Morgan Stanley: China’s Minksy moment is here

From Morgan Stanley comes the latest must read bearish China report. The outlines here are right but MS underestimates the impact of a Chinese hard landing upon the world. I’m currently working on a members’ special report about how and when this business cycle ends but MS nicely describes how that ending begins.

We have described in detail over the past two years how we believe China’s twin excesses (excessive investment funded by excessive debt) will inevitably unwind, causing a substantial slowdown in China’s economy, significantly below market expectations. In recent weeks, a trip to the region and further research into China’s shadow banking system have convinced us that China is approaching its “Minsky Moment,” (Display 1) which increases the chances of a disorderly unwind of China’s excesses. The efficiency with which credit generates economic activity is already deteriorating, as more investments are made in non-productive projects and more debt is being used to repay old debts.

Based on our analysis, our baseline case is that China may slow from the current level of 7.7% Gross Domestic Product (GDP) growth to 5.0% over the next two years. A disorderly unwind could take Chinese growth down to 4% in a shorter time frame with potentially disastrous consequences for levered Chinese assets (banks, property) and the entire commodity supply chain (commodity stocks, equipment stocks, commodity-sensitive countries and their currencies).

The consensus is more optimistic and expects China’s economy to grow by 7.4% in 2014 and 7.2% in 2015. Most market participants have concluded that the Chinese economy, despite its excesses, will slow only moderately as the government successfully manages to “soft-land” the credit and investment boom and that, as a result, the impact on global GDP growth could be moderate and is not likely to derail the global developed-market-led expansion. However, one of the more controversial conclusions of our analysis is that global economic growth could be impacted severely enough to cause a global earnings recession.

china minsky 1_0

Hyman Minsky was a neo-Keynesian economist who developed a theory called the Financial Instability Hypothesis, similar to the Austrian school of thought, about the impact of credit cycles on the economy. In his 1993 paper entitled “The Financial Instability Hypothesis,” Minsky identified three financing regimes that economies can operate under: the first, which he called hedge finance, is a regime in which borrowers have sufficient cash flows to meet “their contractual obligations,” i.e. interest payments and principal repayment, usually by having a large equity component in their capital structure; the second, speculative finance, is a regime under which borrowers have cash flows that are sufficient to pay interest but not to repay principal, i.e. they must roll over their debts; the third, Ponzi finance, is a regime in which borrowers have insufficient cash flows to pay either principal or interest and therefore must either borrow or sell assets to make interest payments.

china minsky 2_0

Minsky stated that “it can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system.” His paper draws the following two conclusions: 1) that “the economy has financing regimes under which it is stable, and financing regimes in which it is unstable” and 2) “that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.” In essence, the longer an economic expansion goes on, the greater the share of speculative and Ponzi finance, and the more unstable the economy becomes.

Our analysis indicates that China’s economy has arrived at that unstable state where speculative and Ponzi finance appear to dominate. From a macroeconomic perspective, very few economies have ever created as much debt as China has in the past five years. China’s private sector debt has increased from 115% of GDP in 2007 to 193% at the end of 2013.3 (Display 2) That 80% increase over five years compares to the U.S.’s 26% in 2000-2005. In recent years, only Spain and Ireland have achieved debt growth greater than China’s.Every year, China is now adding $2.5 trillion of private sector debt to a $9.7 trillion GDP.

There is evidence that this debt growth has become excessive and non-productive. It now takes 4 renminbi (RMB) of debt to create 1 renminbi of GDP growth from a nearly 1:1 ratio in the early and mid-2000s. After the massive stimulus and more than doubling of new bank loans in 2009, the government attempted to stabilize credit growth, but the growth of the shadow banking system exploded instead. Shadow banking now accounts for more than a fifth of total credit in China—or about 40% of GDP from a base of 12% just five years ago. The shadow banking system funnels credit to borrowers who can no longer get loans from the formal banking sector, such as Local Government Funding Vehicles, the property sector, and companies in sectors with massive overcapacity and low or negative profitability such as coal mining, steel, cement, shipbuilding, and solar. Work by Nomura’s Chief China Economist indicates that more than half of Local Government Funding Vehicles, which borrow money on behalf of local governments to invest in infrastructure, have insufficient cash flows to pay interest or principal; the exact manifestation of Minsky’s Ponzi finance regime. Total local government debt adds up to RMB17.9 trillion (nearly $3 trillion) according to the latest, likely understated, national audit. In addition, estimates show that up to one third of all new borrowings are currently being used to roll over existing debt, and that interest payments on debt represent nearly 17% of Chinese GDP—a staggeringly large number (which excludes principal repayments) and which is nearly double the level that the U.S. reached in 2007. (Display 3)

china minsky 3_0

It is clear to us that speculative and Ponzi finance dominate China’s economy at this stage. The question is when and how the system’s current instability resolves itself. The Minsky Moment refers to the moment at which a credit boom driven by speculative and Ponzi borrowers begins to unwind. It is the point at which Ponzi and speculative borrowers are no longer able to roll over their debts or borrow additional capital to make interest payments. Minsky states this usually occurs when monetary authorities, in order to control inflationary impulses in the economy, begin to tighten monetary policy. We would add that this monetary tightening often begins to occur at the time when the size of speculative and Ponzi borrowings have become so large that the demand for additional capital to keep these borrowers afloat becomes greater than the supply of such capital. We believe that China finds itself today at exactly this juncture.

The People’s Bank of China (PBOC) has been slowly tightening credit for nine months. This can be seen in the steady uptrend in interbank financing costs (the one-month Shanghai Interbank Offered Rate, or SHIBOR, is up 220 basis points since last May). The PBOC’s latest Q4 Monetary Policy Report indicates it intends to continue to tighten liquidity in order to control the excessively fast growth of shadow banking credit.

