Big Trouble in Chinese Manhattan

The global meet and tweet at Davos has produced something surprisingly interesting. In between the pretty pictures, a research report from UBS shows that government spending as a share of global GDP hit a high last year. The last time it reached 14% was in 1980. And it’s growing faster than private spending. That flies in the face of the austerity politicians have been crowing about. The result is of course record government debt to GDP levels.

The kicker is that UBS identifies the shrinking working age populations as a serious concern for reducing the debt levels of developed countries. Debt is fixed, and less people make it more of a burden.

Attempts to write off or inflate away the debt is going to clash with the growing voting block too-retirees. It’s their assets that will suffer in their pension funds. It’s going to be interesting to watch this dynamic play out.

The markets were interesting overnight too. Gold jumped and the Aussie dollar’s slide continued, despite a pickup in inflation. The theory is that higher inflation should reduce any chance of an interest rate cut. Stable or higher interest rates usually make the Aussie dollar more attractive in the market, so its value will increase.

But our currency is also a ‘risk on’ type of asset. You take a punt on the Aussie dollar and Australia’s resource economy if you’re feeling optimistic about China. But that’s a tough position to hold right now. There are rumblings in China’s shadow banking sector. Investors are currently selling out of construction projects at a loss. A ‘farmers mutual cooperative fund society‘ in Yancheng closed its doors…literally. Depositors had been unable to get their cash out. So they borrow the money instead.

Sober Look blog pointed out how the stress in the Chinese financial system is leading to higher interbank rates. That’s despite monetary injections by the Chinese central bank.

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Source: Sober Look

This is how financial crises start and then go systemic. Banks stop trusting each other and their funding dries up.

The economics of debt have a lot to do with momentum. While people are borrowing, the stock of money and credit expands. That increases economic activity and creates more opportunities for people to borrow as business expands. But when borrowers repay, the momentum disappears and the effect reverses. If the borrowed money was invested in something that doesn’t generate a yield, rather than in a productive asset or a property with a tenant, the debt becomes a dangerous burden.

That’s why China may be on a crash course of capitalism when it comes to debt. But that’s not the only crash course the country is on. Marketplace shows how building just for the sake of it is beginning to cost investors too.

The buildings rising from a saltwater marsh in the port city of Tianjin looks an awful lot like New York City. But don’t be fooled, says Lin Lixue, a dapper young spokesman for a local developer. This Manhattan replica aims to be a bigger Apple.

‘“Our goal is to create the world’s largest financial center, right here, within ten years,” says Lin. “We’re building skyscrapers, we’ve got China’s largest high-speed railway station coming soon, we’re building a tunnel under the sea, and we’ll soon build several subway lines.”

Li sounds like a boy whimsically building sandcastles.

Local real estate analysts tell Marketplace that developers and investors are selling their investments in Yujiapu at a loss, nervous about the future of China’s economy.

Building a city bigger than Manhattan in a swamp is a bizarre allocation of resources. It sort of makes sense to keep a debt fuelled boom going while you can. But what about the consequences when it stops?

So shadow banks and property in China are both struggling. Oh, we almost forgot, China’s HSBC flash PMI came in weak too. It reported January manufacturing activity at 49.6. A six month low and a contraction.

Is this why the gold price popped around 2%? Remember, the gold market has a new top dog. China’s voracious demand topped India, the previous number one gold market, in 2013. That’s at least as far as the official numbers show anyway. Gold smuggling into India is big business.

Now that China is outdoing India, we’re sure the politicians will come up with a way to subsidise gold imports instead. The rumour mill is already reporting the import restrictions will be relaxed. That was one reason given for gold’s impressive jump.

The other cause could be an even more interesting one. China announced its gold reserves were unchanged in 2013. Unchanged over five years, in fact. Which nobody seems to believe.

If the Chinese are lying about their gold accumulation, you have to wonder why? Perhaps because they are mopping up the physical market and don’t want the price to surge…yet?

We have no doubt that gold will feature heavily at our upcoming symposium. The Grand Hyatt was voted into the top 10 hotels in Australia recently. And the 100 new seats we’ve squeezed in are selling fast.

But we want to leave you with some thoughts from Dylan Grice from Edelweiss Holdings, and a keynote speaker from our previous conference. He believes that prices are special. They communicate very useful information to you.

And if you manipulate prices, it’s like rearranging a message. You’ll get the wrong signal.

And the key price that governments manipulate is of course interest rates. That means they are no longer a true measure of the price of debt, or anything. Grice believes there’s an additional element destroyed too – trust. Fudging the rate they pay makes them seem more trustworthy than they are. Untrustworthy borrowers should pay higher interest rates.

The artificially low rates today are setting people up for an epic disappointment. When reality hits, Grice expects as much of a social upheaval as an economic one.


Nick Hubble+
for Markets and Money


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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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