Last week, when looking at the latest Chinese credit data, we made two troubling observations: first, China's economic growth was slowing across a number of key data points despite massive new credit injected into the economy over the past year. Second, that the formerly massive credit impulse - which was responsible for pushing the global economy and markets out of the early 2016 rut - was no more, and that overall system credit growth slowed to 14.4% yoy from 14.9% the prior month, which was the slowest total credit growth in the past 27 months.
While there were some nuances, such as where in China's economy was credit being overstimulated (household) and where it was stifled (shadow banking), the bottom line as we showed in one chart is that absent a significant burst in credit creation, or credit impulse, China's real estate prices - the backbone of the entire economy and its "wealth effect" - was lookingat a hard landing.
Which led to the conclusion that "in the end, whether China's deleveraging is premeditated or accidental doesn't matter: a few more month of China's credit impulse collapsing and it will be too late to prevent a hard landing, first in China where real estate was, is and will be the most popular and important asset, and then the rest of the world. As we explained in "Why The Fate Of The World Economy Is In The Hands Of China's Housing Bubble", to understand what the world economy will do in 6-9 months you only have to follow China's debt creation and housing market today."
And right now, both of those are headed straight down, and the worst is yet to come: as Deutsche Bank sumamrizes in its latest snapshot of China's banking system, "we are likely at most halfway through the financial deleveraging process. New regulations on asset management and liquidity risks will be phased in and more rules will probably follow."
Which means even less credit creation, even faster slide in property prices, and even greater global credit deflation which is coming just as the world's central banks are poised to tighten financial conditions expecting a deluge of inflation. The result will be another economic crash in the coming year.
... unless, of course, Beijing capitulates, reverses course again, gives up on its second deleveraging attempt in 3 years, and conceded that its economy can only grow if it is flooded with trillios and trillions in new credit. And, according to the WSJ, this is precisely what happened, because as China prepares to unveil its economic blueprint for 2018 in just a few hours, "people familiar with the plan say it will show that Beijing is finding it hard to cut debt without jeopardizing growth."
According to the WSJ's sources, in the blueprint plan to be unveiled on Wednesday, past talk of bringing down debt, the priority for the past two years, is gone in favor of a pledge to just control the rise in borrowing. The softening of the goal - which was to be expected by anyone who did not assume that China would voluntarily unleash a hard landing on its economy - which was decided earlier this month by the Communist Party’s top leadership, is an official acknowledgment of how hard it is for Beijing to wean the economy off debt-driven growth.
In other words, China has just admitted - for the second time - that not only does it have an unprecedented debt addiction, but it will never be able to get over it. Which is a problem for the country which according to the IIF has over 300% in total debt to GDP. In fact, one could make the argument that this is where Chinese rates surge for no other reason, but simple credit and sovereign solvency risk.
Unfortunately, China no longer has a way out, as an official involved in policy discussions told the Wall Street Journal: “Let’s face it, it’s not realistic to reduce leverage when the whole economy relies on banks for financing."
Bingo.... and also game over, because as even the IMF showed recently, China is now at - or above - its maximum possible debt capacity.
The IMF chart above is hardly a coincidence: both the IMF and the World Bank have urged Beijing to tackle debt even if it squeezes economic expansion in the short term. Well, it appears that Beijing once again has decided to ignore these generally worthless NGOs.
So what does the new posture reveal?
By tempering the stance on debt, Beijing is signaling it still seeks relatively high rates of growth and that more debt will be tolerated to reach that goal. For the world, that means greater demand from China for oil and other commodities, but also continued worries that Chinese debt could spiral out of control and hurt the global economy.
The lightbulb moments continued: “The Chinese government is bowing to the complicated reality it faces, recognizing the risks of debt-fueled growth but unable to wean itself from rising debt levels,” said Eswar Prasad, a China scholar at Cornell University and the IMF’s former top official in China.
Yes, a tricky predicament if there ever was one, or rather an outright dilemma: keep growing your debt and suffer a financial sector paralysis and crash, or slow down the economy and face a working class revolt.
Needless to say, the optics of the reversal are ugly: for the past two years, deleveraging has been a centerpiece of President Xi Jinping’s economic policy. But while regulators reined in borrowing between banks, the kind of practice that enabled smaller lenders to ramp up risky borrowing, the country’s overall debt load continues to climb faster than growth.
As reported at the time, China’s ruling 25-member Politburo decided on the shift on Dec. 8 as it set the agenda for the annual Central Economic Work Conference this week, where economic priorities are laid out in greater detail. A statement after the Politburo meeting listed control of the “macro-leverage ratio,” or the country’s debt-to-GDP ratio, as a major piece of the government’s effort to fend off risks next year. That contrasted with its statement ahead of last year’s economic conference, which described debt reduction as a key task.
The change followed rounds of discussions by Mr. Xi’s economic deputies and financial regulators since the summer, according to the people familiar with the deliberations. An oft-cited issue during those talks, the people said, involved state-owned banks’ outsize role in economic activity.
And the anticlimax: China simply can't function if the credit-hose is not on max:
That led to the conclusion that with businesses lacking easy access to other forms of financing, such as stock sales, tight restrictions on bank loans would hurt growth too much. A World Bank report issued Tuesday shows outstanding bank loans reached 150% of China’s gross domestic product in November, up from 103% a decade ago.
Ironically, China may have no choice but to unleash the overdrive on debt because of fears of growing trade wars with the US:
Xi has talked about the need to focus less on the speed of growth and more on its quality. That has raised expectations that Beijing will take more meaningful steps to curb its debt binge, especially that of state companies. Macquarie Group estimates state firms’ debt makes up about two-thirds of Chinese corporate debt.
But with threats of trade penalties against China from Washington and a softening property market at home, authorities have grown more wary about the growth outlook.
“All these things have been declared before, such as less emphasis on GDP target, but there has been no effect,” said Anne Stevenson-Yang, co-founder of J Capital Research, which focuses on the Chinese economy.
Even China's top power officials - those who understand the looming dilemma better than anyone - admit the world's (formerly) fastest growing economy is trapped.
Senior officials who gathered at Beijing’s Jingxi Hotel for the economic meeting this week are stressing the need to prevent financial risks, such as rampant borrowing among banks that has made the country’s financial system more vulnerable to short-term disruptions.
But they are also wary of taking too-drastic action. Earlier this year, a wave of regulatory measures jolted China’s financial markets. Since then, banks and other financial institutions have seen their funding costs rise, causing concerns that the lenders would then make it more expensive for businesses to borrow, thereby hurting growth. Such worries are adding to Beijing’s wariness of dealing with debt, officials say.
To be sure, some are still holding out hope: “The overall direction of deleveraging won’t change in the long run,” said Zhang Ming, a senior economist at the Chinese Academy of Social Sciences, a government think tank.
Of course it won't: but when the real deleveraging comes, it will be i) uncontrolled and ii) far more brutal than Beijing's controlled attempts at reducing debt.
Meanwhile, the biggest risk facing China will get even bigger: the debt bubble feeding the housing bubble in a symbiotic death loop, will make deleveraging without a crash impossible.
Another worry over China’s debt buildup: More than half of new bank loans are flowing into the real-estate market, not to areas of the economy that can improve the country’s competitiveness. The property market, including construction and home furnishings, accounts for a third of overall growth. Beijing is looking for ways to rein in housing speculation without setting off a housing crash that could torpedo the economy.
Finally, since this is China - the country whose modern economy is the very definition of absurd, the economic plan to be released on Wednesday "is expected to outline measures to ward off property bubbles"... even as China formally admit it can no longer exist without a stead supply of non-stop debt.