If the private lenders stop making money then the cascade
will truly begin. That there also exists
a mass of unsold housing is obviously insane as that means that the natural
buyers cannot get credit. Why Not?
If there is no sane reason for a well-heeled young buyer to
buy your housing, it is time to run for your life.
What will collapse is credit. They cannot print money fast enough to
prevent a sudden return to a rational sentiment and once underway all will wait
to see how cheap is cheap. That will
depend then on real incomes much of which has to be supported by government as
well.
China’s Monumental Ponzi: Here’s How It Unravels
March 29, 2014
China is the greatest
construction boom and credit bubble in recorded history. An entire nation of
1.3 billion has gone mad building, borrowing, speculating,
scheming, cheating, lying and stealing. The source of this demented
outbreak is not a flaw in Chinese culture or character—nor even the kind
of raw greed and gluttony that afflicts all peoples in the late
stages of a financial bubble.
Instead, the cause is
monetary madness with a red accent. Chairman Mao was not entirely mistaken when
he proclaimed that political power
flows from the end of a gun barrel-–he did subjugate a nation
of one billion people based on that principle. But it was Mr.
Deng’s discovery that saved Mao’s tyrannical communist party
regime from the calamity of his foolish post-revolution economic
experiments.
Just in the nick of time,
as China reeled from the Great Leap Forward, the famine death of 40 million and
the mass psychosis of the Cultural Revolution, Mr. Deng learned that power could be maintained and extended
from the end of a printing press. And that’s the heart of the so-called China economic miracle.
Its not about capitalism with a red accent, as the Wall Street
and London gamblers have been braying for nearly two decades; it is a
monumental case of monetary and credit inflation that has no parallel.
At the turn of the
century credit market debt outstanding in the US was about $27 trillion,
and we’ve not been slouches attempting to borrow our way to prosperity. Total
credit market debt is now $59 trillion—-so America has been burying
itself in debt at nearly a 7% annual rate.
But move over
America! As the 21st century dawned, China had about $1 trillion of
credit market debt outstanding, but after a blistering pace of
“borrow and build” for 14 years it now carries nearly $25 trillion.
But here’s the thing: this stupendous 25X growth of debt occurred in the
context of an economic system designed and run by elderly party apparatchiks
who had learned their economics from Mao’s Little Red Book!
That means there was
no legitimate banking system in China—just giant state bureaus which
were run by party operatives and a modus operandi of parceling
out quotas for national credit growth from the top, and then water-falling
them down a vast chain of command to the counties, townships and villages.
There have never been any legitimate financial prices in China—all
interest rates and FX rates have been pegged and regulated to the decimal
point; nor has there ever been any honest accounting either—-loans have
been perpetual options to extend and pretend.
And, needless to say,
there is no system of financial discipline based on contract law. China’s GDP
has grown by $10 trillion dollars during this century alone—that is, there
has been a boom across the land that makes the California gold rush appear pastoral
by comparison. Yet in all that frenzied prospecting there have
been almost no mistakes, busted camps, empty pans
or even personal bankruptcies. When something has
occasionally gone wrong with an “investment” the prospectors have gathered
in noisy crowds on the streets and pounded their pans for relief—-a
courtesy that the regime has invariably granted.
So in two short decades,
China has erected a monumental Ponzi economy that is economically
rotten to the core. It has 1.5 billion tons of steel capacity,
but ”sell-through” demand of less than half that amount— that is, on-going
demand for sheet steel to go into cars and appliances and rebar into
replacement construction once the current pyramid building binge finally
expires. The same is true for its cement industry, ship-building, solar
and aluminum industries—to say nothing of 70 million empty luxury
apartments and vast stretches of over-built highways, fast rail,
airports, shopping mails and new cities.
In short, the flip-side
of the China’s giant credit bubble is the most massive malinvesment of
real economic resources—-labor, raw materials and capital goods—ever known.
Effectively, the country-side pig sties have been piled high with copper
inventories and the urban neighborhoods with glass, cement and rebar
erections that can’t possibly earn an economic return, but all of which has
become “collateral” for even more “loans” under the Chinese Ponzi.
China has been on a wild
tear heading straight for the economic edge of the planet—-that is, monetary Terra
Incognito— based on the circular principle of borrowing, building and
borrowing. In essence, it is a giant re-hypothecation scheme where every man’s
“debt” become the next man’s “asset”.
