I marvel at China’s financial system, even though I’m aware that a mountain of bad debt is looming in the background. The latter seems to be one of those facts that markets learn to live with, so that anyone prepared to go long credit or equities is a little like playing the game of truth or dare.
The dare part is represented in the grinding ever tighter of global credit spreads and a global equity market rally that has been running for the best part of a decade. For married couples the 10-year mark is their tin anniversary, and this seems an appropriate label, given what might be regarded as the market’s tin ear for the underlying reality which has prevailed during the bull market decade.
As far as China’s deafness is concerned, I think rather often of the doom-mongering analysis of a former Fitch Ratings credit analyst called Charlene Chu, who made a name for herself by warning of the colossal debt in the country’s financial system.
Ms Chu may have left the agency in 2014, but her descriptions of bad debt ratios astronomically higher than the official statistics remain fresh in the memory. Yet the precipitous debt market sell-off that is the logical outcome of that research has failed to occur.
I suspect the truth is that as long as the entire Chinese market retains its command elements, there will be no crisis.
According to a more recent report produced for Autonomous Research, where she is a founding partner, Ms Chu reckons China is on track to register almost US$8trn-equivalent of bad debt by the end of this year.
That’s a hair-raising number which renders China’s US$3trn-odd of foreign exchange reserves slightly less of a smug tally by comparison. But assuming the figure is about accurate, there are still ways to address that debt mountain, all of them bog-standard: establishing bad banks, debt-for-equity swaps, bond-for-bond swaps, loan forgiveness and other tools that move the debt off balance sheets.
I’m sure the Chinese authorities are well aware that all of those methods, even if backed by the most formidable political and practical will, invite moral hazard on an epic scale. But they don’t have much choice other than to continue to kick the can up the hill. And centrally directed bank lending can be sustained as long as Beijing is willing to recapitalise banks as and when necessary. A Lehman moment in China is unthinkable.
China’s banking industry is one of the most vibrant in the world. It’s easy to pooh-pooh the vainglorious nature of the “One Belt, One Road” infrastructure dream child of President Xi Jinping which aims to replicate the ancient Silk Road linking China’s trade to the West, but there’s an element of motivational genius in the scheme.
OBOR might not have been absolutely necessary to bring the Chinese banks out of the shadows and into the international loan and capital markets – they’ve been moving front and centre of that game for well over five years – but it will create a heady momentum.
And although I believe that the gimmicky nature of the scheme will inevitably produce more than a few white elephants, it might well represent a Keynesian boost to national infrastructure spending which will reverberate in growth numbers for those countries on the OBOR route. Keynes on steroids, if you will.
Chinese banks will be in the thick of the lending action and stand to collect considerable amounts of fees if the scheme continues with the momentum it has established early on.
Already there have been moves from China’s financial authorities to rein in off-balance-sheet lending and curb the use of the interbank market to raise funds for bond market speculation.
Moves to crimp credit growth have pummelled Chinese bank stocks in recent months, as well as prompting a sell-off in the domestic bond market such that the yield curve has toyed with inversion between two years and the long end.
Meanwhile, Chinese banks, which have been known to rely heavily on shadow banking activity, have also seen their shares fall on the perception that the authorities are determined to contain the use of shadow products such as trusts and pledged loans.
All of this seems to go towards ameliorating the potential horror of a bad loan bust that would occur if economic growth were to nosedive.
But with China’s command economy turning to increasingly subtle measures to keep growth on target for the magical achievement of doubling in size between 2010 and 2020, I have little doubt that the can will continue to be kicked up the hill to the necessary effect in the time left to achieve that goal.
And for global credit and equities the game of dare will continue until a truth brings it to an end; that truth seems unlikely to originate in China’s banking system, for now at least.
