Necessarily Aggressive
Doug Nolan
The Wall Street Journal ran with the headline “What if China’s Property Crackdown Goes Overboard Too?” for its Tuesday’s “Heard of the Street” article.
A Bloomberg piece went with “China Property Crackdown Alarms Analysts as Economic Risks Grow.”
September 7 – Bloomberg (Sofia Horta e Costa):
“Warnings that China’s campaign to cool its property market will go too far are multiplying.
Economists at Nomura Holdings Inc. are calling the curbs China’s ‘Volcker Moment’ that will hurt the economy.
The credit squeeze in the property sector is ‘unnecessarily aggressive’ and may weigh on industrial demand and consumption, wrote colleagues at Bank of America Corp.
A prominent Chinese economist cautioned of a potential crisis should home values drop below mortgages.
Stabilizing China’s housing market under the mantra of ‘housing is for living, not for speculation’ is one of the many campaigns being waged by Xi Jinping as he seeks to reduce the cost of raising a family and defuse risks in the financial system.
Yet it’s also one of the toughest goals to achieve given the vital importance of the sector to the economy -- the industry accounts for more than 28% of gross domestic output.”
The Wall Street Journal article (Jacky Wong) concluded with the following:
“Longtime China watchers may expect the government to dial back property curbs when they start to bite in the usual on-again, off-again fashion.
The risk is that in the current fevered political and regulatory environment, the ‘on’ button might stay pressed a bit too long -- with very serious consequences for financial stability and growth.”
The U.S. mindset holds that if markets faltered on a Fed taper announcement – or, God forbid, a 25 bps rate increase – this would provide unequivocal evidence of a policy blunder.
Long forgotten is the more traditional alarm when a central bank fails to move in a timely manner to tighten policy - “falling behind the curve.”
Markets in the past feared the Fed being late to respond to inflation and excess.
This circumstance would at some point require an aggressive policy response.
The job of the Federal Reserve is “to take away the punch bowl just as the party gets going.”
This critical insight from the great central banker, Marriner Eccles, is dismissed as hopelessly archaic.
These days, it’s more a central bank’s job to spike the punch at the earliest indication the party might be losing its momentum.
A view took hold that inflation had been permanently defeated – that enlightened central bankers possessed the tools and mastery to ensure inflationary pressures would remain under tight control.
And with inflation well-harnessed, there was no reason to fear elevated asset prices that were in the past vulnerable to Fed-orchestrated tightening cycles.
And with inflation dead and buried, the availability of open-ended QE ensured central bankers enjoyed unparalleled capacity to respond with overwhelming stimulus in the event of faltering securities and asset markets.
Asset inflation and Bubbles are no longer to be feared, and they certainly don’t justify monetary tightening that might unduly jeopardize economic prosperity.
As is too often the case, conventional thinking is more wishful than wisdom.
Inflation is very much alive, and it’s definitely not controlled by central banks.
And, importantly, asset inflation and Bubbles pose momentous systemic risk to economic, financial and social stability.
The assumption is that a cautious Beijing will “dial back property curbs when they start to bite” – just as they’ve repeatedly succumbed in the past.
There is so much at risk – to China’s maladjusted economy, the bloated financial system, and vulnerable social stability.
To be sure, risks have inflated to such extremes, specifically because Beijing developed a habit of flinching.
As I’ve written over the years, “Bubbles scoff at timid.”
Inflationary dynamics gather momentum over time; inflationary biases become increasingly entrenched.
Mr. Eccles’ wording “just as the party gets going” was not happenstance.
There’s a steep price that will have to be paid for not quashing inflationary dynamics early.
In China’s case, not only did officials fail to repress housing inflation and speculation, their propensity to back off early worked to further invigorate Bubble Dynamics.
Literally tens (hundreds?) of millions of property (apartment) speculators became emboldened.
Beijing would ensure their housing wealth only inflated.
Housing was for living, while housing speculation became the ticket to a better life.
Beijing recognizes it has an urgent problem.
Its historic apartment Bubble has created enormous economic imbalances.
It poses a great threat to China’s financial system.
Moreover, Bubble excess is exacerbating social inequality, with mounting risk to social stability.
They are forced into being Necessarily Aggressive because previous feeble tightening attempts failed.
The pertinent question has become: how much pain are they willing to tolerate?
Having fallen significantly “behind the curve,” speculative dynamics will be restrained only through the administration of pain.
Speculators have to suffer.
Ditto for lenders.
Lessons must be learned the hard way.
But at this stage, a determined tightening risks a Bubble collapse with serious systemic risk.
And if Beijing again loses its nerve, it will display weakness.
At this phase of the cycle, a revived bubble would have disastrous consequences.
September 9 – Bloomberg:
“Regulators in Beijing have signed off on a China Evergrande Group proposal to renegotiate payment deadlines with banks and other creditors, paving the way for a temporary reprieve as the cash-strapped developer struggles to come to grips with more than $300 billion of liabilities.
China’s Financial Stability and Development Committee, the nation’s top financial regulator, gave its blessing to Evergrande’s plan last month after the property giant missed interest and principal payments on some loans, a person familiar with the matter said…”
Evergrande’s four-year bond yields rose to 62% in Wednesday trading, before the above news of lender forbearance sparked a relief rally (yields ended the week at 52.5%).
Other troubled developer bonds also reversed higher.
Yet an index of Chinese high-yield bonds ended the week with yields not far off highs since March 2020.
My assumption is there’s no turning back for Beijing this go round.
They intend to break speculative psychology – orchestrating a so-called “Volcker Moment.”
And this is consistent with the signal sent this year from safe haven global bond markets.
This is, however, necessarily a high-risk strategy, with Chinese officials keen to avoid a “Lehman Moment” – the type of panic and acute market dislocation that would unleash grave systemic instability.
