBoC balance sheet

China: foreign exchange reserves are decreasing again, but the PBoC balance sheet keeps growing - Click to enlarge

It seems China’s commercial banks are unable or unwilling to come along and ease their own lending standards to an appreciable extent. This could be a sign that  bankers are becoming concerned about the pool of real funding and the ability of borrowers to repay their debts.

China, y/y growth in the monetary aggregates M1 and M2

- Click to enlarge

The latter is near its lowest growth rate since at least 2000 (when this data series begins), while the former is also at an uncommonly low 5%. If one looks carefully, by the time the market scares occurred in 2015 and early 2016, M1 was already expanding sharply again – in other words, it was the lagged effect of the previous slowdown in monetary growth rates that began to impact financial markets. This suggests that the impact of the current slowdown has not played out in full yet.

China MRR and loan growth

China’s minimum reserve ratio (MRR) has just been pushed to the lowest level since 2008, but bank lending growth continues to stagnate. - Click to enlarge

After a brief – albeit weak – recovery phase, China’s stock market has entered a kind of “grinding bear market” that has in the meantime undercut the lows of the sharp 2015 – 2016 decline. Nevertheless, so far the effects of a relatively tight monetary environment in China and the US are actually more strongly felt in other emerging markets, many of which inter alia depend on strong commodity prices.

A few EM stock markets even look downright cheap by now and even Chinese stocks look superficially inexpensive. Alas, as noted above, the effects of the credit crunch are highly unlikely to have played out in full just yet. Patience seems definitely advisable at this juncture, especially as developed market stock markets currently look as though they want to fall out of bed with a big thud in order to play catch-up.

$SSEC weekly from 2014 to today

The recent “grinding” bear market has begun to undercut the early 2016 panic lows. - Click to enlarge