Back in the day, central banks were seen as…well, rather boring, to be honest.
Lots of grey suits talking about indecipherable things such as consolidated worldwide external claims of monetary financial institutions, etc.,… yawn!
Nowadays, of course, that’s all altered. Central bankers now see themselves as economic and share price ‘managers’ who use interest rate policy and QE (quantitative easing, which is turning debt into money) to achieve their new-found goals. If there’d been any remaining doubt about this, just look at how the US Fed has gone ‘dovish’ about future rate hikes after the end-2018 stock market sell-off.
And we’re looking at a global phenomenon here. Take China. Economic growth is slowing sharply and Chinese shares have had a terrible time since-mid-2015.
But now the People’s Bank of China is getting involved, is this about to change…?
Chinese growth woes
First, the headlines: Chinese third-quarter economic growth rate has recently fallen to 6.5% on an annualised basis.
OK, at face value that still looks very healthy. The UK is currently struggling to expand its GDP by more than 1.5% a year.
But that latest Chinese growth figure was the lowest since the great financial crisis a decade ago. The 6.6% year-on-year print was the worst out-turn for 28 years. Car purchases have just declined for the first time in more than 20 years. And December 2018 saw the worst fall in the country’s exports for two years.
What’s more, that 6.5% is something of an illusion. Much of it comprises excess investment in infrastructure, etc. – you’ve probably heard about those ‘ghost’ cities with few if any inhabitants.
And there’s a very nasty flipside to all this excess spending.
Far. Too. Much. Debt.
China’s financial system is in crisis, “complete with gutted banks, bankrupt companies, and state bailouts”, notes Michael Shuman for Bloomberg Businessweek.
Again at first glance, that may seem like hyperbole. It’s not the sort of crisis that was evident in the Western world a decade ago.
Yet by mid-2018, China’s overall debt/GDP ratio had climbed to 253%, according to BIS (the Bank for International Settlements) data, up from 140% a decade earlier.
Granted, the Chinese authorities can exercise more control over their economy than Western democracies can. So, for the moment at least, they’re more able to restrict the impact of the borrowing binge.
Trouble is, the bad debts are really building up.
‘Non-performing’ loans officially reached the highest level in a decade at end-2018. Sure, the government says that’s below 2% of the total debt pile. But “hardly anyone believes that statistic”, notes Shuman. Amid estimates that the real percentage could be at least 10 times as high, “the true extent of the debt and the damage is probably higher than anyone can guess”, he says.
Meanwhile, local government borrowing, which has funded much of the country’s infrastructure spending, is unquantified. S&P Global Ratings recently described it as “a debt iceberg with titanic credit risks”.
“China is a debt junkie, and like any addict, it needs a fix – of credit – to keep going”, says Shuman. “Each attempt to stimulate the economy with fresh credit has a smaller payoff. When that short-term relief wears off, the economy begins to slow again. Chinese leaders get the shakes, lose their determination to tackle the debt, and inject another hit of credit. Eventually the state will have to fix the mess, just as the US government did in 2008.”
Exactly. But the key word here is ‘eventually’.
For the moment, China is still in credit-junkie-fix mode.
What do I mean? At end-January, the PBoC unveiled a bill swap facility that will allow holders of commercial bank perpetual (i.e. non-maturity) debt to switch into central bank bills that can be used for borrowing collateral. The China Banking and Insurance Regulatory Commission immediately eased restrictions on insurance companies that invest in, or may be looking to invest in, perpetual debt.
I told you that central bankers talk in indecipherable jargon!
What this means in plainer language is that, according to monetary analysts, China has moved one step closer to full-on QE, which some reckon is imminent.
“Others fear that this sort of action might spook markets into thinking the floodgates of stimulus had been thrust open”, says Frank Tang in the South China Morning Post.
“There is already lots of liquidity in the market”, says Ding Shuang, chief Greater China economist at Standard Chartered Bank. “Further easing would give the impression of an all-out stimulus”.
“We believe the central bank may lower benchmark lending rates in the middle of this year”, says Guotai Junan Securities’ chief economist Hua Changchun. “It will go further in terms of credit risk mitigation tools, and possibly buy Treasury bonds, local government bonds, financial bonds or even corporate bonds directly”.
Apologies again for the excessive amounts of bank-speak. But you’re probably getting the picture by now.
China is deferring its day of financial reckoning. When that finally happens, things could get very nasty. But until then, what will be the effect of all this extra cash in the system? And will it drive Chinese – and possibly global – shares higher?
That’s going to be a key issue for investors. And it’s just one of many areas across the globe that my colleague Jim Rickards covers at Strategic Intelligence in clear, impartial and thought-provoking analysis that challenges conventional wisdom.