Greece is connected to China by the very same thing which has been connecting sex, drugs, and rock’n’roll since Bretton Woods – dollars.
Last week I shared some thoughts on the unintended consequences of actions taken in Europe and why Greece may matter as a result. There is zero chance that the actions taken will result in a stronger Europe, a stronger euro, or an economic strengthening in either Greece or the wider eurozone. Zero!
As interesting as Greece and the euro is, my attention today is on China and how China may well be forced by events taking place globally to make some far reaching choices.
Two scenarios have been widely discounted by the market with respect to China. The first is a remnimbi devaluation and the second is a hard landing for a slowing Chinese economy.
We know that the Chinese economy is slowing. We know this because Beijing tells us it’s so. Their last numbers were that the economy has slowed to their growth target of 7%. Bang on their target rate. How convenient! Now of course these numbers are rubbish, but it’s telling that they’re acknowledging a slowing economy.
We account for these government numbers in the same way we account for any government numbers: by acknowledging that underneath all the pompous sophistication of bureaucrats everywhere pulsates the brain of a tree shrew. The important takeaway is that they’re acknowledging they’re slowing.
China’s Market Crash
As everybody now knows, the Chinese stock market lost over 30% in 3 weeks wiping $2.8 trillion off the books. The only way to lose that much money in such a rapid period of time is by getting caught by your wife having hanky panky with her best friend.
Sure, investors who bought at the top are hurting, but consider that the stock market is up roughly 80% over the last 12 months, and this is AFTER the crash. Viewed with that timeframe and taken into context this is hardly problematic.
This correction is nowhere near as big a concern as it would be if we had a similar occurrence take place in the US due to who is participating.
80 – 90% of the domestic A-share market is made up of retail investors. Novices. This was a bubble waiting to burst as retail investors flooded the market with a record 40 million new brokerage accounts created in the last year. Not only were novices entering the market but they were entering it on margin. By June of this year margin lending as a percentage of market cap ran as high as 20%. While these investors make up the majority of the market they represent a small part of the population. The free float of China’s markets is about a third of GDP, whereas in the developed world this number is over 100%. A soaring stock market and a crashing stock market will have little effect on the vast majority of Chinese households. This is unlike the developed world.
Essentially, this is a tiny portion of the market that got burned. It really needn’t be a problem unless someone does something stupid and causes unintended consequences. Sadly this is exactly what Beijing is doing.
Is China or the US the Next Greece?
Perhaps it’s simply a matter of timing and what’s racing across the news feeds but I’ve read quite a few articles about how the US and China are next after Greece. Debt levels are cited along with a host of other similarities. This is – how do I put this politely – rubbish. The US and China are NOT Greece. Even if the debt levels were the same the similarities end there. Greece cannot issue its own currency. In last week’s missive I mentioned that:
Greece, however, no longer issues its own currency and as such there exists no release valve. Trapped in a deflationary spiral the economy continues to contract: 0.2% in the first quarter of this year following a 0.4% in the last quarter of 2014. When Greece joined the euro, they ceded monetary sovereignty to Brussels, and in doing so stuck a plug in its currency release valve.
That makes Greece unique. The US, on the other hand, can print all the currency they want and pay their debts at par. Greece can’t do that. The bonds of the US, Japan and even China are not at all to be likened to the bonds of Greece. One needs to make a distinction between debt denominated in the country in questions own currency and debt denominated in some other currency.
For countries sporting high debt levels and where simultaneously those debts are foreign denominated this can become a huge problem. Just ask that crazy woman in Argentina…
The Asian crisis, which I discussed last week, is such an example whereby debts denominated in USD became unsustainable. Once the rout started a self-fulfilling trend developed whereby as the currencies in Southeast Asian nations moved lower this added multiples to the payments required on leveraged assets. A vicious unwinding of the carry trade.
What I find the most fascinating is not the correction in the Chinese stock market but the actions taken by the PBOC subsequently.
This can only be described as outright panic. Consider the following actions taken.
- China Securities Finance Corp has lent $42 Billion to 21 brokers instructing them to buy blue chip stocks
- A $40 billion stimulus plan to “foster growth”
- Speeding up infrastructure spending.
- Capital controls by another name: controlling shareholders and board members are locked up for 6 months from selling stock.
- All new IPOs stopped
- PBOC slashed rates and eased reserve requirements.
- Chinese investors are now allowed to use their properties as collateral to buy stocks.
Aside from the fact that they are doing exactly the opposite of what should be done I find it telling that they are so willing to slash rates and devalue the yuan.
As mentioned, this needn’t be a problem if they simply let the market correct and find its equilibrium.
They haven’t done that and this is what has caught my attention more than anything else.
The Debt Component and What This May Mean for the Yuan
Debt is important to understand as debt is the “gasoline” added to any trade. Debt, or more correctly put, leverage amplifies gains and losses and as such is both the prozac as well as the viagra of global markets. I wrote extensively about the US carry trade in our USD Bull Report but will summarise an important point.
China boasts an estimated US$3 trillion borrowed and invested in various Chinese assets. A decline in those assets values materially affects investors who’ve leveraged their positions, but what really really matters is when the funding currency appreciates and those investors who are short dollars are forced to buy back their dollar positions.
Now this is where Greece and China are interconnected. Greece, as mentioned, threatens to be a poster child of Europe and the euro. This is naturally bullish for the euro in the same way that spandex pants look good on Angela Merkel – not so much!