Revisiting the Bursting China Bubble
Doug Nolan
The late-nineties U.S. “tech” Bubble was financed, at the margin, by high-yield debt (telecom, in particular), speculative hedge fund levered finance, and GSE liquidity.
The Bubble was reasonably well contained within the technology, telecom and media sectors.
Importantly, since the Bubble was not systemic, the system readily responded to Fed reflationary measures.
It helped tremendously that housing and mortgage finance were, even in the midst of the bursting tech Bubble, demonstrating powerful inflationary biases.
The resulting mortgage finance Bubble was more systemic.
This historic Bubble was - at the margin - financed by perceived safe and liquid (money-like) “AAA” mortgage securities and derivatives (too much acquired for leveraged speculation).
This critical dynamic ensured the Bubble period was more prolonged, excesses broader and deeper, and associated financial and economic structural impairment much greater.
Accordingly, the subsequent U.S. bust was deeply systemic.
Post-2008 crisis reflationary measures were unprecedented on a global basis.
It’s worth noting that while the so-called “great financial crisis” (GFC) was global, it was not in the true sense of the term “systemic.”
Importantly, China and EM (generally) were at the time of the crisis demonstrating strong inflationary biases (i.e. vigorous Credit growth, asset inflation, speculative impulses, economic momentum, etc.).
Beijing moved aggressively with a $600 billion stimulus program, as China and the developing world provided the key “economic locomotive” driving global recovery.
The current backdrop is unique.
The global Bubble period was unprecedented in scope and duration.
Bubble Dynamics went to the foundation of global “money” – central bank Credit and government debt.
This provided unparalleled durability to Bubble Dynamics, where years of the most egregious excess (i.e. monetary, fiscal, leveraged speculation, Bubbles, manias, mal-investment, etc.) wreaked historic financial and economic structural maladjustment.
Bubble excess could not have been more systemic on a global basis.
The world is these days literally confronting scores of Bubbles, some bursting and others at the cusp.
This creates significant analytical challenges.
There is the complex “Periphery to Core” dynamic.
There are also faltering Bubble sequencing issues, along with a dispersion of policy responses.
And speculative dynamics have never before played such a pivotal role in global liquidity dynamics.
In short, as we’ve witnessed in recent weeks, many independent yet interrelated Bubbles create extraordinarily complex (and erratic) global dynamics.
Acute China Bubble fragility last year was a key dynamic working to sustain ultra-low global bond yields (thus elsewhere extending “Terminal Phase Bubble Excess”) even in the face of intensifying inflationary pressures.
Recall that Chinese Crisis Dynamics began with the Huarong eruption in April 2021.
While Beijing stuck a band aid on Huarong (recapitalization), the blood would soon be spurting from numerous wounds.
Below 14% in May 2021, Evergrande yields would be at 75% by mid-October.
It was not long before “isolated” developer issues turned anything but: Shimao, Lonfor, Sunac, Kaisa, Fantasia, Sunshine 100, Greenland, Modern Land, China Properties Group, Xinyuan Real Estate, Powerlong, Zhongliang, Zhenro Properties…
July 4 – CNN (Laura He):
“Another major Chinese developer has defaulted on its debt, dealing a new blow to the ailing real estate sector in the world's second largest economy.
Shanghai-based Shimao Group failed to pay the interest and principal on a $1 billion bond due Sunday…
On Friday, a survey by China Index Academy — a property research firm — showed that prices for new homes in 100 cities plunged more than 40% in the first half of this year, compared with the same period last year.”
The Chinese developer crisis is old news.
Beijing, of course, has everything under control. Indeed, global markets were bolstered again this week by reports of additional stimulus measures.
July 7 – Bloomberg (Jana Randow and Alessandra Migliaccio):
“China’s Ministry of Finance is considering allowing local governments to sell 1.5 trillion yuan ($220bn) of special bonds in the second half of this year, an unprecedented acceleration of infrastructure funding aimed at shoring up the country’s beleaguered economy.
The bond sales would be brought forward from next year’s quota, according to people familiar…
It would mark the first time the issuance has been fast-tracked in this way, underscoring growing concerns in Beijing over the dire state of the world’s second-largest economy.”
The bottom line is that the situation in China continues to deteriorate despite massive Beijing stimulus.
Understandably, Chinese officials are turning panicky.
While some economic indicators reflect an uptick in economic activity from pent-up Zero-Covid demand, there is little to indicate the type of bounce back in confidence necessary to power a sustainable recovery.
