Wow, the punters clearly positioned themselves wrongly for ‘the taper’. The ASX200 surged 2% yesterday on what looked like a massive short-covering rally. But in overnight trade in the US everyone looks like they’ve calmed down a bit, with the main S&P500 index backing off just a tad.
While most stock markets around the world brushed aside the taper and focused on low interest rates staying that way for years, a few markets didn’t participate….
Both the Chinese and Hong Kong stock exchanges fell over 1% yesterday. Hmmm…
It’s looks like China was busy trying to avert another credit crunch. According to the Financial Times:
‘The Chinese central bank has made an emergency money injection after a surge in interbank rates, trying to prevent a repeat of the cash crunch that rattled global markets earlier this year.
‘In a highly unusual move, the People’s Bank of China said it had conducted a “short-term liquidity operation” to provide credit to banks in need of money.
‘According to the central bank’s own rules, it is only meant to announce SLOs one month after their implementation, but on this occasion it was unwilling to brook such a delay. On Thursday afternoon, it used its account on Weibo, China’s Twitter-like platform, to tell a jittery market that it had provided banks with the emergency cash.’
So while global markets celebrated the taper, China’s central bank was trying to keep the credit ship from keeling over. Expect more such activity, because this relates to China’s attempts to rebalance its economy. ‘Rebalancing’ is a sanguine way of looking at it. More realistically, the Chinese economy will experience a rather harsh economic ‘adjustment’ in 2014 as it tries to move away from investment related economic growth, without popping its credit bubble, which this year inflated to historic levels.
That’s going to be very hard to do, because part of the adjustment process is to let insolvent firms go bankrupt. It’s these bankruptcies that cause the credit crunch.
And genuine adjustment is likely to hurt the Hong Kong property market. The Hong Kong stock exchange, the Hang Seng, is very sensitive to property price expectations. The index is only up 1% this year. Clearly investors aren’t too bullish about next year’s prospects.
So is 2014 going to be the year of China’s economic ‘adjustment’? Don’t ask us! We thought 2013 would be the year. In retrospect, it was the year of rhetoric with little action to back it up. But things might change on that front in 2014. It’s very unlikely that China’s credit bubble can keep expanding at such a rapid clip. When credit growth slows down, it usually heralds the start of the adjustment process.
China Watcher Michael Pettis wrote about this ‘adjustment process’ recently. Referring to China’s three decades of spectacular economic growth, he wrote:
‘…the most difficult part of growth miracles has not been the growth miracle itself but rather the subsequent adjustment. Consider the most notable examples of growth miracles: the United States in the 1920s, Germany in the 1930s, the Soviet Union from the late 1940s to the early 1960s, Brazil from the late 1950s to the late 1970s, Japan in the 1980s, and many others.
‘There is…plenty of historical context within which to place China’s spectacular achievement, and it is clear from this context that the most difficult part of the process has always been the subsequent adjustment, during which time the imbalances generated by the spectacular growth were addressed and resolved. But they were not always resolved successfully.’
Pettis goes on to make three generalisations about these prior historical growth surges. We’ll just stick to the first one, because we think it’s particularly apt for China:
‘First, the investment-led growth miracle always culminated in a period during which debt began to grow at an unsustainable pace, and in every case the miracle was brought to a halt either because of a debt crisis or, most obviously in the cases of Japan and the Soviet Union, because extraordinarily high debt levels locked the country into a long period of stagnant growth during which the financial system struggled to bring debt levels under control.’
China’s debt growth over the past five years has been extraordinary. According to Fitch ratings, total debt-to-GDP has increased from around 130% in 2008 to around 200% today. For a developing economy, such rapid growth is dangerous.
If you think about it, the adjustment process is really already underway. Put another way, the crisis moment is approaching. There are some comparisons to the lead up to the US credit bust. Back in 2007, a couple of Bear Stearns’ structured credit funds froze up. A year later the company was bankrupt.
In June, China experienced a sharp credit crunch. That was warning sign number one. But, as usually happens, the market dismissed it. We may have just experienced another little warning sign with yesterday’s action. Unfortunately, the taper story overshadowed everything.
Maybe it’s nothing. Maybe we’re seeing the prospect of a credit crunch where one doesn’t exist. After all, central banks are pretty powerful, right? Especially China’s. Well, bring on 2014 because if China can get through another year unscathed then we might have to start believing in the miracle economy.
In related news, gold continued its post-taper rout, falling below US$1,190 just prior to the open in Asia today. The West doesn’t appear to want or need gold. It’s no longer hot. Of course, much of the volume in the gold market is not physical bullion changing hands. It’s paper trading.
The LBMA (London Bullion Market Association) publishes daily clearing volumes for gold and silver here. In the 10 months to October 2013, the average daily clearing turnover on the London OTC (over the counter) market was 32.84 million ounces. That’s a bit over 1000 tonnes cleared DAILY. Actual trading volumes would be more than that.
We recently emailed the LBMA to ask about the massive volumes. We enquired as to whether it included gold trading as a currency. FX traders can make bets on gold by buying or selling units in XAU, which is the currency symbol for gold. In fact, we emailed them about five times…and have yet to receive a reply.
Given the size of the volumes (and the recent downward trend in the gold price), we’d guess that FX traders and hedge funds are selling units of XAU big time. It’s pushing the ‘price’ of gold down sharply and scaring many holders out of their positions.
Yesterday, we speculated that the West’s physical gold is flowing eastwards. This Bloomberg article, ‘What’s Happening to All the Gold’ supports that view. The Bloomberg reporter says the vaults in London are emptying out (we’re not sure how he knows), with the gold flowing to Switzerland for recasting into 1 kilo bars for the Chinese market.
‘He who has the gold has the power,’ is an old saying in the financial world. Given China’s precarious situation, it looks like it’s stocking up on financial firepower ahead of its big adjustment next year.
2014 is shaping up to be a big one. One thing’s for sure, it won’t be all beer and skittles. So stay nimble, stay sceptical, and keep your eyes open. And, as Ron Burgundy would say, ‘Stay Classy’.
Well, that’s the last Markets and Money from your editor this year. On behalf of the DR team, we’d like to wish you a very Merry Christmas and a happy and safe New Year. Most of all we’d like to thank you for reading our stuff each day. Or at least occasionally…
Take care, and we’ll see you again next year.
Greg Canavan +
for Markets and Money