As the ramifications of what the Federal Reserve said yesterday loom over the major markets of the world, the credit crisis in China is not being given its due focus. China, being the world’s second largest economy, will have a huge impact on both emerging markets and the developed world if and when it implodes. One of the most vulnerable economies in the world today is Japan, where currently Abenomics is hinging on so many factors that it is simply not in the hands of Shinzo Abe and Bank of Japan’s Governor Kuroda to anchor it merely with their quadrillion sized stimulus.
Japan showed a 6.3 percent increase in exports to China last month, the highest gain since Dec 2010. While the boost is encouraging, it should also be noted that while Japan is trying to come out of a recession, China is on the verge of entering one. This dynamic will drive China to cut down on imports as the country turns into a bigger mess every day.
China’s Economic Woes
China is already showing all signs of a financial crisis. HSBC flash PMI fell to 48.3 in May compared to the consensus estimate of 49.1. The country’s exports grew at just 1 percent in May, much lower than the Bloomberg estimate of 7.4 percent, after a massive crackdown on fake invoicing by Chinese exporters. In contrast, exports from China were up 14.7 percent in April. Imports in May slipped 0.3 percent, showing poor domestic demand.
But China’s economic condition is far worse than that. The country’s debt pile has risen to 205 percent of GDP, and analysts say about one-third of that is bad debt. Borrowing in the largest Asian economy continues to rise rapidly, but GDP isn’t growing at a similar pace. That’s because a large number of Chinese businesses are raising fresh debts to pay off old ones with high interest rates.
Latest in China’s financial woes is a liquidity squeeze that pushed the Shanghai Interbank Offered Rate (Shibor) to an all-time high of 13.44 percent on Thursday from just 7.66 percent on Wednesday and less than 4 percent at the beginning of June. Chinese banks use Shibor to lend money to each other. The shortage of cash has prompted local banks to borrow at higher rates from other banks.
Bank of America Merrill Lynch analyst Winnie Wu said in a research report that the the cash crunch will affect China’s GDP growth, increase lending rate and unemployment rate, and push private sector enterprises into trouble. Fitch Ratings’ Charlene Chu has given a number of reports on how China’s credit bubble can wipe out its entire banking system which has piled up a record amount of assets. Chu observed that China has shown a massive increase in credit ratio to GDP and has said that the next six months would be crucial.
China Woes Impact on Abenomics
A financial crisis in China would prompt investors to turn towards safe haven currencies like Japanese yen, spurring demand for the yen. In that case, a strong yen will affect Japanese exports. That will be in stark contrast with Abemonics, which aims to boost exports and equities by devaluing the yen. The recent spike in yen prompted many investors and analysts to call Abenomics a failure. So, what would happen if the yen rises even more in case of a Chinese crisis?
Moreover, a crisis in China will also reduce imports. The dragon is the second largest trading partner of Japan, as the country exported goods and services worth $144.7 billion in 2012. Japan’s exports to China fell 10 percent in 2012 due to political tension between the two countries. A financial crisis in China could pose an even bigger threat to Japanese exports.
Hedge Funds Hanging In For Now But May Sail
Meanwhile, most hedge funds have been betting big on Abenomics, i.e., short on yen and long on Japanese equity. All of the big names in the hedge fund industry have been on the short side of JPY—Dan Loeb, David Einhorn, Ray Dalio, George Soros, Paul Tudor, and Jeff Gundlach have shared their short theses on JPY and there has been no indication that any of them have covered their positions.
The interesting, if not worrying, fact is that while Japanese stocks fell, large macro hedge fund managers not only stuck to their long positions in Nikkei but also added more. A prime example is George Soros—his firm Soros Fund Management further added to its positions in Japanese equities as markets were busy shedding their gains.
Despite losing in the first weeks of June, large global macro funds like Fortress Macro, Tudor Global, Moore Capital, while paring back their value at risk in Japan, remain invested in short yen and long Nikkei positions. According to investors of Fortress Macro Fund, returns were down 1.8 percent in the first week of June whereas Paul Tudor’s Tudor BVI Global slid 1.9 percent and Louis Bacon’s Moore Capital was down 1.7 percent in the same period. Caxton Global showed a -1.3 percent return to June 10.
A China crisis may turn the equations for these hedge funds. For the time being, all eyes in midtown are looking at Beijing.
(Additional reporting by Tabi Hussain)