China is burning through its foreign-currency reserves at such a blistering pace that the country will run down its cushion in a few months, forcing the government to wave the white flag and float the yuan, says Societe Generale global strategist Albert Edwards.
“The market remains content that massive firepower remains to support the renminbi. It does not,” Edwards, a perma-bear with a propensity for doom-and gloom-prognoses, said in a report published Thursday.
Societe Generale, using the International Monetary Fund’s rule of thumb on reserve adequacy, estimates that China’s foreign-currency reserves are at 118% of the recommended level. But that cushion is likely to evaporate soon on a combination of capital flight and the continuing effort by financial authorities to stem a dramatic drop in the currency.
Kyle Bass sees trouble in the banks:
Hedge fund manager J. Kyle Bass, the founder of Dallas-based Hayman Capital, has a warning about a “ticking time bomb” in the Chinese banking system.
Over the last ten years, China’s banking system has grown from less than $3 trillion to $34 trillion, equivalent to around 340% of Chinese GDP…
When loans approach a nonpayment status, Chinese banks typically push them offbalance sheet… the non-performing loan is transferred to a ‘Trust Company’ while the bank continues to be the ‘guarantor’ (i.e. the bank retains all of the credit risk). In exchange, the bank records the ‘asset’ as a Trust Beneficiary Receipt or TBR.
… Chinese bank capital – the equity buffer – is significantly overstated…
Now, the worse news. TBRs are one of the biggest ticking time bombs in the Chinese banking system because they have been used to hide loan losses…
“One can make many assumptions regarding the collectability of such loans, but our takeaway is that the system is already full of massive losses,” he said.
He also thinks they are technically short of money right now:
When a host country has a large industrial base, enormous money supply (M2), and large import/export business, there is a certain amount of liquid reserves that are required to run the day-to-day operations of the country (think working capital). Over the years, the IMF has fine-tuned the formula used to calculate this ‘reserve-adequacy’ metric. It can be best calculated as follows…
For China the equation is as follows: 10% * $2.2T + 30% * $680B + 10% * (RMB 139.3T / 6.6) + 15% * $1.0T = $2.7 trillion of required minimum reserves
Hayman Capital estimates that China’s FX reserves right now are in a range of $2.1 trillion to $2.2 trillion if you take commitments to various bodies like China’s sovereign wealth fund (CIC) into account.
According to Bass, China’s reserves are “already below a critical level of minimum reserve adequacy.”
“In other words, China is CURRENTLY out of the required level of reserves needed to safely operate its financial system,” Bass wrote.
Finally, an interesting comment at Free Republic discussing this:
Last year, China’s foreign exchange reserves took a sharp turn – up in the first half, down in the second. The annual average doesn’t well reflect the growing monthly burn rate since the August 2015 Chinese stock market crash.
As of January 2016, their monthly burn rate was over $140 billion a month, and growing month over month, as they try to prop up both their currency and stock markets.
Also, things start breaking well before foreign reserves hit zero. The hard floor is actually over a trillion dollars, which is needed just to settle the next few months worth of imports (food, fuel, commodities), but other cash needs get squeezed before they get there, like propping up their banking system (which has world-class amounts of bad loans on their books).
Things depend a good bit on how the burn rate changes over this year. If it accelerates all year, they will reach limits where they have to allow either their currency to collapse, their stock markets to crash, or both.
Worst case – they hit the skids hard this year with currency collapse, stock market crash, and a big economic contraction producing high unemployment.
Best case, they squeak through this year, and the global economy picks up next year, raising their boat along with the tide.
If market pressure eases and they can reduce their burn rate, or if they choose to sacrifice one priority for the other (e.g. a proposed 15% currency devaluation in the next few months, or letting the stock market tank), then they will be able to slow or halt their burn rate, and possibly kick the can down the road longer.
Their banking system is really insolvent with bad and fraudulent loans, but the government is unlikely to ever formally admit that or allow appropriate bankruptcies – they are likely to print money to keep their banks open.
Capital flight is putting a lot of pressure on their currency, as companies and rich people are trying to sell Chinese denominated assets and accounts to buy overseas assets and accounts. People are voting with their feet. There is a pretty profound loss of confidence in the prospects for the Chinese economy, and the honesty of their accounting.
Future developments, whether market or government policies (even those intended to stem the outflow), could result in a stampede for the exits, which might precipitate a currency crisis (which in turn could trigger other crises, like depleting reserves, stock market crashes, severe recession, etc.)