Of the $1.8 trillion in Trust Loans provided by the shadow banking sector, nearly $600bn, or RMB 3.6 trillion will come due in 2014. (Display 4 shows maturities for a sample of half of collective trust loans, which represent one quarter of total trust loans)

Defaults or near-defaults have begun to occur with regularity over the past three months and are likely to pick up in quantity significantly over the next year. As it is becoming more clear that investors may not get all of their money back, interest rates on trust products, wealth management products (WMPs), corporate bonds, and bank loans have risen by roughly 200 basis points in the last year. (Display 5)

china minsky 4_0

So at the same time that large amounts of debt come due and borrowers are increasingly stretched, growth is slowing, monetary policy is being tightened, and market rates are beginning to rise, making new borrowings even more expensive and difficult. The combination of these factors indicates to us that China’s Minsky Moment is approaching.

The unwind of this credit boom is likely in progress, and we expect it to pick up speed over the coming months and quarters. It will likely involve a steady drip of defaults and near-defaults as insolvent borrowers finally become illiquid. Market rates for all assets except central government bonds and central bank bills will likely continue to rise, reflecting increasing market fears of default by shaky borrowers. Asset values will likely begin to deteriorate as stressed borrowers attempt to sell assets to stay afloat. As a result, banks and other financial entities could begin to increase provisioning for bad debts and to reduce credit availability by gradually tightening credit standards. This could lead to a credit crunch where credit to the economy is choked off for all but the safest borrowers.

This rise in defaults, non-performing assets, and credit standards could exacerbate a significant slowdown in economic activity concentrated in the areas most dependent on debt, such as local government infrastructure spending and the sectors with the greatest overcapacity mentioned above.

The impact would therefore be most visible in the fixed investment side of the economy, particularly in infrastructure, real estate construction and related industries (cement, steel, machinery, etc.).

In time, the slowdown in growth and the increase in defaults could become significant enough that the government would intervene and ease policy to moderate the downturn. This policy easing would likely involve a combination of monetary easing and extraordinary liquidity by the PBOC and possibly, some fiscal stimulus. But until then, the impact on assets that are dependent on China’s debt growth and investment spending growth could be severe.

We recognize that it is extremely likely that the Chinese government will attempt to stave off the unwind or at least keep it orderly in an effort to achieve the ever-elusive soft landing. One way that the government could attempt this would be by stepping in to bail out borrowers on the verge of default. A version of this occurred in January, when the well-publicized default of a RMB3 billion China Credit Trust product was averted when an unknown entity stepped in to pay the principal due to investors, though not the remaining interest due (worth approximately 7% of principal). The unknown entity is likely to have been either the local government of Shanxi, home of the coal mining company that defaulted on the underlying trust loan, or the Ping An insurance company, parent of China Credit Trust. The benefit of the government or other entities stepping in to bail out borrowers is that it helps prevent investors from losing money, maintaining their faith in the financial system and ensuring they continue to buy trust products offering rates five times above deposit rates. The drawback is that credit continues to be extended to weak or insolvent borrowers, potentially leading to an even higher level of bad debts in the future. The problem is not eliminated, it is simply postponed. Interestingly, growth is likely to be negatively impacted whether or not the government steps in frequently to prevent borrowers from defaulting. First, scarce capital is being provided to prevent default by insolvent borrowers (“zombies”) rather than being channeled toward productive investments. Second, in order to limit the cumulative size of the bailouts, the government is likely to continue to restrict the growth of shadow banking and lending to these uncreditworthy borrowers. Lastly, market rates are likely to continue to rise, reflecting increasing market unease with the growing number of near-defaults.

Most other analyses we have seen conclude that China could slow more than currently expected by the consensus, but that the global economy is well-positioned to withstand such a slowdown. Our conclusion is a bit more pessimistic. We have found that every 1% of Chinese GDP deceleration could reduce global economic growth by 60 basis points. On a current dollar basis (i.e., not purchasing power parity, or PPP), the global economy is expected to grow about 3% in 2014 and 2015. (Display 6)

china minsky 5_0

Therefore, if the Chinese economy were to slow by 200 basis points to 5.4%, from current expectations of 7.4% for 2014,13 (Display 7) global economic growth would slow to 1.8%, substantially below potential of 2.8%. This could have a significant impact on global equities, as our analysis shows that the global economy needs to grow at least 2.5% for global corporate profits to grow. Thus, a 1.8% pace for global GDP growth would result in earnings down roughly 13%, a huge miss compared to current expectations of 11% earnings growth. At this point, this is not our base case but a risk scenario we are closely monitoring.

china minsky 6_0

96 Responses to “ “Morgan Stanley: China’s Minksy moment is here”

  1. The Lorax says:

    I think I read this exact same story in 2010, 2011, 2012 and 2013.

    Won’t happen. If it does happen, they’ll stimulate. We are the chosen people.

    • No, you didn’t. I began being mooted 12 months ago. It’s real. Timing is the question.

      • The Lorax says:

        Wednesday, February 10, 2010: Looming Problem of Local Debt in China– 1.6 Trillion Dollar and Rising
        http://chinesepolitics.blogspot.com.au/2010/02/looming-problem-of-local-debt-in-china.html

        Debt, Minsky, Ponzi, rebalancing, over-investment … blah, blah, blah. The likes of Victor Shih, Andy Xie, Chovanec and Pettis have been banging on about this stuff for half a decade.

        Won’t happen.

      • My point is that it was not real, in the data, until twelve months ago, as credit traction began to slip materially…

      • The Lorax says:

        So? As soon as there’s any hint of things getting out of hand, the CCP will magic away all the debt, and throw a few trillion Yuan at FAI and 3d1k will be popping champagne corks (again).