Indeed, evidence supports the view that the housing downturn is becoming only more deeply entrenched.
July 6 – Bloomberg (Chris Anstey):
“Charlene Chu, famed among China watchers for warning about a debt bubble when at Fitch Ratings, says that pain is only just beginning for credit extended to Chinese property.
In the wake of Beijing’s sweeping crackdown on leverage built up in real estate, China Evergrande Group and others have defaulted on a slew of bonds.
Chu, a senior analyst at Autonomous Research…, estimated that ‘we have 30 companies who’ve defaulted with total liabilities of around $1 trillion…’
‘We’re just so early in this process of these defaults happening, and restructurings usually take quite a long time,’ said Chu…
‘We haven’t really gotten to the point of saying, ‘OK, well, what really is going to happen with that building?’”
Indicators point to broadening Chinese Credit instability.
Curiously, Huarong CDS was up another 64 bps this week, with a two-week surge of 202 bps – to the high since October 2021.
Vanke CDS jumped 105 in two weeks (45 bps this week) to 372 bps.
One of China’s largest and financially stable developers, Vanke CDS traded below 100 bps in September.
Meanwhile, Country Garden, China’s largest developer, saw bond yields surge 255 bps this week to 29.47%.
Yields were up 950 bps over the past month, almost back to March spike highs.
Sunac yields were up 517 bps this week, Lonfor 1,624 bps and Kaisa 530 bps.
The Bloomberg Chinese offshore ($) high-yield index surged 92 bps this week to 24.37%.
The Bloomberg Asia (ex-Japan) High Yield Index yield jumped 31 bps this week to a record 16.42%, with a three-week gain of 231 bps.
It’s worth noting that the yield on this index spiked to a crisis high of 13.35% during March 2020.
July 7 – Bloomberg (Rebecca Choong Wilkins):
“A China Huarong Asset Management Co. perpetual dollar bond is set for its biggest drop since the company spooked investors about its financial health last year.
The sudden plunge followed a steep drop the past week in an offshore perpetual note sold by smaller peer China Great Wall Asset Management Co.
The company missed a June deadline to publish its 2021 annual report, renewing concerns over the health of the nation’s state-controlled bad-debt managers and echoing a similar delay by Huarong last year.
‘We are starting to see a contagion effect from Great Wall to the whole AMC space,’ said Nicholas Yap, head of Asia credit desk analysts at Nomura…”
Further evidencing heightened contagion, conglomerate Fosun International bond yields surged 650 bps this week to a record 24.74%.
Yields are up almost 15 percentage points in four weeks.
July 2 – Financial Times (Edward White and Cheng Leng):
“Chinese billionaire Guo Guangchang, whose global empire includes French resort group Club Med, Portugal’s biggest bank and the English football club Wolverhampton Wanderers, was among the last men standing.
A decade ago, Guo’s Fosun along with conglomerates HNA, Dalian Wanda, CEFC and Anbang drove an explosion in offshore Chinese investment but most were undone after President Xi Jinping called time on the debt-fuelled acquisition spree.
Guo survived the crackdown.
But he is now back in the spotlight after a sudden sell-off in property bonds put scrutiny on a liquidity crunch and $40bn debts at his expansive conglomerate.”
There is ample evidence that China’s historic Bubble is in increasing peril.
Things are really bad, but are almost certainly a lot worse than what we think.
Most ominous of all, China’s Bubbles are faltering even with ongoing massive (double-digit) Credit growth.
July 5 – Bloomberg:
“China’s debt will likely hit a record this year as the central bank tries to boost credit and shore up the struggling economy, according to a government-backed think tank.
The overall leverage ratio -- total debt as a percentage of gross domestic product -- is projected to increase by 11.3 percentage points to around 275% this year, according to Zhang Xiaojing, director of the National Institution for Finance and Development.”
Quietly, China’s deteriorating Credit backdrop has been a key factor in recent sharp reversals in global commodities prices and bond yields.
And I believe the world would today be panicky of the unfolding Chinese crisis, if not for two key elements.
First, especially in the current fraught geopolitical backdrop, Beijing will stop at nothing to ensure China remains on a growth trajectory.
Second, China’s massive international reserve hoard ensures Beijing retains the firepower to thwart the type of currency crisis that typically dooms EM Bubbles.
On the suddenly critical subject of reserves, China’s International Reserve holdings declined another $56.5 billion during June to $3.071 TN.
Reserves are now down $179 billion y-t-d to the lowest level since they sank $46 billion in pandemic-period March 2020.
