From Anne Stevenson-Yang at J Capital courtesy of FTAlphaville:
The kind of inflation that the government can generate is asset inflation, and regulators are using every tool in their power to abet that swelling of value. They are directing the flood of money into equities and, once per-share valuations grow, companies can issue secondaries and buy out their debt. This should, of course, raise gross profit by reducing the company’s expenditures to service debt. It does nothing for return on invested capital except to toss the ball of hot debt from the top of the balance sheet to ready hands at the bottom.
The stock valuations are a logical next stage in a system that relies on high collateral values to under-pin debt. Now, instead of securing a warehouse full of copper or steel, a company need only gain access to one of China’s exchanges and list its shares. Previous defaulters or companies that delisted in disgrace, like Chaori Solar, which defaulted in 2014, or Focus Media, which went private following credible accusations of massive fraud in financial statements, are being reborn as viable investment targets, with plans to relist and pay off old debt out of IPO proceeds.
A core problem for this means of economic alchemy is that the companies we interview in our regular surveys do not complain about debt service but about declining gross margins and gross sales volume. This is true at a minimum across steel and cement, e-commerce and advertising, coal and methanol, building materials and property, autos, and exporters of light industrial goods. The debt service obligation is in the nature of a nasty annual task much like filing taxes. Few companies pay interest from their operating profit. Instead, every November-December they need to find a new way to capture bridge loans that will pay off the current year’s obligations before they refinance in January.
The reason China’s debt is so parlous is not its sheer volume but its un-payable nature: many of the assets that have been financed with lending are empty new districts, gleaming shopping centers with no shoppers, airports with no flights, vanity projects like the Olympics and the country’s 60th anniversary parade, and other Ozymandian visions. They will never be valuable, commercially or socially, and even when the projects were being financed, few of the borrowers had concrete ideas about how they would generate income to justify the borrowings.
…Much of the stock market bubble is moving money toward companies and governments that are as much drains on the economy now as they were two or three years ago. This is not a formula for real economic renaissance. It also does not have to be in order to provide temporary respite to the looming bankruptcies and unemployment that will ultimately afflict the economy. Probably the biggest benefit to the economy comes in the sustenance of public confidence, serving as a prop to forbearance—in other words, it keeps people from running the banks. Ultimately economic restructuring is required, and that cannot happen without letting the debt scofflaws, like Baoding Tianwei, go to their corporate graves. Unfortunately, there is no evidence that that will ever happen.
As for how long it can last, that is anyone’s guess. To remain afloat, the economy requires a continual incremental influx of capital in the region of RMB 1.5 trn per month, the additional Total Social Financing coming into the system on average. Much of this comes from the credit system. But lenders need to be emancipated from the burden of dedicating upwards of 80% of their capital to refinancing. To the extent that the equities markets assume this burden with incremental capital raises, the economy stays together. Should that growth flatten or decline, the authorities will need to look for another piggy bank.
Supports ye auld glide slope and that’s about all.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
