China plots the doom of iron ore

It’s not new. We’ve seen it before. Every attempt fails. But a new plan is afoot to end China’s real estate driven growth addiction that keeps Australian iron ore above $30. Via Societe Gereral:

Policy directions in 2021: normalisation, de-risking and reforms

  • The Central Economic Work Conference reiterated policymakers ’intention to continuing with policy normalisation and resuming de-risking,while mindful of the pace of adjustments, pledging to avoid “an overly abrupt turn”.\
  • Fiscal policy will turn less accommodative. Weexpect a 3% on-budget deficit rate (vs 3.6% in 2020), no special CGBs (vsRMB1tn) and RMB 3tn in special LGBs (vsRMB3.75tn).This would point to an over 2pp contraction in the fiscal impulse.
  • De-risking will resume onmultiple fronts, including implicit local gov debt, property developers and fintech. The increased tolerance for SOE defaults could lead to repricing of SOEs’credit risk, resulting in a tightening effect on credit conditions.
  • Given these, monetary policy will likely have limited scope for further liquidity tightening. We think that the PBoC will have a small window in 2Q/3Q to take one (or two)rate hike(s), but afterwards it may need to turn more lenient in managing liquidity to mitigate any excessive drag from de-risking.
  • Eight areas of reforms under the  banner of the “dual circulation strategy” are highlighted for 2021, covering tech innovation,supply chain resilience, domestic demand, opening up of the economy, food security, anti-monopoly,housing in big cities and green development.
  • The downside risk has increased due to the rise in domestic COVID-19 cases.
  • A wider outbreak of COVID-19 domestically could weigh on the recovery in consumption and the service sector.
  • On the upside, the vaccine hope has lifted the prospect of faster economic normalisation globally in 2021. Also, under the Biden presidency, the US will probably continue to view China as a long-term competitor, but the bilateral relationship should be less volatile.

In particular for iron ore:

The “three red lines” policy

  • The policy was proposed end-3Q20
  • 12 largest developers submitted debt reduction plans end-Sep,detailing how they will reduce their borrowing within one year andto fully meet the targets within three years.
  • In early Jan, it was reported in the media that the policy will beextended to cover as many as 30 key developers.•If implemented, well over half of the combined balance sheet of theentire real estate sector would face material deleveraging pressureover the medium term.
  • Caps on banks’ lending to the housing sector. In early Jan, the PBoC/CBIRC announced caps on each bank’s lendingto the real estate sector, covering both developer loans andhousehold mortgages.

There will be notable imapct on growth, if implemented

  • It is important to economic growth.
  • Housing market activity directly accounts for c.10% of GDP. Linkages with upstream and downstream sectors further boosts its weight to 20-25%.
  • Land sales account for 10% of infrastructure funding. Despite the switch to special LGB funding, its equity-like features could still make local governments cautious over project investment.

It has serious implications for financial stability and household wealth

  • Housing accounts for 30% of bank loans, 15% of trust lending, 8% of domestic NFC bonds, and 25% of offshore USD bonds.
  • Housing investment has always been the most preferred form ofsavings by households, accounting for 70-80% of their wealth.

➢The cumulative drag on overall economic growth could be as large as 0.5-1pp over 2021-2023, under a gradual deleveraging scenario.

As said, this is not quantitatively different to what we heard 2011. Since then the realty monster has grown every year, including the commodity catastrophe year of 2015:

Note that a simple plateauing of floor space under construction in 2015 was enough to sink iron ore to $38. So long as vaccines deliver their promise, China will probably go ahead with these reforms in 2021 and crash iron ore again in 2022.

But expect it be halting, reversed quickly, and accompanied by desperate stimulus Hail Mary’s, as usual.

Which only means that the eventual end will be very much worse and more debilitating over the long run as the entire Chinese economy is sucked into the endless debt quagmire of Japaification.

David Llewellyn-Smith
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  1. Australian Federal Police raid Queensland properties linked to shutdown of DarkMarket website –

    Brisbane and Gold Coast… which Im guessing is linked to NSW.

    Why is all the Crime that happens in Australia linked to NSW? Every single time something goes wrong in Australia and some drug lord gets busted, it always has something to do with NSW. They come to QLD to hide ( especially Gold Coast ).

    Just noticing the patterns here.

