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Wednesday April 27, 2005 - 11:18:42 GMT
Black Swan Capital - www.blackswantrading.com

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Chinese banks and yuan "revaluation"?

Quotable

“The individual entrepreneur, when faced with the credit stringency of the crisis, is right in regretting that he has expended too much for an expansion of his plant and for the purchase of durable equipment; he would have been in a better situation if the funds used for these purposes were still at his disposal for the current conduct of business. However, raw materials, primary commodities, half-finished manufactures and foodstuffs are not lacking at the turning point at which the upswing turns into the depression. On the contrary, the crisis is precisely characterized by the fact that these goods are offered in such quantities as to make their prices drop sharply.

Ludwig von Mises, Human Action

FX Trading

My father-in-law is a world-class executive. He used to travel frequently to visit customers across the globe. (He has given all that up to sit on the beach, sip red wine, lavish attention on his grandchildren, and conquer the stock market through his online trading account.) Over the years, when I saw him after he returned from some far-off place, I would ask, “Dad, how was your trip?” His standard answer was: “Pretty good. Takeoffs equaled landings.” That answer does have a way of summing it up nicely. For the Chinese economy, we have takeoff, but not yet a successful landing.

I noticed this in the Economist over the weekend regarding Chinese banks—another concern to add to the list of banking problems brewing beneath the surface [my emphasis]:

“The banks' old bad debts are worrying enough. But potential investors should probably be more concerned about what has yet to appear in the books. Between the start of 2001 and early 2004, China went on an almighty credit binge. Bank lending jumped by 56% in 2003 alone, as the government first tried to shore up growth and then lost control of a racing economy before trying to rein it in last spring. At the state's behest, banks lent enormous sums for new factories, roads and airports, many of which will never make money.

“A tenth of all outstanding bank loans, or around 2 trillion yuan ($242 billion), is now owed by consumers. Mortgages, which account for 90% of this, grew at an annual compound rate of 115% between 1998 and 2004, according to KGI, a securities firm. Last year, they rose by 38%, against just 6% for corporate loans (see chart). Banks have been delighted to grant home loans because they carry only a 50% weighting in the calculation of risk-weighted assets—a tribute to the perceived safety of mortgages.”

Is it any wonder why Beijing is growing increasingly concerned about the real estate market (a la the push for capital gains taxes in the story from The Standard sited above)?

And this is supposed to be a banking system with the efficiency to deal with a market-based currency system? Maybe the Chinese officials know something we don’t know. Here’s one guess: If they allow the yuan to float i.e. free capital controls, the domestic Chinese savers decide that maybe Citigroup, or Bank of America, or Barclays represent a safer place to store their savings than China Minsheng Bank or any other of the debt laden state-extension institutions that pretend they are commercial banks.

Now add to this the fact that domestic Chinese companies are borrowing funds from international banks in significant numbers, for the first time according to Startfor.com. That means Chinese firms are for the first time exposed to the vagaries of real lending institutions that expect to be paid back—even if interest rates move higher. And even if the thin margin in which these firms operate in China were for some reason to disappear, these international banks will still have the gall to expect loan repayment—unlike the nice people funneling money through the Chinese state-extension institutions.

And this excerpt from a recent Mr. Stephen Roach missive, economist extraordinaire at Morgan Stanley: “The co-dependent relationship between the US and Chinese economies is about to take a new twist. As the US Federal Reserve finally gets serious about monetary tightening, an export-led Chinese economy could come under pressure. China can ill afford to ignore this risk.

“But new flaws are starting to show up in China’s policy strategy. The currency peg constrains Chinese authorities from using traditional monetary policies for macro stabilization. Rather than adjust interest rates to control the price of credit, administrative measures are used to control the quantity of credit, as occurred last spring and seems to be occurring again.

“However, because of the renminbi peg and its linkage to a still-accommodative Fed, China continues to receive large speculative capital inflows, which may well overwhelm the impacts of administrative tightening measures.”

Rock on Chinese financial bubble! Don’t worry about the hissing sound you hear in the background—that’s just the Fed letting some much needed air escape from the global asset balloon. And we all know how easy it is to land a balloon—don’t we!

Jack Crooks

 

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