So, Beijing will attempt a controlled process of Bubble deflation.
We’ve already witnessed a Huarong bailout and some forbearance for Evergrande.
As for the big picture, China’s strategy is similar to Fed efforts during the late-twenties: Try to tighten finance for speculative endeavors, while promoting lending for productive investment.
It didn’t work for the Fed, and I don’t expect a successful outcome for Beijing.
Late in a major speculative cycle, levered speculation becomes a primary source of system Credit and liquidity.
Faltering Bubbles and resulting deleveraging ensure a contraction of speculative Credit.
This could be somewhat offset by Credit growth in “productive” sectors, though this is much easier in theory than in actual practice.
Throwing Credit at such an acutely imbalanced economy at a cycle inflection point is fraught with risk.
I expect the faltering Chinese real estate Bubble - and the associated unwieldy changes in financial flows through the economy - to prove highly destabilizing.
China’s August lending data was generally disappointing. At $460 billion, Aggregate Financing (system Credit) bounced back (from July’s $164bn) to beat estimates, bolstered by strong growth in government bond issuance.
Bank Lending, however, was notably weak.
At $189 billion, New Loans were about 15% below estimates.
This was about 5% below August 2020 and only slightly ahead of August 2019.
While Consumer Loans somewhat recovered from a dismal July, at $89 billion they were down about a third from August 2020 and 12% lower than August 2019.
According to Reuters, “Some major Chinese banks had stepped up lending toward the end of August and reduced a backlog in property loans after being advised by the central bank to increase loan quotas for the month.”
Corporate Loans jumped from July’s exceptionally weak $67 billion to $108 billion, though August was second only to July for the weakest growth so far this year.
September has in the past been a seasonally strong month for lending, so perhaps we’ll have a clearer view of China’s Credit dynamic next month.
At 10.3%, August’s year-over-year growth in Aggregate Financing was the weakest since December 2018.
It’s worth noting the abrupt slowdown in China’s M2 monetary aggregate continued in August.
At $25 billion, M2 growth was only about a quarter of the August 2020 level – with expansion over the past three months slowed to a mere $10 billion.
At this point, the benefit of the doubt goes to the China Credit slowdown thesis.
September 5 – Bloomberg:
“China’s Vice Premier Liu He made a strong pledge to continue supporting private businesses after a spate of regulatory crackdowns in sectors from after-school tutoring to Internet platforms rocked financial markets.
‘The principles and policies for supporting the development of the private economy have not changed,’ Liu, who is President Xi Jinping’s top economic adviser, said…
‘They don’t change now, and will not change in the future.’
China must stick to socialist market economy reforms and persist in opening up the economy, Liu said, vowing the country will protect property rights and intellectual property rights.”
Frog in the pot syndrome.
The Shanghai Composite surged 3.4% this week.
For how long can the semblance of Beijing having every under control hold?
All eyes on China’s real estate markets.
September 8 – Yicai Global:
“Sales of second-hand homes in China’s first-tier cities such as Shanghai and Shenzhen plunged last month amid ongoing policy adjustments to rein in the country’s housing market.
Some 18,000 pre-owned homes sold in Shanghai last month, down 40% from a year earlier, the biggest drop so far this year…
The total value of the deals fell 44% to CNY57.4 billion (USD8.9 billion).
The average price was CNY3.18 million (USD492,000), a 7% drop…
In Shenzhen, sales fell for the fifth straight month, plunging 82% to a 10-year low of 2,043 units…
The number of deals also fell in Beijing, dropping 10.7% from July to 15,942 units.
Guangzhou, another first-tier city, recorded 7,000 new home sales, the lowest in the past 15 months.”
U.S. equities markets were under some broad-based selling pressure.
The VIX spiked into Friday’s close, ending the week at almost 21.
Curiously, U.S. corporate Credit was bullet proof.
Still dancing…
September 10 – Bloomberg (Brian Smith):
“The U.S. investment-grade primary market completed its busiest week in history after an eyebrow-raising 54 high-grade companies sold debt in just four days to break the record for number of deals…
Weekly volume of $77.8bn ranks fifth all time, trailing only four weeks in 2020 when issuers rushed to the capital markets in search of liquidity…
Bond sales nearly doubled projections of $40bn-45bn, accounting for more than half of the $140bn expected for the entire month…”
September 10 – Bloomberg (Lisa Lee):
“The leveraged finance market is bracing for a surge in new deals, fueled by booming demand for M&A financing and investors hungry to get their hands on anything offering an alternative to rock-bottom interest rates.
September could see as much as $110 billion of U.S. high- yield bond and leveraged loan sales, according to bankers…, making it one of the busiest months in years.
The leveraged loan market already saw 12 deals launch on Tuesday, and there’s little sign the deluge is set to slow anytime soon…
The impending onslaught adds to what’s already been a historic year. U.S. junk-bond issuance of about $346 billion is on pace to surpass last year’s record $432 billion.
Leveraged loan supply of around $400 billion, excluding repricings, is already the most since Bloomberg began tracking the data in 2013.”
Off the charts bond issuance.
Euphoric.
August job openings “JOLTS” data were reported Wednesday, with a record 10.934 million unfilled positions.
August Producer Prices rose at a stronger-than-expected 8.3% annual rate (China’s up a larger-than-expected 9.5%).
National home prices were reported up 18% y-o-y, the strongest annual housing inflation in the 45-year history of the data series.
And the latest thinking is the Fed will pass on beginning tapering at its September 22nd meeting.
Why is the Fed dragging its heels?
It was reported this week that a number of Fed officials have been actively trading their stock accounts.
For an institution in the process of destroying its credibility, they should be smarter than that.
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