    Living next door to NSW is like living next door to a Brothel. You know its only a matter of time before something goes wrong.

  2. rough calculations
    China residential floor space per person – 46sqm
    Australia residential floor space per person – 64sqm

    • Quite the opposite I would have thought.
      Onwards and upwards to 100m bodies….. It’s all we have

  3. pfh007.comMEMBER

    China cannot end its iron ore addiction for one very simple and obvious reason.

    Australian has built its current comfortable middle class lifestyle on this once in history giant commodity boom.

    We will not have our ability to buy expensive imported vehicles and other creature comforts curtained!

    End of story.

    Iron ore (and other commodities) holds up the Aussie dollar and generates a trade and current account surplus.

    That artificially inflated Aussie dollar allows the RBA to run ZIRP.

    Running ZIRP allows us to keep our debt driven asset price bubbles alive.

    Our debt driven asset prices bubbles make us feel wealthy and give those with ‘equity’ the means to pay for all those fancy cars and private school fees.

    We will not be denied our birthright by some nation of lowly paid people living under the yoke of stalinists.

    • Well said pfh! On the eve of Australia Day it’s nice to see someone standing up for Aussie values!

  4. What is it that you do not understand about the Triffin Paradox?
    I know it’s hard to wrap your head around the discontinuity but any dominant country creating and provisioning global liquidity must at some point, make this transition. Japan failed to push through the barrier because it was always first and foremost a nation of savers. Bottom line here is that you can’t be the one provisioning an expansion in global liquidity without running a deficit. China is at this threshold, China either makes the transition or it gets buried under the massive debt load it has already created. I get it that you’re focused on the latter outcome but at the same time they’re focused on punching through this barrier.
    Its a Paradox, its discontinuous, non-linear and time variant. It makes absolutely no sense at the Micro level yet perfect sense at the global Macro level. There’s no way to sum up all the parts of this global equation and get the outcome that China is seeking, yet at the same time the only outcome that makes sense (from China’s perspective) is to blast through this barrier.
    China has no choice now but to continue down this pathway, at the same time the US has no choice but to resist China’s advancement, which is precisely why these financial liquidity change overs normally require a war or some other major event which allows the world to accept this financial discontinuity.

    • pfh007.comMEMBER

      Chinese debt load?

      They don’t owe significant money to anyone other than their own banks and that is not relevant as the big ones are all public owned and effectively tied to the central bank which can never fail.

      The ONLY thing that matters in China is whether they are allocating resources, that otherwise would be available to households, to productive purposes.

      Try living in a house without a plumbing or a decent kitchen or power and it is not difficult to understand why the Chinese local governments across China are still building millions and millions sq metres of new housing.

      And then there are the local roads, freight rail and local passenger rail.

      There is less low hanging fruit than there was 20 years ago or even 10 years ago but there is still plenty.

      China quite sensibly wants to get the low handing fruit picked as fast as possible.

      What is really remarkable is that China has been able to earn enough foreign income to pay for all of the commodity imports that its fixed investment program requires. That has been incredible and it is STILL working. Shutting down Chinese exports would quickly shut down their capacity to pay for commodities.

      Lazy and dopey Australia will continue to graze idly on this process as though it will continue forever and even though it probably has only another 10 years to run.

      10 years is not long to get ready for having to work for a living again.

      • Maybe, just maybe there’s a solution where the Capital account and the Current account are not the only parts of a zero sum game.

        • pfh007.comMEMBER

          Everthing must balance but smart countries understand that and do what they can get away with doing.

          Mercantalism has a long and proud history.

          USA did it
          Japan did it
          Korea did it
          Taiwan did it
          Singapore did it
          Germany did it

          and most of them are still doing it.

          What is impressive about China is that they have been very disciplined in directing a large chunk of the proceeds of their export income into building infrastructure of lasting value and into buying the commodities required to do that.

          If Australians or Americans were running China there would be a class of people getting very rich and a hundreds of millions of people receiving very little benefit. The communists remain quite popular because anyone with eyes can see that the income that China is generating is being sprayed into public goods even if some of the cadres are also getting very rich.

          Ultimately that is what is driving the free market loons in the west nuts. The idea that a bunch of communists would actually act in the public interest stuns them.

