China’s Internal Credit War

The Grizzly Bear is huge and wild;
He has devoured the infant child.
The infant child is not aware
It has been eaten by the bear.

– Infant Innocence, A.E. Houseman

–Yesterday we mentioned a possible rift growing between local government leaders in China and the central planners in Beijing worried about inflation. The local leaders have been gunning the growth engine and boosting the demand for Australian resources. But the central planners and bankers are worried about socially destabilising inflation.

–The China Daily reports that, “Yuan Shuhong, deputy director of the Legislative Affairs Office under the State Council, said local leaders should receive deductions in their job evaluation, if local debts exceed a certain limit.” Yuan said the accumulation of too much local debt could lead to a negative appraisal by Beijing.

–So Beijing is sending in the lawyers to restrain credit growth. This should be interesting. What’s even more telling is that the crackdown on local government borrowing is, “part of efforts to change from a GDP-oriented model of growth to a sustainable and environmentally friendly one.”

–Has China’s economy reached the limit of debt-financed growth? It’ll be worth following up on. Local government debts of $1.65 trillion amount to nearly 25% of Chinese GDP. The ratings agency Moody’s has said the actual level of local government debt may be half a trillion dollars larger than China’s national auditor reported.

–Moody’s analyst Yvonne Zhang said in a note: “Banks’ exposure to local government borrowers is greater than we anticipated.”  Zhang called for a “clear master plan” to solve the problem. She warned that without a plan, the ratings outlook for Chinese banks could turn negative.

–Ah yes, the master plan! The master plan is probably going to involve a restructuring of the debt. Hmm. That sounds familiar. China’s stimulus tab is coming due. It’s also possible that the central government could spend some of its huge foreign exchange reserves to recapitalise banks after they take losses.

–But it shows you that all the world’s problems are from the same genus: rapid credit expansion. The species are different depending on the location. In Australia, it’s household debt. In Europe, it’s government debt. In America, it’s both. And in China, it’s local government debt to build fixed assets. Same problem. Different instances.

–Yuan’s most worrying comment is that China is trying, at the central government level anyway, to shift from a growth model to a sustainable model. You can argue the merits and benefits of that. But if it is the plan—and the plan is carried out—it almost certainly means lower demand for iron ore and coal, Australia’s two large exporter earners.

–If China’s banks are sick, then Italy’s banks are in the intensive care unit. Italy’s top two banks, Unicredit and Intesa Sanpaolo, have lost 30% of their market value in the last two months, according to the Wall Street Journal. Italy’s banks are the largest holders of Italian government debt. And the spread between the yield on Italian government bonds versus German government bonds has reached its highest level since Europe introduced its common currency.

–Italy has a public-debt-to-GDP ratio of 120%. The government thinks it can grow its way out of the debt problem. But in the meantime, the cost of borrowing goes up, adding to its debt woes.

–The trouble for Europe is that Italy is not Greece. Italy is Europe’s third largest economy. Slowly the debt crisis has migrated from the periphery to the centre. For example, financial institutions in France and Germany have a combined exposure to Italian debt—both government and corporate—of €689 billion, according to the Journal and the Bank of International Settlements (BIS).

–This nearly matches the combined level of their exposure to Portugal, Ireland, Greece, and Spain. The exposure clocks in at €801 billion, according to BIS. “Financial institutions in France hold €98 billion in Italian government debt and €42 billion in Italian bank debt, while German entities hold €51 billion in government debt and €50 billion in bank debt,” the Journal reports.

–It used to be that investors would flee to government debt when stocks became too dangerous. Now it might be the other way around, with investors fleeing to stocks to escape government debt. Just not bank stocks, obviously!

–Before personal bankruptcy laws came into effect in the 19th century, a borrower unable to pay his debts was thrown into prison. He stayed there at the mercy of his creditor. Perhaps those laws should be revived. Only this time, the politicians and bankers who have put the general public into debt should go to prison…for the rest of their natural lives.

–The papers are full of winners and losers from the government’s carbon tax. Blah blah blah. Nearly everyone will be a loser in the long run. But for investors, the big winner is obvious: natural gas.

–Rent seekers will be pleased that the government will set up a Clean Energy Finance Corporation (CEFC) and fund it to the tune of $10 billion. A government-picked committee will pick winners in the alternative and renewable energy industry to spend taxpayer money on—this from the government that has burned down homes and wasted billions in its previous efforts to stimulate the economy.