        Apologies for my skepticism, but I’ve seen this movie before.

      • Rutherford says:

        Timing is not so much as the question, rather it is everything.

        Gravity has been defied to the point where we are questioning gravity — and ignoring gravity has paid off handsomely. ..until it doesn’t.

      • I don’t know whether you’re being sarcastic but if so let us know because your thesis needs to be addressed if not.

      • Jake89 says:

        Rutherford’s spot on. Can-kicking (defying gravity) has paid off handsomely, but someone, somewhere will be left holding the bag. Its a timing issue. Economic laws exist.

      • It what universe has denying gravity in China paid off? In the presumption of an endless high dollar, err, nup.

        In the presumption of endless high commodity prices and mining profits? Errr, nup.

        The correction started two years ago and is ongoing and anyone thinking otherwise has been pulverised.

        If you mean housing then sure, so far it’s going OK but the investment world is much bigger than that.

      • Jake89 says:

        Don’t worry I’m with you on this one HnH. I guess I was talking ‘GDP’ (lol). China’s economy seems a right mess and its going to hurt soon. Its not good growth.

      • Jake89 says:

        The economic problems exist, the question is who pays. Given the interlinkage between the CCP and business over there, its sure going to be interesting.

        What may be more important is how this unravels with their current account. Peter Fraser below talks about foreign reserves. How does the Chinese relationship with the US bond market for example interact? Surely the US has to be considering this issue and may need more QE soon enough.

      • The Lorax says:

        Regardless of whether I am being sarcastic, the thesis needs to be addressed. Why can’t they kick the can again? Why isn’t China different? Why can’t China ignore the economic laws that have applied to other nations in the past.

        Certainly, there has been nothing like the Chinese economic miracle in human history. The scale of the place for one, the bizarre combo of communism and capitalism, the extreme reliance on fixed asset investment. Everything in China is a first. Why can’t they be the first to kick the can for 100 years?

      • migtronix says:

        I’m with you Lorax, I am recently capitulated bear, its a horrible lost feeling to be making money doing the exact opposite of everything you think you should be doing. Sigh.

      • Macro Polo says:

        Everything in China isn’t a first, it’s just bigger – it’s all been done before.

        Michael Pettis makes a study of investment driven growth models: Pre-depression US; Latin american countries; 80′s Japan; Soviet Union etc… Makes for good reading to put China’s growth and challenges in context.

        It seems odd that you are content to believe the communist model is stronger than capitalism – but communism has frequently led to failed economies once the forceful hand can no longer keep everything in line, because some factor changes – for the Soviets this would probably be the 80′s drop in oil prices which killed revenues, while for China it was probably the collapse of the trade surplus in the GFC, forcing it to increase unproductive investment at silly rates just to keep the GDP number ticking over without much thought for quality of growth.

      • casewithscience says:

        @ Lorax saying:

        “So? As soon as there’s any hint of things getting out of hand, the CCP will magic away all the debt,”

        The problem is that the debt isn’t with the CCP – it is in private hands. To “Magic it away” would involve the CCP paying out to investors that should otherwise be burnt. What you are suggesting is an entire market systems that is “too big to fail”.

        Not a problem, if the Chinese want to take a high interest loan (which will never be repaid) from the US and Europe then this transaction will be complete and the world’s largest labour force will end up in the hands of the wealthy elite that own everything else.

        Alternatively, the CCP is just going to let some fail, and watch the internal finance supply contract until GDP growth is about 4-5%. I suggest they will take this option because they remember the last time they got screwed by the West. The problem being that if the landing is too hard, then there will be protests on the street and chaos.

      • migtronix says:

        @macro interesting thoughts as always but the Chinese look about as communist as US or Japan at the moment, and it wasn’t oil prices that killed the soviets it was information leakage.
        The economic collapse came AFTER the revolution

      • Macro Polo says:

        Mig, I’d disagree that information leakage was a cause – instead I’d call it a precipitating factor. Just IMHO:

        Information leakage didn’t set the economy on an unsustainable path, it merely revealed the extent of the wastage and loss-making involved – ending the facade. I see that more like tightening monetary policy in the West and having that reveal who was imprudently leveraged – but I’d stil call the leverage on bad investments the cause of the unsustainability, not raising the cash rate which precipitated a crisis. If you can hide losses for a while, revealing the losses isn’t the cause of the problem, creating loss making economic activity is the problem in my view.

        In China, before the GFC, I think they were mostly sustainable in that growth reflected growing productivity and less wasteful investment – at least they had the potential to begin rebalancing without a hard landing. Instead they went the opposite way when export demand collapsed, and now it seems likely that a lot of bad debts will come due over the next few years. Maybe information about how many enterprises in China are loss making will precipitate the crisis, but I still wouldn’t consider that the cause – the cause was the event that caused them to go on an unsustainable path.

        Again, just, like, my opinion man.

        As for communist China, you are right – I was meaning the term more in regards to huge financial repression from being a command economy, rather than simply the political/ideological nature of communism. Despite small moves to liberalise – interest rates, the exchange rate etc are all still heavily manipulated to repress the consumer.

    • MattU says:

      I remember reading Nouriel Roubini back in early 2011 and he called a financial event in China for second half of 2014. Its a while back but it was along those lines. Growth to 4-6% for the next few years.

    • 3d1k says:

      Lorax I don’t think 2014 will be the year. I do expect a few more defaults, god knows an economy that size should expect a failure or three. These ‘failures’ will be allowed and somewhat selective – the message being carefully framed to some sectors. The renewed emphasis on weeding out corruption, particularly at official level will also see a scalp or two.

