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Page 1: Catalysts for Crisis - herzog.economia.unam.mxherzog.economia.unam.mx/deschimex/cechimex/chmxExtras/document… · Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 ... control

Catalysts for Crisis

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Conditions for Crisis

• Total indebtedness is about 200% of GDP

– Corporate debt: 130%

– LGFV debt: about 90%

– Government: about 26%

• But these categories overlap

• Meanwhile, industrial production is slowing:

– 2013 power output growth <5%, coal output 2%, steel up

2%, cement flat

• And real credit rates are high, perhaps average 20%.

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Less Growth from More Credit

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6Nominal Credit Intensity

Real Credit Intensity

Total Social Financing (RHS)

Trend of Real Credit Intensity

Ratio:TSF/Incremental GDP Trillion RMB

Sources: PBoC, NBS, CEIC, The Conference Board

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Using Infrastructure Investment to Drive Growth

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2007 2008 2009 2010 2011 2012

Fixed Asset Investment (FAI)

Central Government FAI

Infrastructure FAI

Real Estate FAI

Percentgrowth, y-o-y, 3mma

Sources: NBS, CEIC, The Conference Board

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Bank lending, total social capital, and money supply

• TSF & M2:Total Social Funding surged as % of

total, eclipsing bank lending. Bank lending was

38% of new lending. M2 money supply exceeded

200% of GDP

• Deleveraging: Substantial deleveraging going on

across China. Severe in benchmark cities such as

Wenzhou, Ordos, Changsha. Ordos has rapid

exodus of wealthy individuals, many leaving

substantial liabilities behind

• Local Government Finance Vehicles (LGFV): Being

privatized and their paper securitized to reduce

the “on balance sheet” debt of local governments

& banks. Local governments now selling future

tax revenue to private investors. Wenzhou is

selling off their Audi fleet

• Control M2 money supply

• Diversify, regulate, and supervise channels of capital to add

transparency and restore confidence

• Maintain stability of RMB value through PBOC and Forex

deployment

Choices facing the Chinese Government

M2 in terms of GDP M2 Growth (%)

M2 Level and Growth Rate

TSF vs. Bank Lending

B

Source: Central Bank of China, IMF

Source: Central Bank of China, Deloitte Analysis

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Recoveries Become Briefer and More Shallow

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Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12

PMI: new orders PMI: new export orders

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The PMI measure of employment shows a steady fall.

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may-12 jun-12 jul-12 ago-12 sep-12 oct-12 nov-12 dic-12 ene-13

PMI Employment

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And the relationship to cash injections is very direct.

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0%

5%

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15%

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25%

30%

35%

-80%-80%-80%-80%

-60%-60%-60%-60%

-40%-40%-40%-40%

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0%0%0%0%

20%20%20%20%

40%40%40%40%

60%60%60%60%

80%80%80%80%

Jan-2007 Jul-2007 Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Jul-2010 Jan-2011 Jul-2011 Jan-2012 Jul-2012

Floor Space of Buildings Under Construction: Residential Buildings: YoY M2: YoY

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Why the consumer data is useless

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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Retail Sales ofConsumer Goods(NBS)

Difference withHouseholdConsumption figurederived fromExpenditure GDPAccounts

Difference withHouseholdConsumption figureestimated by NBSQuarterly HouseholdSurvey

Seasonal-adjusted real value at 2011 price (bn RMB)

Sources: CEIC, NBS, The Conference Board

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But household consumption is shrinking

in each quarter.

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2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Householdconsumptionfrom expenditureGDP

Householdconsumptionfrom quarterlysurvey

Retail sales ofconsumer goods

Real year-over-year growth rate at 2011 prices

Sources: CEIC, NBS, The Conference Board

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The Mechanics of Crisis

• Prices in certain locales increase yearly then monthly then

weekly then daily.

• Speed of financial innovation exceeds regulators’ ability to

control it and investors’ ability to understand the nature of

their investments.

• Velocity of money accelerates.

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The Mechanics of Crisis

• Early defaults undermine market confidence. Market

participants begin changing their activity to focus on short-

term payback.

• Lenders raise rates and shorten maturities

• Capital flight accelerates.

• Corporates engage in carry trade by borrowing USD and

pledging RMB.

• Forbearance by some key financial institution ends.

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Some Aspects of the Bubble

• Art prices skyrocketing, even for known fakes.

• Fast growth in sales of luxury watches, luxury cars.

• Speculation in almost anything: garlic hoarding,

$10,000 packets of cigarettes, tea selling for $100,000

an ounce, white spirits for 600,000 per bottle.

• “Land King” projects where prices spiral madly. Beijing

property now selling for 600,000/m2, up by 10x since

last year.

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The Case of Ordos

• Universal participation in private lending funds.

• Housing prices rising monthly, weekly, daily, then hourly.

• Crash in October 2011. Banks needed bailout in February

2012.