–The CEFC is almost guaranteed to be rife with incompetence and corruption. It is the nature of government agencies. And the central problem is that this isn’t investing at all. This is spending money on technologies that cannot reliably deliver base-load power in a cost-competitive way. This is a gift, a subsidy, and an occasion for front running, in which favoured industries and companies are going to get money because they’re connected.

–Same as it ever was with government-run programs. The really scary creation of the carbon tax is the Climate Change Authority. This new organisation will set targets for greenhouse gas emission levels in the same way the Reserve Bank sets targets for the price of money. It will even be run by former RBA governor Bernie Fraser. More on how this price-fixer will work tomorrow.

–Why is gas the winner? Even before the carbon tax was announced ABARE was reporting:

“The share of gas in electricity generation is projected to grow from 19 per cent in 2007-08 to 37 per cent in 2029-30. Gas-fired electricity generation is based on mature technologies with more competitive cost structures relative to many renewable energy technologies. As such, it has the potential to play a major role in the transition period until lower-emission technologies become more viable.”

–The emphasis added there is our own. But the fantasy of cutting emissions by 80% before 2050 is laughable. The only way to reduce emissions that much is to drastically reduce the amount of electricity the country produces, which may, in fact, be the result of the de-industrialising Greens. Their fondness/fanaticism for a cold, dark, and medieval world of subsistence living is alarming.

–In the meantime, gas-fired power will keep the lights on in Australia while the renewable industry tries to figure out if it can scale up and deliver the energy the economy requires. Federal Energy Minister Martin Ferguson is already talking about the conversion of the Latrobe Valley’s coal-fired power Hazelwood plant to gas. This is why our Revolution in the Desert report talks about gas as the next big energy thing in Australia.

–The most frustrating aspect of the carbon tax is that it’s a continuation of the trend by government to grab more power at the expense of economic and political liberty. The emotional justification—it’s saving the planet—seems to satisfy a lot of people. But the reality is that the taxing of carbon dioxide is just another way for the Welfare State to finance its permanent growth.

–Australia is a global leader in this sense. At a time where the perpetual debt model of the Welfare State is running into its natural limits—the inability to service existing debt—this government has shown the rest of the world’s elite a way out. If you tax carbon dioxide you create a vast new tax base from which you fund the growth and power of the State.

–If you doubt that this is all about government income and making more people dependent on transfer payments, just look at how the case is being made to the public. It’s all about how much you will get from the government and which industries will receive compensation. Government bureaucrats and a taxpayer salary will make those decisions on your behalf. And you’ll pay for the privilege.

–There will be a point where Australians realise the real motivation for these laws is the expansion of government power. It’s not about saving the planet. It’s about doing what you’re told and accepting the government’s power to regulate the minutest aspect of your private life. All for the common good, of course. Australia has been eaten by the bear.


Dan Denning
Markets and Money Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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6 Comments on "China’s Internal Credit War"

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Damn straight! Australia, always the innovator has mastered the welfare state when many have failed. ROFLMAO!!

…gulp! :O


CEFC – Rex Connor rides again! Where’s Khemlani?


ABARE used to be our best agency and now it is rubbish.

think carbon-tax = coal-tax = energy-tax. Coal is a competitive advantage for Oz and it is about to be discarded. Though there may be valid environmental reasons for doing it, strangling our coal industry must have an impact on national prosperity (though the outcomes may not be visible until its instigators are ready to retire). A similar warning was forthrightly stated by former PM, John Howard. Unlike other taxes, a C-tax will not be judged by the revenue it raises, but rather, by the number of coal mines shut down. So far, nobody outside the coal industry wants to provide… Read more »

Wave power a la Garden Island Naval facility, Perth, most definitely could provide base load power if used large scale. It would, however, mean that people have to stop spouting the usual anti-renewable bs such as ‘This is spending money on technologies that cannot reliably deliver base-load power in a cost-competitive way. This is a gift, a subsidy, and an occasion for front running, in which favoured industries and companies are going to get money because they’re connected.’ WTF do you think nuclear has been all along?

your nanny

to daniel:
if wave power’s so great, put your money and your friends’ into it. don’t expect taxpayers to join you.

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