          While the communists still have lots of people to lift out of agrarian poverty they should be fine. So long as they are able to continue to export enought to buy the stuff they need domestically. As their need for commodity imports slows down their need for lots of export income will slow as well. There is plenty of steel in China that will stay there for centuries.

          The difficulty for the communists is the one they have been struggling with for the last decade.

          When there is no longer a need to direct so many resources at fixed investment and they allow the households to hold on to more of their income will they still support the communists…especially if the corruption within the party continues?

          Keeping corruption out of politics is as important for China as it is in Australia.

          How successful have we been at that?

          Not very when one considers how we have allowed private banks to hijack the public monetary system and use it support their business model.

          • So close and yet so far
            Think about our (Australia’s) present position as a Transition state between two stable end points
            The markets are telling us that Capital has zero or possibly a Negative value while Hard assets have Infinite value
            Makes no sense except in the context of a major global transition. This sort of Asset hoarding is exactly the behaviour that one sees in a country that is about to suspend their current currency and reissue a new currency.
            think about what reissuing a currency does to the value of debt held in the old currency.
            We’re in the midst of a global financial transition, there’s zero (or negative) cost to developing business in the old system (hence the low value placed on savings / capital). Assets are the safe bet during transition so naturally the longer the transition takes the higher these asset prices will ratchet.
            Expectation is the missing piece of equation.
            Our Expectation points to an acceptance of this financial transition and therewith an expectation that our capital “savings” base will be recalculated at some point in the near future.

          • pfh007.comMEMBER

            “..This sort of Asset hoarding is exactly the behaviour that one sees in a country that is about to suspend their current currency and reissue a new currency. Think about what reissuing a currency does to the value of debt held in the old currency…”

            Which country are you referring to?

          • Well look for instance at Germany after the 1948 currency reform Reichsmark change over to Dmark
            Lots of hoarding ahead of the reform and a huge uptick in commerce after the reform.
            or look at Yugoslavia in 1989/90 before the situation degenerated into civil war
            or the Brazilian Real in 1993/4
            In all cases you see Asset Inflation and an unwillingness to trade long duration assets (eg real estate) for the currency of the day.
            Countries that successfully reissue their currency invariably create legitimacy by rewarding work, the flip side of this is that they devalue “savings” and all the unsupported fiat money that was created in the lead up to the reform.
            there are plenty of examples of success and failure when it comes to currency reissuance. the thing to remember is that the failures usually end in some sort of war.

          • pfh007.comMEMBER

            Which country are you referring to?

            I mean, which countries do you think are about to reissue their currencies?

            I don’t see that happening but what we might be about to see will be just as revolutionary.

            Countries allowing non-banks and the general public to operate accounts at the Central Bank and settle their transactions without the involvement of banks or their flakey unsecured investment accounts (aka deposit accounts).

            Once public monetary systems are unplugged from the private banks and their bank credit as public money scam the asset price bubbles driven by the private banks will deflate like yesterdays party balloons.

            There will be just no point in blowing asset price bubbles.

            Or to be precise there will be no pressing public interest in encouraging them or protecting the promoters of them.

          • Infrastructure of lasting value?
            All infrastructure requires maintenance.
            Hows that Shanghai trash bridge holding up?

  5. Been saying for over a year now that any new stimulus in China will not be even close to the 2016. Will never happen as Chinese learnt a good lesson from 2016.
    Yes, there will be some defaults in the industry and Chinese authorities will tolerate that to a point. Some larger operators will be saved but prices will not be allowed to go higher from here so speculation in RE in China is gone.
    High end property will not suffer longer term but that’s not a market the unwashed can play anyway.
    Chines addresses two important issues with such move:
    Reduces its dependence on IO and
    Pushes IO price to fall where Australia will be hurting.
    As I said on many occasions, new stimulus packages will be directed to environmental industries and services such as tourism and education.
    In short Chine will stop building empty cities.

  6. Watch the implementation of the Property Tax. Nothing in China will change until it is implemented.

  7. Shades of MessinaMEMBER

    Witness Twiggy Forrest’s Boyer speech on the weekend where he is pivoting hard into Renewables and Hydrogen (along with the pre-existing Ag focus).

    Think he has deduced what’s up (if he hasn’t already been told behind the scenes by some well placed friends in Beijing).