• Property prices now 30-50% of what they were pre-crisis.

• Migrants, wealthy people have left the city. Retailing mostly

closed. Unemployment very high.

• Local government borrowing from state companies to meet its

fiscal needs.

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New Manhattan: The Plan and the

Reality

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Meizhou LED Base

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Taizhou Logistics Port

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Over-development Everywhere

• No risk associated with over-investment.

• New developments destroy rather than create jobs

• Developments “cash in” dormant land resources and

so expand the money supply before the economy is

capable of absorbing it efficiently. The waste in future

must be recognized as a reduction in GDP.

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Some other bubbles

• Tulip Mania, The South Sea Scheme, Railway fever, 1929

• Each craze entailed the rapid expansion of credit

• There tend to be defaults then a long period of calm, while

market participants wait to see whether the bubble will burst,

Confidence declines, but people still want to take advantage of

the bubble.

• There will be mini-recoveries but ever briefer

• Credit becomes shorter term and higher-cost

• When one market participant steps down, the circle breaks.

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Tulips: 1630s

• Booming textiles trade creates major wealth expansion

for the Dutch.

• Syndicates were forming to support voyages. Company

shares were traded.

• As prices rose, the quality of the tulips declined.

• Annual average wage: 200 florins. Emperor Augustus

tulip in 1637: 9,000 florins.

20

Edward Chancellor: “The Devil Take the Hindmost”

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Souq al-Manakh, 1982

• Trade in Kuwaiti stock market was conducted using

post-dated personal checks.

• In eight months, the value of the cheques exceeded

$90 billion, and interest rates were 300%. The shares

exchanged were nominally worth $200 million.

• Cheques were due at end of year. But in August, one

speculator asked that a check be cashed early. The

owner defaulted and the market crashed.

21

Edward Chancellor: “The Devil Take the Hindmost”

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South Sea Mania, 1720

• The expansion of British trade combined with the

murkiness of investment in colonial expansion to

generate speculation in many traded companies.

• The South Sea Company bought British public debt in

return for shares plus fiscal commitments to pay

interest. Then it traded the shares actively to increase

value.

• Copycat companies emerged. To protect the share

price, the government passed the “Bubble Act” to

curtail them—and this triggered a market sell-off.

22Edward Chancellor: “The Devil Take the Hindmost”

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Some Commonalities

• Pre-condition is expansion of the money supply. Money has to

go somewhere.

• Forward delivery stretches out; the object of speculation is not

actually being delivered.

• A confidence jolt is followed by a quiet scramble to recover

value, then a decisive fall.

• There is always some specious argument about why the object

of speculation is actually very valuable—Florida real estate has

an ocean view. The internet will create phenomenal value.

Urbanization will generate 20 years of growth.

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Two paths to crisis

• Probabilistic

– The system develops multiple areas of instability. Odds are

that some external shock will trigger a panic.

– Types of triggers:

• Large and politically sensitive default

• Bank run

• Pre-paid apartments are not delivered, owners protest publicly

• Significant fall-off in exports or major devaluation by a trading

competitor

• Big default by a debtor nation

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Two paths to crisis

• Deterministic

– The banking system reaches the end of its ability to kick the

can down the road.

– Types of triggers:

• Term deposits, wealth management products default en masse;

investors lose their principal.

• Cash runs short; banks do not have money to lend. Economic

activity grinds to a halt.

• Government tries to ease cash shortage by printing money and

generating hyper inflation.

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The Most Vulnerable Regions

• Inner Mongolia

• Zhejiang

• Jiangsu

• Hefei/Bengbu

• Guiyang

• Tianjin

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Post-Crisis Scenarios

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Scenario 1: Lost Decade

•Gradual deleveraging and absorption of over-

capacity means that the economy sees very low

growth, under 3% annually, for a very long time.

•Deflation. Consumers hoard cash.

•Growth drops even lower. Unemployment is high.

Scenario 2: Tabula Rasa

•Deflate asset value through high inflation,

significant devaluation of the currency, and

opening of capital account or re-issuance of a

new currency.

•De-legitimate the gray market, rewrite the rules.

•Use aggressive government buying to defend

against attacks on the stock market.

•Freeze deposits, out conditions on their

withdrawal.

• State assets are auctioned off.

Scenario 3: Fragmentation

• Governments, under pressure to find cash for

their own operations, begin freelancing. They

privatize whole functions and farm taxes. They

impose fees on services and unofficial tariffs on

products from other regions. Eventually, some

issue their own currencies.

• Some regional economies improve, some see

negative growth. Investment capital follows the

growth and exacerbates the imbalances.

Scenario 4: Dramatic Reform

• Its back to the wall, the central government

initiates sweeping reforms in financial services,

health, education, and distribution. Unrestricted

private ownership is permitted. Growth in

services sectors over time lifts the banks out of

the crisis and recapitalizes them.


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