      Rabinovitch suggested a controlled deleveraging which I suspect is close to the mark. I do not expect it to be at the velocity many here do (at least as far as it possible to control events).

      All in all, steady as she goes, the economy maturing with attendant winners and losers.

      And if bolstering required

      http://news.xinhuanet.com/english/china/2014-03/19/c_133197090.htm

      • The Lorax says:

        I love it when you link to the offical news agency of the Chinese Communist Party.

        Serious question: Do Aussie miners have lobbyists on the ground in Beijing?

      • casewithscience says:

        @Lorax

        ” Do Aussie miners have lobbyists on the ground in Beijing?”

        Yes – its called the Australian embassy.

        (or King Wood Mallesons, if you prefer).

  2. Geof says:

    Although I believe this scenario is more than likely to unfold for China, I’m still keeping my BHP and RIO shares because I have no faith that the situation will unfold in any predictable way. I learnt during the GFC that government intervention can keep alive the apparently unsustainable against the best rational analysis. Also mining is the only major globally competitive industry Australia has and at least these miners have real assets – and their competitiveness will be boosted by depreciation of our dollar . There is still plenty of need long term for raw materials for new infrastructure in the developing world and also for a backlog of projects in many developed economies such as the USA and Australia due to past underspend on infrastructure.

    • It’s a tough decision if you’re sitting on capital gains. But if you think this will happen then be aware that iron ore will be the epicentre of the storm and it will trade at levels nobody believes possible right now, for a goodly period of time.

      • Geof says:

        I lost faith in my previously impeccable ability to make rational investment decisions during the aftermath of the GFC. Now I have a largely defensive portfolio and I’m more than content to stick with it, and watch with a sense of awe the sheer scale of possible adverse outcomes in China – and the world’s financial sector at large.

        ps I agree with you “that iron ore will be the epicentre of the storm and it will trade at levels nobody believes possible right now, for a goodly period of time.”

  3. jimbo says:

    I can’t believe this one hasn’t had more impact. The Premier is practically telling us they’re screwed.

    ‘Speaking after the annual session of the national people’s congress, Li Keqiang said: “We are going to confront serious challenges this year and some challenges may be even more complex.” He told lenders to China’s private sector factories they should expect debt defaults.’

    Haircuts all round.

    http://www.theguardian.com/world/2014/mar/13/china-li-keqiang-wans-investors-bankruptcies

  4. aj. says:

    “Asset values will likely begin to deteriorate as stressed borrowers attempt to sell assets to stay afloat. As a result, banks and other financial entities could begin to increase provisioning for bad debts and to reduce credit availability by gradually tightening credit standards. This could lead to a credit crunch where credit to the economy is choked off for all but the safest borrowers.”

    I’d have to admit to some skepticism as well that this will come to pass. The western economies moved heaven and earth to bail out leveraged asset owners, China doesn’t even have to romance such an outcome through the central banks.

    Currencies seem like relatively irrelevant things these days.

  5. Janet says:

    Why do we all think that almost simultaneously ‘they’ are coming out with warnings of monetary tightening? The Fed has; the BoE has; the market leading RBNZ did! Perhaps because they now recognise that QE beyond the initial rescue phase has failed, and in fact damaged the real economy, as it did nothing except stimulate speculation. The Wealth Effect doesn’t work in a debt saturated world.

    • aj. says:

      Trying to jawbone speculators? They can’t go back from here without a big mess…

    • Gunnamatta says:

      Thats basically how I see it Janet.

      QE has failed to offer a bridge to some sort of economic growth, but to some extent succeeded insofar as it prevents the meltdown of the economic present for those that have assets already. The lack of meltdown also allows the massively indebted to continue servicing their debt (in Australia at least).

      The true down side of QE is that it has channelled so much of the worlds productive capital into non productive assets (particularly RE) and as the realisation increases that this is the evolutionary economic cul de sac we find ourselves in the idea of breaking something to get ourselves out will become more pronounced. The status quo would point to the breaking of the western worlds poor/working class first (which carries the risk of major social dislocation) which will presumably deliver marginal utility in terms of getting better economic growth, but as this becomes more apparent breaking other things will occur to both the uber rich who own the game, and the rest who start to question the uber rich a tad more.

      Should be a hoot.

      • China-Bob says:

        I’m slowly coming to the conclusion that QE only works if it creates wide spread inflation. So far all we have is Asset Inflation (RE and Western equities), however wide spread price and wage inflation are MIA. Krugman would argue that we simply didn’t stimulate enough, the initial QE was undersized and kept the inflation genie bottled up because demand never out paced supply, or in other words the world production capacity has never been stressed since the GFC started.

        Personally I think we are right on the cusp of a price inflation breakout, this will be fueled by China’s Minsky moment, In China today it is VERY difficult to find new finance for manufacturing. It doesn’t matter if your expanding an existing factory or building something completely new, the answer is NO. Today there is no appetite for new equities (so equity financing s dead), new debt financing is almost impossible because hidden unforeseen RISK is expected around every corner. The big BIG deal killer is the absence of Local government “help”.

        Ten years ago in China every local government had many very inventive ways to get the ball rolling most schemes involved low priced Real-estate that was immediately borrowed against for the full value of the land AND/OR became the main asset on many companies balance sheets. It was the real reason for interest in the new Equities.
        Well thats all gone, from what I can see it has been replaced by a vacuum. The current manufacturing environment in China has a lot of small manufactures (small cogs in larger value chains) getting totally screwed. The bad news is that things are no better at the top of the value chain because for them Ponzi finance is dead, the 2000 era “gifted” assets have all been mortgaged to the hilt or in many cases both Mortgaged AND Sold.

