EM Vendor Financing

–Did you see the story of how a delegation of over 300 hundred Chinese businessmen stitched up over $16 billion in deals with Indian partners during Premier Wen Jiabao’s visit this week? It’s the emerging market vendor financing arrangement that could power a global binge in hard asset buying!

–A lot of the deals were financed with Chinese capital. After all, if it’s not going back to America to keep bond yields low so Americans can buy what the Chinese make, it has to go somewhere else like India, so THEY can buy what the Chinese make. But first a word about Australian housing prices, which, despite our repeated warnings, haven’t crashed…yet

–Maybe they haven’t crashed because they’re not the over-valued. That’s what the International Monetary Fund concluded in a recent research note. An IMF working paper said that Australia’s house prices are over-valued by 5-10%. It said Australia’s house-price-to-income ratio was about 20% higher than its ten-year average, which apparently equates to an over-valuation of 5-10%.

–You can read the whole report for yourself here, if you’re a glutton for mind-numbing statistics.  There is some interesting analysis about the relationship between a high terms-of-trade and house prices. But the more conventional numbers like house-price-to-rent and house-price-to-income ratios show that Australia is leading the global bank in unaffordable and overpriced housing.

–Given how bad the cricket is going, it’s nice to beat the English in something isn’t it? That said, the IMF is wrong. Australian houses are over-valued by far more than 5-10%. The IMF is just playing it conservative, not wanting to appear “extremist.” But if there’s one thing you should have learned from the last few years it’s that credit bubbles produce extreme outcomes. The highs are very high. And the lows are lower than you expect.

–Mind you, we have no special grip against houses. Owning your own roof seems like the ultimate in financial/physical security. But it’s only secure if you can buy it a price that doesn’t ruin your finances and put you into perpetual debt. It’s hard to believe that Australia will somehow be alone in the world in escaping a deflation in asset prices that were inflated with the global credit boom (especially borrowed money from abroad).

–A big “X” factor right now is what’s happening to the price of money all over the world. Judging by the action in the ten-year U.S. bond market, the price of money is going up (at least for U.S. borrowers). Now this could be “the bond vigilantes” finally turning on Ben Bernanke. It COULD be the sign of a long march out of the U.S. Treasury market and into, say emerging markets.

–But before we get to that conclusion and what it means for Chindia, take a look at the chart below. It’s a twenty year chart of the yield on ten year notes. As you know, bond yields move inversely to bond prices. Falling yields have meant rising prices for the last twenty years, which explains the bull market in U.S bonds.

U.S. ten-year Yields on the Rise


–Even if you’re not a chartist, you can see two sharp lows in late 2008 and late 2010. Dare we call it a double bottom? Dare we call it the end of the U.S. bond bubble and the beginning of a great migration of capital out of corrupted and compromised U.S. financial markets? And hey, the yield has crossed the 50-day MA. If the 50-day MA crosses the 200-day, hello bond bear!

–What’s important about this trend is that it could be the reversal of something that’s been going on for the last  thirty years. You can see from the chart below that ten-year yields have been declining since Paul Volcker slayed inflation in the early 1980s with high interest rates. That ended the gold and silver bull market and kicked off a 20-year boom in U.S. equities and bonds.

–Is it all ending now for U.S. markets? That is, are they no longer the safest, best place for the world’s investors to park their extra savings? Well, the chart below says that what’s bad for the U.S. markets is good for the emerging ones, Australia included. There are three lines on the chart. The black line tracks EEM, an exchange traded fund of emerging market stock markets. Australia is the orange line. The U.S. dollar index is the green line.


–You can see that the dollar rally that peaked in June was bearish for the All Ordinaries and emerging markets. Capital flew back to America and the greenback. Europe was in crisis (and still is). Parts of Athens were even on fire (and still are). But since then—the recent Ireland-related dollar rally not-withstanding—emerging market stocks have gone up.

–Of course the Dow has made a two-year high in the same time, in U.S. dollar terms. But the big question is whether big global savers like China have finally decided there are better places to invest in the world, includingin China. Chinese banks loaned out another US$1.1 trillion this year in the domestic economy. But there’s more where that came from.

–Which brings us back to India. Is China providing cheap credit to India so Indian firms can buy Chinese goods? And isn’t this the same kind of “vendor financing” that characterised China’s relationship with America?

–The Financial Times reports that, “The wider economic engagement [between China and India] is spearheaded by financing deals between China Development Bank and top Indian companies like Reliance Communications, ICICI Bank, Essar and IDBI Bank. Other financial groups seeking to expand business with India include ICBC and Bank of China.” There’s more:

Among the biggest [of the deals], two Indian companies controlled by billionaire Anil Ambani received just over $3bn in financing commitments from a consortium led by Chinese banks, reports the WSJ.

Such generous financing is of course related to other deals such as the one by Ambani’s Reliance Power, which in October ordered a whopping $10bn worth of Chinese power generation equipment from Shanghai Electric, all financed by Chinese banks, namely the Export-Import Bank of China and other commercial banks.

Ambani’s Reliance Communications meanwhile on Wednesday said it had signed a $1.93bn syndicated loan arrangement with China Development Bank and other institutions to refinance short-term debt it took on to build its 3G telephone network.

–The FT also reports that the state-owned China Development, which “acts as a key instrument of Beijing’s foreign policy has, in recent months, “lent money to a German bank, a South African platinum mine, Romanian wind power projects and Australian mining ports – as well as extending $20bn to Venezuela and $1bn to Angola to secure oil supplies for China.”

–What does it mean? If the Chinese are worried about a US/dollar bond crash, they’re going to be awfully anxious to “Exit the Dollar” in an orderly fashion—before the dollar craters. That could spark a kind of frenzied bidding war for non-dollar assets. And though there are a lot of ways it could play out, we’re going to keep it simple and recommend buying gold and silver on the dips.

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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5 Comments on "EM Vendor Financing"

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“The IMF is just playing it conservative, not wanting to appear extremist.”

Spot on there. Not sure how anyone can provide graphs like that and keep a straight face whilst saying “only 5-10% overpriced”.


Another view, perhaps?


It’s important to consider the source, in both cases… .


1 aud = 1.3402 nzd.

But I did that residential mortgage out of my NZ branch office at the peak of the bubble in 2005 at what, 1.08?

Now who is that currency swap counter party of mine on those forex bonds and those leveraged off the AUD balance sheet again?

And how long is my average funding bond term now? And how much is that swap going to cost next time I roll it over?


I’m only on page 3 of the IMF report……

Take a look at the ireland bubble… no wonder they are screwed…. The others don’t look that bad on page 3….. must keep reading to see how incomes have risen….

Question to editors: How is 120% rise over 20 years a bubble in one asset but a 600% rise in 10 years (silver) not a bubble in another asset?


I think the IMF make a good case. Supported by facts.

I am not suggesting house prices in Aus are cheap, but they also do not seem to be stratospheric… perhaps *finger in the air* 20-30% too high.

Anecdotal evidence of the sort of jobs out there in aus, the income and the cost of a nice place in turramurra, prices appear to high for incomes.

What is more of concern is the AUD bubble.

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