Financial columnists are necessarily involved in prediction, even though forecasting markets is perhaps as reliable as astrology or clairvoyance. At longer time frames, financial market prediction is about as effective as forecasting the weather. But here’s one for you: the infrastructure finance market will be the source of the next global financial crisis. I can’t quite tell you when exactly, but it’s one long-range forecast I’m sure will come true.
Why do I say this? Well, let’s look at the huge potential for the development of a new asset class that looks to be anything but sustainable. You have it already in China in the form of the “Silk Road” project bond, of which more later. You don’t yet have it in the US in the form of “Trump Bonds”, or whatever the name may be, but I suspect it’s only a matter of time.
Infrastructure is to Donald Trump what Obamacare was to its eponymous originator. And that suggests the emergence of a project bond market in the US of epic proportions.
Never mind the fact that the project bond is a cumbersome vehicle for financing infrastructure. Construction milestones are ill-served by project bonds, which deliver the cash upfront and cannot be tailored to meet the specific cashflow requirements which are a salient feature of project financing. The best funding vehicle for that need is undoubtedly traditional non-recourse bank lending.
An old friend of mine who heads up the loan division of a big global bank used to joke that project finance loans either default or get refinanced. There’s some truth in that: refinancing is a handy way to pay off a PF loan once the construction period is done and dusted, and there’s a ready pool of life insurers and pension funds looking for long duration assets to match their liabilities.
But the project finance sector is an inherently problematic investment proposition. One only has to look at the unhappy experience of South Korean contractors in the Middle East in recent years, which involved hyper-aggressive bidding for projects and the subsequent bankruptcy of a swathe of construction firms when their cashflow predictions turned out to be miles off. If there’s a bright spot in that story it’s that those belly flops were funded out of company capex rather than project bonds.
But take the much-hyped Silk Road project in China, the brainchild of Chinese premier Xi Jinping, which was conceived back in 2013 with a view to restoring the ancient trading route connecting imperial China with the West.
Otherwise known as the “One Belt One Road” project, the vision is that the 60-odd countries which sit on this route can issue debt under the Silk Road label and in the process create a brand new asset class, which, when it has assumed critical mass will even have its own trading and settlement system. Bonds have already been issued by Chinese banks under this label and there will be many more to come.
One imagines that Mr Trump wouldn’t be too pleased about the Silk Road project. His sabre-rattling towards China has already stoked fears that he will tear up the “One China” policy that has framed America’s official relations with China and Taiwan since 1979.
Indeed, one assumes that this self-described “King of Debt” will wince slightly every time he has to read about yet another Silk Road financing. He will have to get used to wincing, because there’s rather a lot of Silk Road financing on the cards for years to come.
In fact, China is providing the financing template for Mr Trump’s own infrastructure ambitions. Although he won’t have anything as catchy at his disposal as the Silk Road brand, he will have a model to emulate. He might even want to make a high-profile debut project bond to fund the construction of his wall on the Mexican border.
The problem with creating what appears to be a discrete new asset class for the purpose of funding infrastructure is that you are creating what is quintessentially an illusion.
The idiosyncratic risk of individual infrastructure projects is massive, not least because the projects earn no money whatsoever for rather a long time. Moreover, a big ticket business such as infrastructure tends to be a magnet for corrupt practice and the industry is littered with scams and white elephants which were conceived to line the pockets of politicians.
And of course, once you’ve created a new asset class, with an index that can be spread against a debt market benchmark, you also create the risk of sectoral contamination when you’d have been better off dropping the label entirely.
So my long-range forecast is that these super-charged new asset classes – the Silk Road bond in China and the as yet unnamed infrastructure bond in the US (trust me, it’s coming) – will soon prove problematic. Alright, it may be a stretch to call them the progenitors of a new financial crisis. But I would attach at least a strong health warning, even if they appear to be the means to make either country “great again.”