        Personally I see this Chinese Minsky moment as a huge opportunity, because as these fake value chains collapse they’ll be replaced by value chains with real pricing power and that means global price inflation for all manufactured goods. That’s good news for workers and manufactures especially efficient new era manufactures. This transition provides the business inflection point that enables the new guy on the block to capitalize on the problems of the incumbent suppliers (supply chains).

        I’m hoping for good old fashioned inflation and the wage/price spiral that goes hand in hand with inflation.

      • flyingfox says:

        @CB

        So far all we have is Asset Inflation (RE and Western equities), however wide spread price and wage inflation are MIA.

        Exactly…. But I don’t know whether this will happen or not. The bigger problem for our debt based economy will be that there will be fewer and fewer people to borrow. Most countries have just passed their peak dependancy ratios.

      • China-Bob says:

        @ff,
        I’m not sure I understand:
        Inflation is the force that tames debt, Inflation makes insane debt loads manageable over the long term. The real trick is to survive the transition period from low inflation to high inflation and back to low inflation. Once you’re half way through the cycle its time to load up with all the debt you can possibly manage.

      • flyingfox says:

        @CB

        Inflation is the force that tames debt if the inflation is in wages like you said. You can increase debt by having more debt per debtor or more debtors or a combination of the above. With the first, people need higher wages to handle the higher debt and until any stimulus reaches into wages, the result in the first case will be underwhelming as you pointed out.

        In past the, during the 60′s and 70′s and even into 80′s debt levels were much lower so an increase in debt levels per person was possible. Also there was a strong increase in population, namely the post war baby boom coming through the system. This resulted in natural inflation. More people demanding more things even without increase in quality of life. This ended up in a positive feedback cycle. More demand, led to more capacity and supply coming online, wages grew. You actually had an inflation problem occurring naturally.

        Now the opposite is happening, the proportion of productive workers is decreasing, there is latent capacity and due to lack of demand, wages will stagnate. In this environment, a naturally deflationary one as you pointed out, it is hard to cause inflation in wages.

        Also what I’m trying to highlight is a large structural shift and the the cyclical business cycle which I completely agree with. While the two maybe superimposed, the former is much more difficult to tame.

      • The Claw says:

        The true down side of QE is that it has channelled so much of the worlds productive capital into non productive assets (particularly RE)

        How. If I turn my cow into a spare room I would convert something productive to something unproduction. Is this what you mean? Factories turned into empty apartments?

      • China-Bob says:

        @ff
        I dont concern myself with demographics because we are just at the very beginnings of a new era of automation. Whats considered advanced robotics today will be laughed at in 20 years time. It’ll be like comparing modern 3D Animation with the simplistic animation in a Bugs Bunny cartoons.

        IMHO global demand for manufactured goods won’t even slow down at any time in my life. There is just to many people still living in poverty, the trick will be in understanding how they compensate the makers of manufactured goods. Maybe Chinese fixation with Sydney RE is the beginnings of this new globalized finance model, however it works it has s long way to run….

      • flyingfox says:

        @CB

        I dont concern myself with demographics because we are just at the very beginnings of a new era of automation.

        Now that we have atleast some people admitting the text book is wrong on money creation, demographics should be the next thing. Remember for almost all of human history until say the 80s (give or take 5 years) the human population pyramid has looked pretty similar…

        Automation might create supply, but what about demand…

        There is just to many people still living in poverty, the trick will be in understanding how they compensate the makers of manufactured goods.

        And how do they do it now? …

      • migtronix says:

        @Claw you got it in one mate! The cow has now become an item of worship (collateralised) and is strictly off limits to productivity :)

    • migtronix says:

      So what? QE didn’t work in Japan 20 years ago and everyone still thought it was a good idea. Nothing will change until kaboom and that could be a ways off, they’ll come up with an elaborate cooling system while still running the engine red hot and that might keep mechanical failure at bay until the end of the race (all your assets are now securitised along with your labour)

  6. Ortega says:

    Haha, jeez. Wake up people. It has already started – and it is happening right before our eyes.

    The BearStearns moment is already in the rearview.

    Oh, and when the moment is right, expect these ‘communists’ to be better capitalists than most going.

    You stimulate to achieve a goal.

    You don’t stimulate forever.

  7. Peter Fraser says:

    I watch CCTV China news every night. They are busy talking about building another 5 major cities in the eastern regions and about another 11 cities in the western rural regions.

    China doesn’t owe foreign nations anything and in fact has significant reserves of foreign currency.

    They can recapitalise their banking system and write off the bad debts whenever they want.

    Twiggy and Gina will be resting easy at the moment.

    • Janet says:

      Do you also watch RT? You’ll find a different perspective on Crimea to CNN as well! New Zealand always updates it people on the dairy auction results – when they go up! The last 3 have seen significant falls, and there hasn’t been a dicky bird about it on the news…..

      • Peter Fraser says:

        CCTV is NOT CNN.

        It’s a direct broadcast from China. I’m often amazed at the difference in what is reported here and the view direct from China.

        Perhaps there are two countries, both called China.

      • Janet says:

        I know CCTV is not CNN :) But the polar comparison of a US channel and a Russian one is something to behold! My point being – what would you expect CCTV to show? (I find France 24 annoying, don’t you?)

      • The Claw says:

        there hasn’t been a dicky bird about it on the news

        I know about Jandels and trundlers, but what’s a dicky bird in New Zealand?

    • So there’s no Minsky moment because you watch TV. Impressive!

      • Peter Fraser says:

        Oh come on you are only getting someones view on China. I also talk directly with an Aussie who lives in Beijing and he has been on the money for years when it comes to China, whilst the pundits can’t even translate news broadcasts with accuracy.

