China s Cash Crunch Bear in the China Shop
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1 China s Cash Crunch Bear in the China Shop The Economist 29 th June 2013 Analysed by Edward Tsang Financial Crisis Reminder When investments turned sour in 2007 Banks went bust Lending stalled Confidence evaporated Government recapitalised banks Banks unwilling to lend out Economies hard to recover 1
2 Is China s Economy in Trouble? Interbank interest rate briefly soared to 25% in June 2013 Financial insututes stopped lending to each other Heavy lending Soaring property prices Similar signs as 2008 US financial crisis? Excessive Lending Credit has been rising much faster than GDP Risky! 2
3 Banking in China is safe, isn t it? Significant percentage of private saving Strict rules on lending: 75% of deposits Basel III already implemented Capital requirements observed The biggest banks are state owned The central bank determines whether to lend The Government determines money supply The Economist: Threats to China Growth may be 6% next year Compared to Government target of 7.5% According to Dragonomics (research firm) Loss of confidence Rumour of bank defaults and ATMs out of cash Shanghai composite index fell by 5.3% on 24 June The Economist implies: China has had wasteful lending & unproducuve spending This is a bubble, which could burst like US in
4 The Economist s Advice Let banks raise interest rates To ahract deposit back from shadow banking Introduce deposit insurance Cool overheated industries Suppress speculauve demand for housing By introducing an annual property tax Encourage private investment in industries Currently they are mainly state- owned Is The Economist Right? Is China 2013 similar to US 2007? The Economist gave a series of advices But it did not elaborate on those points (which is very uncharacterisuc of The Economist) Do you agree with the Economist? And why? You don t have to address every point 4
5 Analysis: Cash Crunch in China? Related arucles: Taking credit for nothing The Economist 15 June 2013 Chinese Credit Look Both Ways The Economist 2 July 2013 US 2007 vs China 2013 US 2007 China 2013 High interest rate Soaring house prices Heavy borrowing Reluctance to lend Banks owned privately SecuriUsed mortgage China bought US bonds High interest rate Soaring house prices Heavy borrowing Reluctance to lend Large banks state owned None No one has money to buy 5
6 The 5:30 Rule ObservaUon by ZHANG Zhiwei, Economist, Nomura: Amer credit grew by 30% of GDP over 5 years Financial crisis happens to an economy Precedence: Japan in 1980s USA in 2007 Source: Taking Credit for Nothing, The Economist, 15 th June 2013 The 5:30 Rule Applied to China Total Credit / GDP: 2008: 118% 2012: 167% Warning signal, according to the 5:30 rule Source: Chinese credit look both ways, The Economist, 2 nd July
7 5:30 Rule Didn t Hurt in Credit grew from 2001 to 2004 by over 30% No problem then Why worry now? Source: Chinese credit look both ways, The Economist, 2 nd July 2013 Loan Ownership In the past, most debts are state- owned In a crisis, Gov t backs banks Lending con*nued Recession avoided Now, market economy drives What will happen in a crisis? Source: Chinese credit look both ways, The Economist, 2 nd July 2013 Gov t injected $45Bn to 2 banks 7
8 The 5:30 Rule Applied to China Growth of credit exceeds growth of GDP by 14% Source: Taking Credit for Nothing, The Economist, 15 th June 2013 Remarks: Anomaly? Given rapid growth in credit, it is surprising to see: Slow growth of GDP Low inflauon Ting LU (Bank of America): lending was double counted Big firms borrow from the bond market Then they lend them out, which was also counted 8
9 Anomaly? No Anomaly? Richard Werner (Southampton University): There is no anomaly, only flawed theory Credit doesn t always lead to growth & inflauon Lending by banks sumulate growth & inflauon Lending by others just transfers purchasing power between parues No GDP growth sumulated Most grows in TSF in 2013 from non- banking Credit That May Not Generate GDP Richard Werner s second ObservaUon: Credit on consumer goods or investment add to GDP growth Credit on inflated properues does not! This happened in bubble- era Japan 9
10 Alarm Bell Ringing in 2013 March: bank regulator urged banks to Udy up off- balance- sheet investments April: Fitch downgraded China s raung May: Chinese foreign- exchange regulator cracked down on illicit capital inflows June: interbank lending rates spiked (to 25%) Conclusion China 2013 does look like US 2007 But there are fundamental differences The Economist gave some advice Different people have different theories They all need to be substanuated Alarming bells have rung, no doubt Is China heading towards a financial crisis? 10
11 References Total Social Financing (TSF) Invented by Beijing in 2011 As an indicator of money supply It includes funds raised by non- state enuues Such as corporate bonds, trust loans, individuals, commercial coupons, foreign debts In 2002, TSF was close to 0 In 2012, TSF around 100 trillion Yuan It rose by 21% in January 2013! 11
12 Debt bundled to diversify risk SecuriUsed Debt Backed SecuriUes Collateralized Debt ObligaUons (CDOs) issued Investor Investor Investor Investor An investor could bundle its CDOs to issue new CDOs Basics in Finance Debt to equity rauo rose from 1.5 to 2.0 Debt to equity rauo: 1.2 Expansion 20M Assets 100M New Debts 20M LiabiliUes 60M Equity 40M LiabiliUes 70M Equity 50M AlternaUve scenario 12
13 Basics in Leverage Debt to equity rauo: 2.0 Debt to equity rauo: 4.0 Assets 120M LiabiliUes 80M Assets 100M LiabiliUes 80M Equity 40M Equity 20M Amer losing 20M 13
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