Chinese Reserves have not suffered such a steep decline since the 2015/16 devaluation period.
Reserves are being depleted as finance flows out of China, at least partially explained by speculative deleveraging.
And with indications that Credit market de-risking/deleveraging has regained momentum, it would be reasonable to assume Credit stress accelerates as contagion gravitates to the vulnerable onshore market.
Bloomberg tallies a weekly index of total “World” International Reserve holdings.
Having surged $1.285 TN over the preceding 16 months, World Reserves hit an all-time high $13.047 TN in February.
In a dramatic change in trend, these Reserves have since plummeted $770 billion.
They were down an unusually bulky $127 billion over the past week alone.
Japanese Reserves have sunk $90 billion y-t-d.
So far this year, reserves have declined $25 billion in South Korea and $26 billion in Brazil (through April).
Hong Kong Reserves were down 10%, or $50 billion, since the November 2021 peak.
There have been other notable periods of EM international reserve drawdowns – 2009, 2015/2016, and 2018.
But in each case a surge in global QE liquidity reflated vulnerable Bubbles, with finance flowing abundantly right back to EM.
But today’s de-risking/deleveraging is different.
It’s secular instead of cyclical.
The inflationary backdrop precludes yet another massive round of Bubble-sustaining QE.
Global equities rallied this week.
The S&P500 recovered 1.9%, with the Nasdaq100 surging 4.7%.
Major European indices were up about 2%.
Some financial conditions indicators posted notable reversals.
U.S. High-yield Credit default swap (CDS) prices sank 61 bps in an extraordinary five-week period of volatility (up 59, up 44, down 47, up 48 and then down 61).
Investment-grade CDS dropped 10 to 91 bps (up 10, up 8, down 6, up 7 and up 10).
U.S. bank CDS reversed sharply lower, though the same cannot be said for European bank CDS.
The more positive mood received support from stronger-than-expected June payrolls data (plus 372,000).
JOLTS (job openings) data also surprised to the upside (11.254 million).
The Services PMI (52.7) and ISM Services Index (55.3) both beat forecasts.
By the end of the week, much of the recession talk had simmered down.
Focus shifted to the Fed, with analysts quickly positing that a 75 bps hike is now locked in.
But wasn’t the analytical community just last week explaining collapsing commodities pricing and sinking bond yields as proof of imminent recession?
I’d caution those confident of another big Fed rate hike that the July 27th meeting is still 19 days into the future.
While stocks rallied and some indicators suggested waning “risk off,” the forces of global de-risking/deleveraging were resilient.
In what has become a key indicator to monitor, EM CDS this week traded to highs since May 2020 (up 7 on the week to 344bps).
The euro broke sharply lower, with the week’s 2.2% decline boosting y-t-d losses versus the dollar to 10.5%.
A weak (and increasingly disorderly) euro fuels additional dollar strength, which places only greater pressure on global leveraged speculation (levered EM “carry trades” in particular).
Big EM CDS gains this week included Pakistan (80bps), Egypt (83), Sri Lanka (39), Kazakhstan (33), Guatemala (30), Kenya (15), Turkey (15), South Africa (13), and India (9).
At this point, I doubt the unfolding global liquidity crisis can be contained.
And I wouldn’t be surprised if an intense bout of global de-risking/deleveraging erupts between now and the Fed meeting.
Our central bank is now on a course of aggressive hikes until something breaks.
Markets a week ago were approaching a breaking point, but, in a typical “critical juncture” dynamic, approached the edge of the abyss and recoiled.
In the past, this type of market reversal was in anticipation of a Fed crisis response.
Yet we’re in a New Cycle.
At least for now, the Fed is fixated on its inflation fight, rather than sustaining Bubbles.
This ensures liquidity becomes an increasingly serious market issue.
With liquidity evaporation ongoing, Crisis Dynamics readily apparent, and the central bank liquidity backstop MIA, the global leveraged speculating community will have no alternative than to continue de-risking and deleveraging.
All eyes on China Credit.
Defenseless at the Periphery, EM remains in the crosshairs.
Contagion means more “hot money” outflows, central bank reserve liquidations, and global liquidity destruction.
Key sources of global liquidity have become incapacitated, with little prospect for recovery.
The recent gravitation of Crisis Dynamics from the Periphery to the Core took a break this week.
I expect this respite to the short-lived.
From my perspective, there is too much focus on U.S. data (i.e. payrolls and CPI) and not enough attention paid to global liquidity dynamics.
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