        When was the last time that these guys were right about China?

        I’m not b_b BTW – he is far more knowledgeable than I am on the monetary system.

        My “impressive’ analysis will be right until China amasses foreign debt which may occur if they are no longer a major producer of goods that the world wants – when do you think that might happen?

        Oh I see that you have changed your comment – it’s hard to keep up when comments get re-written.

      • Yeh, changed it. Donlt dissemble. Watching state propaganda is not informative PF. Nor is an anonymous source in China.

        You’re here to offer gentle reassurance for your mortgage business as usual and its entirely appropriate that you use other’s propaganda to do so. I know you have sock puppets. Don’t bother denying it.

        It’s flattering that you think it worth your time to come here with your misinformation but obviously I’m going to point your propaganda out to other readers.

        BTW, I have this friend in Beijing who has been right for ages and says the crash is totally and insanely imminent…

      • Schadenfreude says:

        What I find most unbelievable about all this is that Peter Fraser actually has a friend. You sure its not just the voices in your head Peter…?

      • “I know you have sock puppets. Don’t bother denying it.”

        How have you come to the conclusion HnH? Do you have evidence based on IP addresses or are you speculating based on other observations?

        I have always just seen Peter’s comments as those of someone with a strong opinion, no more propaganda than anyone else trying to get their opinion out there (including myself). But if evidence were to come forth that he is using sock puppets, I would be forced to rethink…

      • Peter Fraser says:

        I’ve never had a sock puppet in my life. People who know me well will appreciate that, and I don’t back away from a view that I believe to be correct no matter how unpopular that makes me.

        If you aren’t broad shouldered enough to have dissenting voices from time to time that you have the problem, not me.

      • Peter Fraser says:

        Bullion Baron – he thinks that I an b_b.

      • You’re still here, PF. But not for much longer as this rate. I have allowed you to distract from the content of the thread already. Any further replies will be deleted if they don’t address the post.

      • Peter Fraser says:

        You are the one who took it off topic.

        My long term view is not dissimilar to yours, but it is further out.

        If we turned this around, can you tell me why the PRC cannot stimulate if they choose to, and why they won’t rehouse the rural peasants and try to lift the standard of living for their 300 million poorest?

      • The Lorax says:

        Fair comment PF.

        A couple of years ago I would have said China can’t stimulate again, they have to deal with structural imbalances, the stratospheric levels of debt, shadow banking, housing bubble and corrupt SOEs. But none of this has happened. Everytime there’s a hint of a crisis they open the credit taps again and spend a few trillion Yuan on FAI.

        I’m just not convinced they can’t do it again, and again, and again.

      • No, fella, you baited with drivel.

        But yes, there is every reason to think that the Chinese will continue to urbanise but that is confuse levels with rates of change and it only the latter that matters.

        Once past halfway urbanisation no longer adds to growth, it takes away.

        But the reason they will also continue the reform process is that if they don’t then a debt crisis looms.

        Is the CCP better served by a sudden collapse or a more controlled descent? The answer is obvious.

      • flyingfox says:

        @PF

        If we turned this around, can you tell me why the PRC cannot stimulate if they choose to, and why they won’t rehouse the rural peasants and try to lift the standard of living for their 300 million poorest?

        They can stimulate. The question is can they stimulate enough to make up for the drop in private credit is there is drop in private credit.

        To put things into context,

        http://www.zerohedge.com/news/2014-03-14/chinas-credit-nightmare-explained-one-chart

        Look at those charts….and we in the west have been talking about QE being distortionary. And remember the public stimulus was only a small proportion of that.

        So again, can they stimulate enough while still not looking like looney buggers? I don’t know.

        The question of housing is even less clear. Back of the envelope clacs show something like 65% (probably higher) of their population can be housed now if all building were occupied. This is essentially the size of their announced city building project.

        Now that the rest of the world is buying fewer things from china and agricultural resources are becoming a premium, makes you wonder why you would want to move > 65-70 of your population into “urban” areas. Note UK and US have ~ 80% urbanisation.

      • Peter Fraser says:

        sorry guys but I’m now banned apparently.

        Cheers

      • You;re not banned but have no reply, evidently.

      • migtronix says:

        Here’s my issue with you PF, regardless of what happens in China or commodity prices the basis reality is with production coming online and the robotics revolution China can get raw materials quite handily w/o any need for Australians. The assets in the ground are owned by foreigners and the work can be done by robots so who needs Aussies? You ignore this and state that Australia can never become Zimbabwe or Argentina so we don’t need no other economy going on just lower the rates so we can build more housing.

      • flyingfox says:

        Where did PF go?

    • Nunatak says:

      Peter,
      I watch CCTV and RT most days on satellite, and there’s do doubt they offer a different perspective.
      But don’t forget these are National news services that are designed to project the most “desirable” image world-wide.
      Given that, and the Chinese obsession with “face”, I doubt that you’ll see much realistic (bad) economic news on CCTV.
      And Janet, hasn’t the RT take on Crimea been fascinating?
      As always, two sides to every story.

      • Peter Fraser says:

        I agree they won’t stray too far from the official line, but I get an independent view as well, which doesn’t toe the party line.

        That aside China can stimulate to it’s heart’s desires anytime it chooses. Their focus now is to reduce corruption so it’s a shakeout until they decide the time is right to stimulate.

      • Gunnamatta says:

        As someone who has worked at a couple of national broadcasters – including RT – and who knows quite a few journalists working in China (not that I would lay claim to knowing much about the place apart from what i read) I would observe that their whole raison d’etre for these organisations is to counter what they see is systemic bias in the english language media (starting with BBC and CNN, but these days more overtly Fox Sky etc). They will always run a line (That includes DW, RT, press TV France 24 ……the lot) and that will always be the line of those in power.

