Tuesday, 11 February 2014

Blown off course - China collapsing?

In February I found a young male Gang Gang sheltering in the hills near the old volcano Palerang.

He had been blown there by a strong wind the night before and was looking worse for wear.  I hunted away the crows that were harrying him and hung around while he got his breath back.

Immature male Gang Gang catching its breath

Underneath, a swamp wallaby looks on.

It was a welcome distraction - I was reviewing a paper which confidently forecast the collapse of the Chinese economy.  The fairly dry analysis was tinged with alarm - the collapse of such an economy is something that should interest us all.

We have heard a lot about the collapse of the Chinese economy in the Western financial press over the last couple of years (and before that such claims were commonplace in Taiwan).  The discussion in the press has been superficial but, when it reaches a crescendo, we see falls in resource shares and a retreat of the $Aust.  Perhaps unfairly, I have been inclined to dismiss these reports as a manifestation of cyclical Sino-American distrust rather than as a serious consideration of internal challenges. 

Having said that, this week has brought news of problems in the Chinese credit market.  While government leverage takes up the bulk of the Chinese credit market (and was the subject of some media attention in 2013), the most significant area of risk in that market is within the trust assets sector.  While this sector is small, it is the area most immediately exposed to high risk.

Last week we saw the first default in that area - in relation to a trust product concerning Shanxi Liansheng Energy Co Ltd.  Reuters reported that the Jilin Trust has advised of the default (sourcing the China Construction Bank).  

This follows hard on the heels of the near default of the curiously named “Credit Equals Gold #1 Collective Trust Product" late last month.  

These events are instructive for a couple of reasons.  Firstly, it gives us an opportunity to look at the types of financial products available to domestic investors and observe the Chinese regulatory/banking approach to defaults.  Secondly, it gives us a basis of comparing these products and approaches to the US experience leading up to the GFC.  

It is noteworthy that despite significant pressure, earlier this week regulators and banks allowed the Liansheng default to occur – scotching the suggestion that risk laden investments carry an “implied guarantee” from the State or banks.  No doubt, the investors who get burnt will not be happy about this.  Perhaps, sensibly, it will make also make credit for high risk Chinese ventures harder to source. 

The collapse of high risk investments in the West is a recognised and recurrent risk – it is not generally seen as a harbinger of economic collapse.  However, a default in a similar Chinese product is relatively unheard of.  Removal of a postulated “implied guarantee” will have system-wide impacts.  

While reviewing the paper, I met a senior official from Shenzhen.  I asked him about the impending collapse of the Chinese economy.  A smile lit up his face, and he started to laugh.  He turned to me and asked whether I had ever considered coming to China to teach English.

I still think the real risk here is underestimating Chinese capability. 

February 2014

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