China's "Childish" Bond Market Crosses Tipping Point

That China faces a number of serious economic (and potentially social) problems is no surprise and as Guggenheim’s Scott Minerd notes, trying to predict when persistent structural problems will lead to a shock for markets is extremely difficult (as we noted here). However, from a symbiotic collapse in the previously ‘virtuous’ bond-market-to-banking-system relationship, to the drying up of easy credit for all but the largest (and least over-capacity) firms, it appears that China’s private sector leverage has crossed the tipping point that signalled crises in the US, UK, Japan and South Korea. Although the recent data (believe it or not) show signs of a stabilization in the Chinese economy, the elevated debt burden should continue to cast doubt over its growth sustainability and the “childish” and non-transparent nature of China’s bond market offers little or no hope for a free market solution.

On China’s “childish” bond market (as we noted here),
(via WSJ),

Worried about a boom in lending by the country’s fast-growing “shadow banks,” China created a cash crunch in June to squeeze their source of funding.


One unintended consequence, though, was a selloff in the country’s $4 trillion bond market.



The selloff – triggered by banks selling bonds to raise cash – bolstered critics of China’s financial system, who point to its bond market as an underrecognized risk to the country as it struggles to control surging lending amid a weakening.



The market trails only the U.S., Japan and France in size,



“China’s bond market is like a child compared to that in other countries,” said Jing Wang, deputy general manager of fixed income at Goldstate Securities Co. which has pared back its holdings of Chinese bonds following the selloff, because it has concerns about near-term volatility and “the lack of transparency in the market” in the long run, he said.




“The goal of developing the bond market is to reduce the dependence on banks for funding, but at the end of the day the risk is back to banks again,”

On China’s real-economy cash crunch and the rising potential for social unrest,
(via NYTimes),

a painful credit crisis is now spreading across Shenmu and cities nearby, as thousands of businesses have closed, fleets of BMWs and Audis have been repossessed and street protests have erupted.

Now the leading purveyors of Western fashions are deserted, monthly sales at restaurants are down as much as 97 percent and the marble entrance to the Fortune Garden Club is shuttered. All but one of the city’s car dealerships have failed.

“It’s an economic crisis just like the United States has had; just like it,” said Wang Ting, an operator of an illegal casino in Fugu, near Shenmu. “There’s no cash, everyone stays home without a job, there’s no way the economy can recover.”

“Almost no one will give you a loan,” said a construction executive

“It’s a national problem, it’s not a local issue,” he said.

Public discontent is fueling street protests. Several thousand residents turned out in mid-July for a demonstration in the expensively paved square across the street from city hall, demanding that municipal officials revive the stalled economy.

China Approaching a Tipping Point?
(via Guggenheim’s Scott Minerd),

The massive build up of leverage in the Chinese financial system continues to represent one of the greatest risks to the world economy, with some estimates putting total Chinese debt at over 200 percent of GDP. China now represents 16 percent of global GDP, and contributed approximately 30 percent of the increase in global GDP in 2012. A crisis in its financial system could have damaging effects on global output and particularly on countries such as Singapore, South Korea, and Australia, which have large export exposure to China. The higher China’s debt levels climb, and the longer the country’s other structural economic issues — such as a consumption/investment imbalance, and an overheating property market — remain unresolved, the more severe the fallout will be should a credit crisis occur.


Trying to predict when persistent structural problems, such as those facing China, will lead to a shock for markets is extremely difficult. The evolution toward a breaking point can take months or years, and equally challenging is predicting how long the crisis could last. Pressure in the United States’ housing market reached its peak in 2006, for instance, but the most significant damage to markets did not occur until 2008. Despite the difficulty in putting a timeframe on a potential sequence of events, we can be certain that the margin of safety for global investments is thin and continues to recede.


For perspective, throughout my career, I have never been through a period of longer than five or so years without encountering a highly damaging financial incident. Mexico’s 1982 economic crisis, the stock market collapse of 1987, the credit crunch of 1989, the bond market collapse in 1994, the Asian financial crisis of 1997-1998, the bursting of the dot-com bubble from 2000 to 2002, and the U.S. subprime mortgage crisis which began unfolding in 2007 and bottomed in 2009 are like the tolling of a bell. As we move further into the second half of 2013 and 2014, it would not be a surprise to hear it toll again…and investors would do well to remember the 17th century words of John Donne, “…never send to know for whom the bell tolls; it tolls for thee.”


A rapid increase in private sector leverage in a relatively short period of time often presages major financial crises. Historical examples include the collapse of the Japanese property bubble in 1990, the financial crisis in South Korea in 1997, and the most recent crises in the United States, Britain, and the euro zone, which all happened after private sector debt surged to or above 170 percent of GDP. Chinese private sector leverage has reached this significant level. Over the past four years, non-financial private sector debt in China has more than doubled, primarily driven by massive corporate borrowing endorsed by government officials to maintain economic growth rates.

Although the recent data show signs of a stabilization in the Chinese economy, the elevated debt burden should continue to cast doubt over its growth sustainability.


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