        In the case of RT and Russia it is a classic example of how the English speaking media completely misses a few issues and how this is seen in one country may not be given any substance at all in the English speaking press. I think what VVP is doing with Crimea is not particularly generous, but Russia has genuine causes for acting the way it does, and they dont get addressed in the worlds englisgh speaking media……I think because to do so raises a lot of implications about the ‘West’ and its elites, which they would rather werent raised at all.

      • saintmatthew says:

        isn’t CCTV a system that films and receives information rather than emitting information?

    • jimbo says:

      I wouldn’t worry about what the fearful minions are saying on prop TV Pete, this is what the head of the show is saying;

      Speaking after the annual session of the national people’s congress, Li Keqiang said: “We are going to confront serious challenges this year and some challenges may be even more complex.” He told lenders to China’s private sector factories they should expect debt defaults.’

      They might build another 16 cities, but those funding it might not get a cent back for their troubles!

    • davel says:

      This is the blind faith argument again – CCP are in control and they control everything so all OK. They’ve built the biggest credit bubble in economic history (relatively easy to do) and now they’re up to the task of making it go away with few adverse consequences (never ever even close to been done before). Never mind also that like it or not they’re part of the global financial system and can’t even come close to ring-fencing the consequences. They have no idea how this will play out, no one does.

      But apparently they’re still building cities so that shows everything is all right doesn’t it? Peter, the model will keep rolling no matter what, its “how it rolls” thats important. Your argument the equivalent of standing in the middle of the US sub-prime wreckage and saying “look, banks are still lending, people are still buying houses! Everything’s going to be fine!”.

      It’s absolutely staggering that people can misunderstand this so badly.

      If Gina and Twiggy are sleeping well its because they’re staggeringly rich no matter what. Its everyone else that needs to worry.

      • Explorer says:

        Gina and Twiggy’s largest assets are shares in geared companies.

        They can be wiped out 90% from company failure because they are geared.

        They will still have a residue outside the reach of creditors and be rich as Croesus on a comparative basis, even if their wealth is reduced by 90%.

      • davel says:

        Yes thats the point, even if FMG is wiped I’m sure Twiggy will have a few mills or so available.

  8. Schadenfreude says:

    Its makes me ill having to deal with these people on a daily basis… The way the Chinese conduct business is dodgy through and through.

    Talk about saving face!!! Pffft, it was only a flimsy mask to begin with, so the sooner they are all shamed and sent packing the better.

  9. Gramus says:

    WAS MINSKY DESCRIBING A CENTRALLY PLANNED ECONOMY? (Yes China still has a centrally planned economy… that is what the NDRC is for)

    Those expecting Bear Stearns/Lehman/Minsky moments underestimate the tools at the disposal of the Party.

    The AMCs (and their number is growing) will be hard at work behind the scenes over the coming year.

    • Ortega says:

      ??

      USSR

      Centrally Planned Economy.

      Collapsed due to reforms that started from a “stalled economy” and a need for “reorganisation”.

      Lets put the BS aside.

      • Ortega says:

        …and the Chinese have ‘tools’ alright… let me tell ya.

      • Gramus says:

        Yeah but it took the USSR almost two decades of economic stagnation post their FAI boom in the 50s/60s to fall over.

        The point is that centrally planned economies don’t behave like market economies and can’t be expected to.

        Those expecting near term Chinese economic collapse don’t understand how the place actually works.

      • davel says:

        Gramus, some truth there but not the full picture. The USSR did not blow a credit bubble on anything like this scale, nor were they ever the worlds producer of cheap stuff (but they did have many of their own resources). Nor was their economy anything like as closely woven into the global financial system as China is today. In short this is a totally different animal because the world now is vastly different to the 50s/60s. China is a hybrid and a credit bubble can be expected to behave like a credit bubble regardless of the political system.

  10. twincamp says:

    The current usd 3.8 trillion of cash and eqivalents with the PBOC seem to cover any deficits mentioned in this article

    maybe its an deliberate oversight by Morgan Stanley ?

    a Minsky moment

    Marx stipulated that capitalism in itself would be the end of days yet he never offered any alternative, its now widely
    recognized that redistribution must occur for all for capitalism to survive

    neither theories is at work in china only dog eat dog but plenty around for the adventure to continue long before
    Mindky writes a new theory. It would seem that the same people who participated in thr U.S sub prime credit
    bubble still is having reoccuring nightmares.

  11. Jake Gittes says:

    What has not been addressed is two different scenarios: Either, the Minsky moment means that Pascoes collapse, or, secondly, a reflation of China’s credit means Australia will have to make more Pascoes to deal with the new boom. A Pascoe deficit would hurt Australia’s optimistic outlook at least until 2020.

  12. hubris_and_hyperbole says:

    I don’t think Morgan Stanley makes the case conclusively.

    “Ponzi finance, is a regime in which borrowers have insufficient cash flows to pay either principal”

    Ok. and Minsky is talking about private debt …so we read on and see Display 2 which looks dire but the source is, er, themselves. Would be nice to see independent primary data being sourced and used to make a case.

    Next they move to local government. Fair enough but are we still talking Minsky now? Or to put it another way will a local government crisis be the same as a private sector crisis?

    They claim that local government “have insufficient cash flows to pay interest or principal”. If we take that on face value then fair enough, but they don’t make that same claim about the private sector debt which would seem to be to be fundamental if you are claiming a Minsky moment is on the way. i.e. earlier in the article they said this condition was required but do not have data to support that this is happening in the private sector.

    Pressed for time but those were the things that jumped out …reading the article through a skeptical prism.

