CHINA UPDATE / CREDIT BUBBLE BULLETIN

China Update

Doug Nolan


We shouldn’t read too much into one month.

With a holiday week, October is typically a sluggish period for lending in China.

But at $88 billion, the growth in Aggregate Financing was about a third below estimates.

It was also the weakest month in years – running about a third of September’s level and 16% below a slow October 2018.

Even with a weak October, six-month growth in Aggregate Financing was 16% ahead of 2018 - with year-to-date growth up 20%.

Principally, overheated Credit system turn increasingly susceptible to trouble.

October Bank Loans increased $94 billion, 17% below forecasts and the weakest lending month since December 2017. Growth was down sharply from September’s $241 billion and ran 5% below October 2018.

A slow October reduced one-year growth to 12.4%, matching the slowest growth rate since March 2017 (a decade low).

Year-to-date, Bank Loan growth of $2.038 TN ran 3.3% ahead of comparable 2018.

It’s worth noting Bank loans were up 27.2% in two years.

Consumer (chiefly mortgage) Loan growth dropped to $60 billion (from September’s $108bn), the weakest expansion since February and 25% below October 2018.

At 15.4%, one-year growth slowed to the weakest pace since May 2015.

At $870 billion, year-to-date Consumer lending was running 2.6% below comparable 2018.

Notably, three-month growth was down 9.0% versus comparable 2018.

Consumer Loans were, however, up 36% over two years, 68% in three and 138% over five years.

Over recent years, Beijing repeatedly responded to heightened economic and financial fragility with serial stimulus.

I have argued policymakers dangerously extended the “Terminal Phase” of a historic Credit Bubble.

Importantly, policy stimulus pushed China’s mortgage finance Bubble into precarious late-cycle extremes.

In my view, Chinese apartment markets demonstrated classic “blow-off” speculative dynamics – creating acute fragility in the process.

From about 5% annual inflation back in early 2018, the 70 Cities Newly Built Residential Buildings price index hit a high of 11.4% this past April.

Year-over-year price increases have now slowed for six consecutive months (to 8.0%).

Of the 70 cities tabulated, 69 showed year-on-year increases in New Home (apartment) prices, with 50 cities posting price gains during October. Still, momentum has clearly waned.

Average New Home Prices increased 0.50% in October, the slowest price inflation since March 2018. Price gains peaked at 1.49% in August 2018 and have been trending downward ever since.

I tend to see Existing Home Sales data as more illuminating.

Examining Existing Home Sales, half (35) of the cities reported price declines in October, up from September’s 28, August’s 20 and May’s 11.

On a year-on-year basis, 13 cities have now posted price declines versus only two in June.

And while average Existing Home prices were up 4.24% y-o-y, this gain has been almost cut in half over the past six months.

Key (i.e. highly inflated) markets are much weaker than the average.

October prices were down 0.60% in Beijing, that market’s fourth consequence decline.

Beijing prices have declined 1.5% over the past year.

Prices in Guangzhou are down 2.4% y-o-y, with Shanghai prices up only 1.1%.

November 5 – Wall Street Journal (Bingyan Wang, Liyan Qi and Stephanie Yang): “Thirty floors above the showroom of a Chinese developer, a 29-year-old woman stood on a small rooftop ledge about 8 feet off the rooftop itself, threatening to jump and declaring that her recent home purchase had ruined her life. Ms. Hou… was one in a group of angry home buyers who had gathered at a real estate sales office in Tianjin… on Saturday, demanding their money back for half-constructed apartments that had now dropped in price. In recent years, Chinese officials have tightened financing to developers and rules on lending for home buyers in an effort to cool a buying frenzy and runaway prices. The government has delivered a consistent message: Apartments are for living, not for speculation.”

I’ve again highlighted the above WSJ extract to emphasize the point that the Chinese (borrowers, lenders, regulators and government officials) have no experience with collapsing mortgage finance and apartment Bubbles.

It is president Xi who has championed housing “is for living in and not speculation.”

Beijing for years has employed timid – and inevitably unsuccessful – measures to rein in housing-related excess.

The upshot has been upwards of 60 million unoccupied apartment units, while mortgage-related Credit growth has become an increasingly prominent source of system liquidity and purchasing power.

