Is China Economy a Fire-Breathing Dragon or a Dragon on Fire?
Companies / China Stocks May 16, 2015 - 02:48 PM GMTBy: ...
MoneyMorning.com 
Shah Gilani writes: Over the last several weeks, I’ve been telling you about “Disruptors,” the economic catalysts that are serving as agents of change in every geographic market, business sector and asset class you can think of.
These Disruptors create winners in some situations, and dislocations in others. And every change brings with it identifiable profit plays.
And if there’s one Disruptor story that has dominated the headlines – and the global financial markets – over the past two decades… it’s China.
With its low wages and economic emergence, China disrupted the manufacturing markets for technology products, the pricing for rare earths, and shifts in demand for energy, food and capital.
The upshot: China, the Disruptor, became China, the wealth creator.
If this talk of wealth seems out of place after I’ve spent the last several weeks talking about making money when markets go down, think again…
Nothing, you see, goes up forever.
Not even China.
Sure, China’s economic growth has been astronomical, and the Shanghai Stock Exchange Composite Index has skyrocketed.
But the laws of gravity haven’t been repealed.
China’s gross-domestic-product (GDP) growth has already cooled off, and stocks took an 8% hit early last week.
While this may not be the beginning of the end for the Chinese economic miracle – and its pumped-up stock market – it could be.
Then again, a lot of analysts and famous short-selling hedge-fund honchos have been calling for a hard landing in China, which hasn’t happened. Still, that doesn’t mean they’re wrong. It just might mean their timing is off.
Here’s what’s scary about what’s going on in China…
The “Fast” Slowdown
China just posted first-quarter GDP growth of 7%. While that’s super-strong by anybody else’s standard, it’s a marked slowdown for China.
For all of 2015, China’s been telling the world its economy will grow at 7%. With three fiscal quarters to go – and 7% the slowest growth since 2009, and the lowest projection for GDP growth in 25 years – there’s a good chance the rest of the year will see more of a slowdown than economists have been predicting.
Meanwhile, as the economy’s been slowing, the SSE Composite has been soaring.
At its recent high of 4,572, that benchmark index is up an astounding 130% in just a year. Since the beginning of 2015, stocks are up 41%. That’s in the face of a slowing economy.
Stocks are being propelled higher by the same “front-running” that occurred in the United States and Europe when speculators flooded into markets ahead of central-bank stimulus moves. Those moves hosed financial assets with catalyzing cheap money, causing a rush higher.
China’s central planners and its central bank, the People’s Bank of China (PBOC), have been making rule changes and cutting bank-reserve requirements and lowering interest rates – to spur lending and ease tight conditions in the slowing economy.
Desperate times, you see, require desperate measures.
While things don’t appear desperate on the surface, the story bubbling under is different – thanks to a mountain of expensive debt that is humbling the borrow-at-any-cost country’s growth model.
Consulting firm McKinsey & Co. estimates the cumulative debt of China’s government, corporations and households in mid-2014 hit $28 trillion. According to analysts at Standard Chartered Bank, financial credit surged to 251% of GDP in mid-2014, up from 147% at the end of 2008.
Local government spending to meet Beijing’s demanding growth rate targets saddled municipal borrowers with more than $3.64 trillion in debt.
As the economy slows, exports taper, construction grinds down and property prices keep falling, the worry is that China will see “rolling defaults.”
The PBOC has been doing its part to spur lending by lowering interest rates and reducing reserve requirements.
While those central-bank moves are to be expected, they’re not enough, according to central planners. In what looks like a desperate move to flood banks with more money to lend to stressed borrowers, securitization rules have been ripped open.
Just recently, the PBOC – with a nod from central planners – announced that regulatory approval of securitization issues of asset-backed securities was no longer required. Now issuers only have to register their deals.
Holy financial crisis redux!
Ostensibly, the idea here is to let banks – which currently hold $28 trillion in “assets” (assets are loans) – package them into asset-backed securities (ABS), which will mean they’ll be “structured… Wall Street speak for leveraged, traunched and chock-full of trouble. Those structured securities will be sold to investors – which, I promise you, will include all the same banks selling loans, to get whole loans off bank balance sheets, selling them for cash to spur lending… to already indebted debtors.
It’s like déjà vu all over again. Only this time it’s China playing the “derivatives of mass destruction” game.
Why will exploding ABS issuance be a problem? How about the lack of regulatory oversight? How about the fact that banks will want to offload bad loans and bury them in structured products? How about the inside-the-ropes, bare-knuckle truth that it was originally a Basel I rule change that lowered the reserve requirements global banks had to maintain against mortgage-backed securities?
That led banks to package all their whole-loan mortgages – and hold them as securities rather than whole loans – which allowed them to massively leverage themselves up with riskier securitized loans believing they could sell them in a market rout.
We know how well that worked.
China is blowing itself into its own bubble. The problem is that it’s eventual bursting is that the contagion will be global and the fallout nuclear.
Will this Disruptor hit soon? It’s possible, but not probable. There’s lots of pumping about to start happening. Watching ABS issuance rates will be a good measure of the pace of leverage building in the system.
It could take years to blow.
Remember Alan Greenspan’s comment in December 1996 that the markets were exhibiting “irrational exuberance”? That bubble inflated another four years before causing the tech-wreck.
Remember Citigroup CEO Chuck Prince’s July 2007 comment to the Financial Times: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
It took another 15 months before that bubble almost imploded the global financial system.
Timing is always tough when ascertaining a bubble’s expansion. We’re not there yet.
So we’ll keep on dancing.
Just remember how to make money shorting, with inverse exchange-traded funds (ETFs) and with puts when the Chinese Dragon sets itself on fire.
[Editor’s Note: We encourage you all to “like” and “follow” Shah on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then bank some sky-high profits.]
Money Morning/The Money Map Report
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