  13. Explorer says:

    Even Greece hasn’t had a revolution or left the EMZ, so China ought be virtually invincible.

    It has a sovereign, non-convertible fiat currency and huge FX reserves and the government has no foreign denominated debt. They also have an army.

    They can protect the bank depositors and limit the losses of the depositors in the shadow banking system as much as they like, subject to causing inflation (more likely in commodities and other physical assets) and a fall in the currency.

    Thye won’t protect everyone, and of those they protect not everyone will get 100% protection, but the world will not end and they will reinflate when the ruling cabal wants to.

    They also have the power to put up the prices on all their exports as their is no short term alternative supplier at the volumes required.

    But they will eventually have slower growth and no country has twice as many houses as the number of households.

    A two child policy or a big bonus for girl babies now would change the demographics completely in 20 years.

    There will be transition, it will be painful from time to time, some companies and people will go bankrupt, but China will go on modernising.

    The increasing number of slowdowns as there is more of a business cycle and changes in composition of the economy from transition will have flow ons to the west, just as slowdowns in the west will have flow back to China’s manufacturing sector.

    But if western economists couldn’t see 2008 coming by July 2007, why will they (or chinese economists) be able to see the Chinese slowdowns in advance, other than by being bears who sing the same tune over and over until they are correct?

    • StatSailor says:


      A two child policy or a big bonus for girl babies now would change the demographics completely in 20 years.

      China’s total live births peaked at 29 mill-in 1963!-compared to 2013′s 16 mil, so either they will need something closer to a 3 or 4 child policy (ie to make up for the shrinking cohort of fertile women) or it would take longer than 20 years to turn their demographics around.

  14. bleeter says:

    can you please put an Exec Summary at the commencement of your tome……thank you

    • hubris_and_hyperbole says:

      So should we believe websites such as this that say Chinese money is here buying property or a tin foil hat website like zero hedge that says they are liquidating. Hmmmm

      • Ortega says:

        You’re confused.

        - The Chinese are here buying property in Aus.

        - The Chinese are liquidating property in Hong Kong (that’s from Reuters).

        Everything is in a state of flux.

        Figure out what might happen next.

      • hubris_and_hyperbole says:

        If the Chinese are liquidating property in Hong Kong on the scale that tin foil hat sites like Zero Hedge carry on about, who are the buyers? Could it be other Chinese LOL?

        Mate do yourself a favour and steer well clear of Zero Hedge and stick to sites that report actual data rather than anecdotes and frenzied hand waving.

      • migtronix says:

        h_n_h ZH report PLENTY of data

        http://www.zerohedge.com/news/2014-03-19/chinese-yuan-collapsing

        calling everything and anything “tin foild hat” is the heights of hubris and hyperbole…

      • hubris_and_hyperbole says:

        I’m assuming your tongue is firmly planted in your cheek. How else to interpret you saying ZH has data and giving me a link that says the Chinese Yuan is collapsing without any data to sustain the frenzied hand waving claim.

        By all means keep reading that rag but don’t be surprised if after years and years of frenzied hand waving, conspiracy theories, hubris and hyperbole, none of the claims they make eventuate.

        I don’t call *everything* tin foil hat but ZH is exhibit #1 for anyone wanting to know what a tin foil hat website is.

  15. ponzoid says:

    Wonder if the Big4 saw it coming?
    “Australian banks’ lending to Chinese borrowers has soared by 75 per cent in a year, as the industry rushes to lift its exposure to Asia’s powerhouse economy.
    The value of loans to Chinese borrowers on the books of Australian banks swelled by $US12.3 billion to $US28.7 billion during the year to September”
    http://www.smh.com.au/business/australian-banks-rush-to-lend-287-billion-to-chinese-borrowers-20140128-31kz8.html

  16. flyingfox says:

    PF, oh where oh where art thou?

  17. Sweeper says:

    China looks really unhealthy at the moment. The PBOC has lost control of interbank rates. Morgan Stanley seems to be saying that interbank rate hikes represent PBOC policy. Personally, I reckon they reflect deteriorating credit because of the way toxic assets have been hidden in trust funds etc.

  18. Hugh Pavletich says:

    The bubble value of China’s housing must be assessed …

    Check out “China Update” at the end of this thread, where I urge researchers / commentators to focus on the quantum of the bubble value in the Chinese housing market …

    http://www.interest.co.nz/property/69057/bill-english-says-greens-anti-sprawl-policies-more-blame-expensive-housing-buying-chi

    The figures are likely to be “horrific” … making the 07 / 08 events look like a walk in the park.

    Hugh Pavletich
    Co-author Annual Demographia International Housing Affordability Survey
    http://www.PerformanceUrbanPlanning.org

  19. Hugh Pavletich says:

    It is clear many need to do some fast reading of Ludwig von Mises “Planned Chaos” to adequately understand the realities and characteristics of command economies …

    http://mises.org/daily/2454

    http://www.amazon.com/Planned-Chaos-Ludwig-Von-Mises/dp/0910614008

    Many in the business community in particular should know better.

    Hugh Pavletich

  20. Hugh Pavletich says:

    Early January I covered China with “China: Big Bubble Trouble” …

    http://www.scoop.co.nz/stories/WO1401/S00034/china-big-bubble-trouble.htm

    Note too … Mike (Mish) Shedlock of Global Economic Trend Analysis gives this extremely important article by H&H of MacroBusiness Au an airing in the United States, with the title “ China Faces ‘Minsky Moment’ On Ponzi Financing” …

    http://globaleconomicanalysis.blogspot.co.nz/2014/03/china-faces-minsky-moment-on-ponzi.html

    We certainly look forward to reading H&H further research on these issues. The work by the Morgan Stanley people is a great credit to them.

    Hugh Pavletich