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Is China In For A Post-Credit Boom Reckoning That Will Cause Worldwide Deflation?

It’s a different sort of red card.  Over the weekend, the Financial Times reported that Li Yonghong, entrepreneur and owner of high-profile Italian soccer club A.C. Milan, missed a €32 million ($37.4 million) interest payment to creditor Elliott Management Corp.  That puts Elliott in position to take over the club as soon as today.

Local sportswriter and A.C. Milan minority shareholder Carlo Pellegatti told the FT: “There are too many mysteries, too many invisible things about the Chinese owner. It is not possible to always continue to wait for the money.”

For debt-laden China, where banking assets exceed full-year 2017 GDP by more than 300% (for comparison, U.S. banking assets are less than 100% of GDP), Li’s money troubles serve as a reminder of the thin margin for error that accompanies high leverage. According to data from the People’s Bank of China, there have been at least 20 bond defaults through May, nearly matching 2017’s full-year total of 22.

The important property sector has also lately shown some cracks in the façade. According to an annual survey of asset managers and commercial banks by China Orient Asset Management Co. and cited by Bloomberg, the total renminbi value of bad loans within the real estate industry will jump by 20% this year. That finding comes as the Chinese government is putting the brakes on a crucial subsidy.  Yesterday, the FT reported that an executive from the China Development Bank told listeners to a recent teleconference that the CDB was tightening loan approvals for its “slum redevelopment” policy, a program which has provided some $1 trillion to homebuyers since 2016. For context, total Chinese GDP last year was $12.2 trillion, according to the World Bank.

Mr. Market has gotten the message: The Shanghai Composite Property Index is down 20% year-to-date, exceeding the 14.5% loss on the broad Shanghai Composite Index. China Evergrande Group, a developer whose high short interest, sky-scraping debt burden and then-rampaging stock price was chronicled last year by Grant’s (“Ever higher,” June 2, 2017) has seen an abrupt turn in fortunes, with its 8 3/4 senior secured euro-dollar notes of 2025 falling to a fresh low of 82.5 cents on the dollar for a yield-to-worst of 12.5%.

  

While un-bullish tidings appear in both credit and equities, the broad currency weakness that has befallen large swaths of the emerging markets has also made its way to the Middle Kingdom. Even after a bounce in recent sessions, the renminbi is down by nearly 4% versus the dollar since the middle of June and 5.5% since April, a substantial move considering the government’s control over FX gyrations via the so-called managed floating exchange rate.

For its part, Beijing is not just standing idly by while asset prices falter. Last week, the People’s Bank of China cut its reserve ratio requirement for banks to its lowest level since 2009. The renminbi rebound last Tuesday followed comments from the PBOC suggesting that the bank may prop up the red backs, according to Bloomberg.

But as the Sino-American trade battle begins in earnest, will Chinese government support of the markets be enough?  Much as night follows day, Anne-Stevenson Yang of J Capital writes today that a post-credit boom reckoning is in store for the world’s second largest economy:  

China has stretched its expansion beyond the reasonable sell-by date through forced credit expansion pushed into enterprises that had no viable way to earn a return, bridges to nowhere, and capital controls, but it cannot prolong it indefinitely. The money creation ultimately leads to deteriorating trade and investment accounts, capital flight, and deflation. 

Stevenson-Yang goes on to speculate on the wider implications of an abrupt end to the credit-driven Chinese “economic miracle”: 

Once the debt crisis comes, it will likely to be deflationary for the world. China will have little choice but to depreciate the currency in the face of demand for dollars, and that will force prices lower across the world. It is clear from recent weeks that the exchange value of the renminbi is now in the eye of a fiscal hurricane as it has not been for years.