It’s worth noting Consumer (largely mortgage) borrowings that averaged $46 billion monthly during 2015 had more than doubled to $97 billion a month this year (March through September).

With a “phase 1” U.S./China trade deal supposedly imminent, global markets have turned more forgiving of disappointing Chinese data.

Yet it’s worth noting October year-on-year Fixed Investment was weaker (5.2%) than expected (5.4%), and the lowest reading since at least 1998.

Industrial Output (y-o-y) dropped to 4.7% from 5.8%, significantly trailing estimates (5.4%).

Also missing estimates (7.8%), Retail Sales (y-o-y) declined from 7.8% to 7.2%, matching the lowest level since 2003.

When I see a sharp slowdown in Credit expansion coupled with broad-based indications of economic deceleration – my analytical curiosity is piqued.

As I have written in the past, trade war escalation is a potential catalyst for near-term Chinese financial and economic instability.

Yet, from the perspective of historic Credit and economic Bubbles, a trade truce would have only marginal impact on underlying fundamentals.

I hold the view Chinese Credit is heading toward an inevitable crisis of confidence – with or without a trade pact.

China’s Bubbles have inflated dangerously since 2016’s brush with Crisis Dynamics.

The S&P500, Dow and Nasdaq all traded to record highs this week.

Perhaps Chinese market moves were more noteworthy.

The Shanghai Composite dropped 2.5% this week to a 10-week low.

The Hang Seng China Financials index sank 4.4%, while Hong Kong’s Hang Seng index fell 4.8%.

November 13 – Bloomberg (Tian Chen and Claire Che): “Cracks are starting to emerge in Hong Kong’s currency and money markets, as traders speculate the local dollar’s resilience to increasingly violent protests won’t last. Hong Kong stocks were already showing signs of stress, losing more than 5% over the past week. Now, liquidity conditions in the foreign-exchange market are the tightest since the late 1990s, or the aftermath of the Asian financial crisis. Interbank rates are climbing -- making funding costs more expensive for banks -- while a gauge of expected swings in the Hong Kong dollar is near its highest in a month.”

In the near-term, China is facing a crisis of confidence in its small bank sector, rapidly rising corporate defaults and an increasingly fragile mortgage finance Bubble.

Meanwhile, odds are rising of a run on the Hong Kong dollar with an attendant crisis of confidence in Hong Kong as an international financial hub.

Recalling the nineties, the breaking of currency pegs can be exceedingly disruptive.

China remains the marginal source of both global finance and economic growth.

Despite all the hoopla of record high U.S. stock prices, the risk of global instability is rising.

Again, I don’t want to read too much into October’s abrupt lending slowdown.

Yet is does have the potential to be the beginning of something important.

China – along with the world more generally – has never been as vulnerable to a sudden Credit slowdown.

Bubbles don’t function well in reverse.

November 15 – Reuters (Marc Jones): “Global debt is on course to end 2019 at a record high of more than $255 trillion, the Institute of International Finance estimated on Friday — nearly $32,500 for each of the 7.7 billion people on planet. The amount, which is also more than three times the world’s annual economic output, has been driven by a $7.5 trillion surge in the first half of the year that shows no signs of slowing. Around 60% of that jump came from the United States and China. Government debt alone is set to top $70 trillion this year, as will overall debt (government, corporate and financial sector) of emerging-market countries. ‘With few signs of slowdown in the pace of debt accumulation, we estimate that global debt will surpass $255 trillion this year,’ the IIF said…”

November 14 – Bloomberg: “China’s central bank unexpectedly added liquidity to the banking system Friday to help lenders through the tax season, a move that analysts saw as a sign that larger-scale stimulus is unlikely in the near term. The People’s Bank of China offered 200 billion yuan ($29bn) of one-year loans to banks Friday. It kept the interest rate unchanged at 3.25%, showing restraint in monetary policy after this week’s worse-than-expected economic data. Liquidity in the banking system is at a ‘reasonable, sufficient’ level as the operation offsets companies’ need for funding to pay tax…”

Curious, isn’t it, that the world’s two great Credit engines are currently both requiring extraordinary central bank liquidity injections…