China is really at risk this year and next. The magnitude of the adjustments needed to bring their accounting and their economy into real balance dwarfs the size of their foreign reserves. They can only hope to spread it over many years (or generations). If conditions force a reckoning on them, it will be wrenching.
It really seems the world is filled with weak spots as we head forward, any one of which could trigger the panic which would take the system down temporarily. That alone will build K-psychologies, which will then further rebel at an r-system based upon lies which only remains operational so long as everyone is risk-blind. That leads to the bigger point.
What is astonishing to contemplate is that none of any of these problems is as large as what will happen when the US begins to have trouble selling its debt, because people begin to realize that the US will have gotten so in debt that it will not be able to pay back any more borrowed money. That will bring the real K-psychology into play. That is the one we read about in the history books, with US Marines flame-thrower-ing Japanese soldiers rather than taking prisoners, and nobody in the country being the least bit bothered.
More and more, a Soviet-style, quiet dissolution of the federal government looks as if it could be the most likely possibility, and it could happen within two decades – and maybe a lot less. The real question is what will happen on the international stage as our entire species goes K in grand style, all at once. Looking at the scale of things, I begin to feel a bit worried.
The K-shift produced by the resource restriction of the Depression probably played a large part in producing WWII, and this appears as if it could make the Great Depression look like a lost wallet. I used to hope r/K might be a good tool to temper r, and guide people away from rabbitism by making them see their decisions were not logical, and were just urges driven by the r-psychology of free resource availability.
Looking out at this, and thinking of what could happen to all the K-strategist soldiers worldwide if another global war began in the massive drive to K after the real collapse, I find myself thinking perhaps it might have just as much utility explaining to the world that a World War might just be an over-expression of K driven by conditions. Perhaps it could illuminate that we might all be better off waiting a bit, and seeing if the decision to go to war was fully logical or necessary.
Could the bonds of K-strategists, and their inherent respect for each other produce a Rodney King moment, driving us all to just get along? The way things look, we may one day find out.
[…] China Is Courting Apocalypse […]
It’s now apparent to me that leftism is, at its core, an expression of the unconscious sense of the widening gulf between the conditions for which we humans are evolved to live and the conditions in which we find ourselves.
Human intellect has created a world where extremely few people are remotely able to function by leveraging the combined innovation of the very brightest people to create conditions even they don’t understand. The result is our modern folie a plusiers, the madness of many, where collective action driven by deep-seated fears and biological maladaptations for modernity resembles reality-denying behaviors of schizophrenia.
The closer I come to grasping what this portends for the future, the more terrified I become. The worldwide collective embrace of intangibles (i.e., performance contracts like insurance) has broken out of rational containment until the embrace of mathematical absurdities (e.g., the debt markets) is openly celebrated on every news program and newspaper financial section.
For just a single illustration of the nascent real-world destruction this has produced, look at GE nuclear power plants that dot the USA. Each and every one of them elevates can-kicking to high art, as the refusal to find or fund a long term solution to their highly radioactive wastes causes each plant to accumulate spent fuel in pools requiring continuous access to electricity, pumping and expert maintenance. If the power goes down or employees can’t (or won’t) fulfill their obligations at any one (or all) of these plants, within a very short time they catch fire and send radioactive materials into the air, just as occurred (and continues) at Fukushima. If this happened, half the USA east of the Mississippi might become contaminated and dangerous for centuries, if not millennia.
Much of the modern world metaphorically exists at the foot of a vast hydroelectric dam, a structure built without serious consideration to “what if” scenarios. The collective madness of the past 50-100 years, built on a foundation of profound human arrogance combined with the collective embrace of high time preference as a consequence of political democracy, has placed this dam (with us at its foot) in the shadow of Mount Krakatoa, or perhaps one of Iceland’s equally massive, far-from-dormant volcanoes.
Where does one go when there’s nowhere to hide?
“Perhaps it could illuminate that we might all be better off waiting a bit, and seeing if the decision to go to war was fully logical or necessary.”
We ordinary folks might not be better of having a war, but oligarchs might. War can be profitable, and perhaps even more importantly if your economy is crashing it can distract people from their misery, and provide another explanation besides the oligarch’s greed and incompetence. Put that together with what’s going on in the South China Sea and I’ll be surprised if we get out of the decade without WWIII.
China and Germany both practice the W.T. Grant strategy: If your goods aren’t selling as fast as you’d like, lure in more customers by offering store credit to anyone who walks in the door. If they have trouble making the payments, refinance them to even easier terms so you can pretend to be making money off them.
Unfortunately W.T. Grant’s bankers and suppliers were not so patient, and in 1976 they forced it into what was then the second-largest bankruptcy in US history.