Thus, local government’s
have meager incomes, but vastly bloated debts based on stupendously
over-valued inventories of land. Coal mine entrepreneurs face
collapsing prices and revenues, but soaring double
digit interest rates on shadow banking loans collateralized by
over-valued coal reserves. Shipyards have empty order books, but vast
debts collateralized by soon to be idle construction
bays. Speculators have collateralized massive stock piles of copper
and iron ore at prices that are already becoming ancient history.
So China is on the cusp of the greatest margin call in history. Once asset values starting falling, its pyramids of debt will
stand exposed to withering performance failures and melt-downs.
Undoubtedly the regime will struggle to keep its printing press prosperity
alive for another month or quarter, but the fractures are now gathering
everywhere because the credit rampage has been too extreme and hideous. Maybe
Zhejiang Xingrun Real Estate which went belly up last week is the final
catalyst, but if not there are thousands more to come. Like Mao’s gun barrel,
the printing press has a “sell by” date, too
Of the more than US$562
million (RMB3.5 billion) that it owed to debtors, US$112 million was borrowed
from 98 private parties with annual interest rates of up to 36%, according
to recent revelations from Chinese media. Under that kind of pressure, the only surprise is that the
default didn’t happen sooner. The company struggled to find capital for years;
the chairman is suspected of borrowing up to US$38.6 million with “fake
mortgages.”
But before Xingrun gets
branded as China’s worst small, private homebuilder, it’s important to
understand how it ended up in the mess in the first place, and what specific
factors brought the operation down, or at least to the brink of collapse (local
government officials insist it hasn’t officially defaulted yet).
Xingrun’s business in Fenghua,
a county-level city that is part of Ningbo in a manufacturing belt on China’s
east coast, ran into trouble through a renovation project starting in
2007, Chinese media pointed out. The company
attempted, after securing government support and taking over for another
distressed local property company, to build high-rise apartment blocks in a
village called Changting. The project required the company to build homes for
the original residents before the existing village could be torn down and the
new buildings built. Construction was slated to start in the first half of
2012. Xingrun projected that it could pay off its debts within three years.
The project never got to
the construction phase. In fact, the small village homes are still standing.
Xingrun built the replacement homes for the villagers but there’s no sign of
its main housing product, high-rises. Nothing has happened because the
residents of the village have tangled the project and the company in a lawsuit
that has stretched for years.
That explains why Xingrun
was unable to pay back its loans. But why has it come so close to keeling over
now? Its troubles with the Changting project persisted for years but the company
simply rolled over loans and borrowed at high rates from private lenders.
One problem for
capital-strapped developers in the Ningbo area is that private lenders no
longer want to lend to highly risky companies. In fact, they are calling in
their loans. This is just one of the problems afflicting Xingrun. The value of
property in some areas of Fenghua is decreasing and that trend has lowered
confidence in developers’ ability to pay dizzyingly high interest rates.
Banks aren’t hot on
lending to this kind of developer either. In the past, a developer such as
Xingrun could ask the local branch of a commercial bank for more credit. The
local branch would take that risk because loan officers there knew that,
somewhere much higher up the chain, officials promoted the lending.
That support exists no
longer. Now, when small developers beg local banks for credit, they will likely
be turned away. Local bank managers are reportedly being told that they may
lend to risky borrowers if they wish, but they will be held accountable.
High risk is something no
one seems willing to stomach these days – in stark contrast to just a year ago.
Fenghua is a small town,
and Xingrun’s reach beyond that area is limited. Analysts have come out strong
in saying that such a default has little systemic risk. The bigger picture in
the region, however, can’t be ignored.
Xingrun’s woes are still
the woes of the local authorities. The default will add US$305 million (RMB1.9
billion) to Fenghua province’s non-performing loan portfolio, pushing up the
rate of toxic assets to 5.27% and making it Zhejiang province’s most indebted
government, according to calculations by The Economic Observer newspaper.
Add Fenghua’s problems to
those of the greater Ningbo region. The area reportedly has at least six years
of housing stock either sitting empty or under construction. The massive
buildout will put small developers under great pressure to pay back loans,
especially if private debtors are calling in high-interest loans. A slowdown in
property prices won’t help either. Without a rescue from provincial-level
banks, Fenghua won’t be the last local government stuck in a jam.
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