The Great Run on China

Here’s a question for you. Is the recent resurgence in the commodities sector the start of a new bull market or simply the result of China’s latest debt surge, and therefore bound to turn back down?

There’s an argument to be made for both sides.

On the one hand, you could argue that ultra-low interest rates, over a prolonged period of time, are finally starting to bring about inflation. Rising commodity prices ARE the inflation.

Or, you could simply argue that it’s China’s recent surge in credit growth that is finding an outlet in the commodities market. For example, in all of 2015, China’s ‘total social financing’ (total credit expansion) increased around US$2.35 trillion. But in the first quarter of 2016 alone, Chinese credit expanded by a massive US$1 trillion.

For the time being, at least, China has abandoned its attempt to rebalance its economy. It’s targeting growth at any cost. And there will be a cost.

Where is all the newly created credit going? An article from Bloomberg last week gives a hint:

Chinese speculators have a new obsession: the commodities market. Trading in futures on everything from steel reinforcement bars and hot-rolled coils to cotton and polyvinyl chloride has soared this week, prompting exchanges in Shanghai, Dalian and Zhengzhou to boost fees or issue warnings to investors.

And then there was this ominous warning from the front page of the Financial Times over the weekend:

China’s total debt rose to a record 237 per cent of gross domestic product in the first quarter, far above emerging-market counterparts, raising the risk of a financial crisis or a prolonged slowdown in growth, economists warn.

Beijing has turned to massive lending to boost economic growth, bringing total net debt to Rmb163tn ($25tn) at the end of March, including both domestic and foreign borrowing, according to Financial Times calculations.

China’s total debt-to-GDP figure is on par with the US (248%), and only slightly below Europe (270%). However, China is an emerging economy with a completely different structure than these two major developed economies. Compared to them, China’s much more fragile.

Global Financial Crisis 2017: Three Crisis Scenarios, and How They Could Impact on Australia

Markets & Money Free Report

Markets and Money editor Vern Gowdie reveals the three crisis scenarios that could play out as the next credit crisis hits Aussie shores…and the steps you could take to potentially navigate profitably through the troubling times ahead.

Simply enter your email address in the box below and click ‘Claim My Free Report’. Plus…you’ll receive a free subscription to Markets and Money.

We will collect and handle your personal information in accordance with our Privacy Policy.

You can cancel your subscription at any time.

The problem for China is this:

As credit expands, the amount of money in the economy expands too. In the short term, that increases economic growth, fooling everyone into thinking that China is back on track; as a result, stock prices rise.

But, in the background, the smart money tries to escape from the Ponzi economy. According to the International Institute of Finance, over US$500 billion will flee the Chinese economy in 2016.

This capital outflow represents a risk to the banking system, because the banks must finance the assets created by the credit boom. But capital outflows make this harder to achieve.

Think of China’s capital outflows as being like a run on a bank. That is, as money leaves, it makes it harder for the bank to fund its assets. At that point, confidence evaporates and the central bank must step in to save the institution.

In China’s case, I’m not sure what could ‘save’ it. The authorities are trying to avoid a potential run by clamping down on capital flows, although that doesn’t seem to be working too well.

The world’s rising property markets (which, incidentally, Phil Anderson predicted) are evidence of this, with land being a prime target for Chinese capital.

The Victorian government knows this only too well. Last week, they announced that, from 1 July, foreign property buyers will pay stamp duty of 7%, up from 3% previously.

Whether this will have an effect on Chinese capital using Aussie land as a bank remains to be seen. But it does show that the issue of foreign investment in residential property is becoming a political issue.

At least at the state level, that is. At the Federal level, it’s a case of hear no evil, see no evil.

The Turnbull government won’t dare to touch the existing property Ponzi scheme in the upcoming election. Over the weekend, in an attempt to make doing nothing seem like doing something, the Prime Minster pedalled just about every negative gearing myth there is.

Despite his claims being debunked on a number of occasions (notably by the Grattan Institute), expect the barefaced lies to keep coming right up to the election.

Clearly, the government has decided that its best strategy to win the election is to tell a lie for long enough, so that it ends up becoming the truth in the minds of those who most want to believe it.

Getting back to the commodities debate…this rally could continue for some time yet. It all depends on how far China’s authorities want to push the credit boom. As I pointed out last week, probably the best indicator for the China credit bubble is the iron ore price.

The price is currently around US$66 per tonne. It’s due for a pullback — or a breather at least — following a very strong rally from the lows of December 2015. But if the price falls back below, say, US$55 a tonne, it’s a sign that the stimulus boost is on the wane.

At that point, watch global capital move back to the short side en masse, as it tries to profit from another big plunge to the downside.

Cheers,

Greg Canavan

For Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

Leave a Reply

Be the First to Comment!

Notify of
avatar
wpDiscuz
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au