Whether or not Larry Summers actually advised the US policymakers to go for a series of bubbles as the only way to keep some economic growth coming, China seems to have settled on it. Two very good articles on emerging risks (or, hitherto unreported) to China. One is how the stock market bubble has given way to a bond market bubble now. One was in Bloomberg and the other was in South China Morning Post (SCMP). The article in SCMP gives a good description of how the leveraged bond market speculation works. It is, again, crazy, as crazy as the stock market bubble.
The most popular way of fixed-income investments has been through pledged repurchases, or repos. In a typical transaction, an investor uses original funds to buy an initial batch of notes, and pledge part of that to a lender at a set period for a set interest rate, or repo rate, in exchange for additional capital. The additional funds in turn are used to buy more bonds. The process could repeat for up to 10 times, Zhou said.
In the first eight months this year, pledged repos trading volume surged to 25.8 trillion yuan, nearly double the full-year level last year, according to Shanghai Clearing House data, which settles the inter-bank bond market that accounts for the lions’ share in the country’s bond market.
Meanwhile, bond trading has also prevailed at the Shanghai Stock Exchange. On September 30, bond trading accounted for over 70 per cent of total turnover in the Shanghai bourse, with less than 30 per cent in stocks, reversing the traditional dominance of scrip in the exchange.
As a result, yields of non-government bonds have been tailing off and credit premium become almost negligible. For example, the yield spread between five-year, triple-A government and corporate bonds shrank to less than 100 basis points, the lowest on record. Yet, at the same time, corporate profits are deteriorating and economic fundaments have not shown signs of improvement. [Link]
This is from the Bloomberg story on the China bond bubble:
While an imminent collapse isn’t yet the base-case scenario for most forecasters, China’s 42.2 trillion yuan ($6.7 trillion) bond market is flashing the same danger signs that triggered a tumble in stocks four months ago: stretched valuations, a surge in investor leverage and shrinking corporate profits. [Link]
In the end, Tracy Alloway’s tweet summed it up best:
I’m increasingly convinced that there’s just a huge ball of excess money in China and it rolls from housing->stocks->bonds-> and back again [Link]
Bloomberg also notes that another market reversal would be a challenge for the Communist Party. In this regard, this weekend piece in SCMP is rather interesting. The Communist Party, these days, is more worried by its legitimacy. Hitherto, it took its legitimacy for granted because it was delivering economic growth and rising standards of living. Now, the fact that it is discussing its legitimacy openly confirms one thing: it has realised that it cannot continue to deliver on economic growth. That cycle has ended.
If you have finished worrying about the bond market bubble, I have one more item on the menu to serve you. That is the worry over the Credit Guarantee Corporations in China. Bloomberg has a good piece on it:
There are three kinds of credit guarantees in China. One is a straightforward pledge made by the parent company, while another involves unaffiliated firms providing surety for each other. The third is offered by specialist firms in return for a fee paid by the borrower. There are 8,000 guarantee firms in the nation, China Chengxin said in August. Fewer than 50 are rated and only one has an international investment grade, according to Moody’s.
State-owned China National Investment and Guaranty Corp., the nation’s largest guarantee company, had outstanding guarantees of 110 billion yuan in June last year, according to Guotai Junan Securities Co.. That’s 18.7 times its net assets. [Link]
The chart in the article is scary and do not forget to make a note of the book reference towards the end of the article:
Joe Zhang, former deputy head of China investment banking at UBS and author of “Inside China’s Shadow Banking: The Next Subprime Crisis
John Williams, the President of the Federal Reserve Bank of San Francisco deserves a special mention for this ‘spade a spade’ remark on the elevation of the Chinese yuan as a global reserve currency:
As long as they have the threat and reasonable expectation that in a moment of panic or crisis that they would clamp down on the movement of capital so it doesn’t disrupt their economy, there is no way that anyone would view the RMB as a reserve currency,” San Francisco Fed President John Williams told reporters on Thursday. [Link]
Nonetheless, the smart money would be on the yuan being admitted into IMF’ Special Drawing Rights in November and that would open the doors for a maxi yuan devaluation next year.