Alan Greenspan Lives...In the Chinese Credit Markets

Happy Trails, Janet Yellen. I liked Janet--it took me a while to get past the "Auntie Janet from Brooklyn" accent--but when you look back on her record, she pulled back the reins on tightening policy when the market was uncertain (or to put it another way, heaving all over itself). I remember saying to some colleagues in early 2016 that the fed would blow up the global economy if they followed through on their dot plot four hikes for that year. Janet pieced together the risks from the slowish economy and strong dollar and put the hiking cycle on ice.

And then she went for it when the skeptics said it was too much, too fast in late 2016 and early 2017. Here we are, at a level of interest rates that many thought would smother the economy not three years ago.

Maybe a couple of years from now we'll look back at this 2005-2006ish market and say, "wow, the fed really blew it allowing such easy monetary policy back then," not unlike the revisionist criticism of Greenspan we hear today.

Let’s go in the way back machine...back to the days before iphones, before Tom Brady….back to the days when a man could be a man...and not tweet about it...December 5th, 1996:  

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?...But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy.”

Maybe that criticism wasn’t so revisionist after all. Take heed...if Greenspan’s record repeats itself, this bubble may have only another four, or arguably another eleven years to run.

The day after the famous “irrational exuberance” speech, risk markets were a global tank-fest as bond and equity traders assumed the Maestro was about to take the punchbowl away. But today, risk markets are to the point that they are defying analysis. Credit spreads are reluctantly grinding tighter, but you can see it is getting harder and harder with each passing bp. Again, looking back to the mid-00s, there's a certain limit to how tight credit spreads can trade but there's no limit to how long it takes credit to show signs of deterioration.

I don't see it out there, in fact, there are signs that even the Democrats agree that maybe we were a little too tough on those Wall Street guys...yes, there may be more credit and accomodation in the pipeline.  More on this next week.

Moving back to EM--aka the short-seller killing fields--earlier this week the brilliant Michael Pettis posted a long but fascinating article on China, growth, and credit.

“Everyone agreed that debt in China is still growing far too quickly relative to the country’s debt-servicing capacity, but the pace of credit growth seems to have declined in 2017, even as real GDP growth held steady and, more importantly, nominal GDP growth increased….”

Put another way, credit growth slowed….but it didn’t. Growth kept on cranking.

Yes, yes, we didn’t all come here today to dig up the debate about the veracity of Chinese growth figures. But that’s what I found so fascinating about this piece. Pettis goes on:

“I am not convinced that observers have seen the beginning of any meaningful deleveraging….Chinese bankers—like those in the rest of the world, no doubt—have always gamed regulatory constraints when it comes to credit creation…. Beijing has been worried about China’s growing debt burden since at least 2012. But in 2017, this issue has become almost an obsession in some quarters. Beijing has made a series of aggressive announcements in the past year testifying to this surge in concern, culminating in an October 2017 statement by PBoC Governor Zhou Xiaochuan, who warned that China could face its own “Minsky moment.”

One way of (reducing credit growth) is to push credit creation off balance sheets and into forms that are less likely to trigger regulatory reprisals. That Chinese bankers might be doing so is confirmed by both anecdotal and official evidence indicating faster-than-expected credit growth in categories that fall outside widely watched measures like TSF….this would mean that China has experienced not the beginnings of deleveraging, but rather a continuation of the trans-leveraging observers have seen before. ”
He goes on to highlight the stark contrast in the way the West thinks about GDP compared to the Chinese. In China, the GDP is an input. In the West it is an output. Here, you put a bunch of labor and capital into the meat-grinder and get something we call “total output” of the economy. In China, the government tells its bureaucrats, provincial governors, and banks what the output is, and they have to figure out how to get there.

Then the PBoC starts to crack down on credit growth and leverage. The governor even uses the term “Minsky moment.”  Heck, even Greenspan never did that. Even when there was one.
Yet that doesn’t change the marching orders for the bankers and provincial governors.  If they need to build a bridge to nowhere so they can chalk it up to the GDP number, they’ll do it. And they’ll find a way to get the money to do it, through “public-private partnerships”, SPVs, wealth management vehicles, or whatever works to keep the wheels turning. Writing down the loan on this type of unproductive economic activity, wherever it comes from, is what we like to call a “tomorrow problem.”

Pettis goes on to state the obvious: this charade is possible only so long as the system has the debt capacity--be it on a bank balance sheet or in the back alley of a deserted third tier Chinese housing estate--to keep it going, and that’s only possible so long as the zombie-assets aren’t required to be written down by regulators, auditors or creditors.  

Regardless, sooner or later, even the massive pool of Chinese domestic savings will be exhausted, and the day of reckoning will arrive.

The US is getting ready to ease restrictions on bank balance sheets and credit creation, just in time for China to open its bond markets to foreigners and start waving in billions of JP Morgan bond index money.

Heaven help us...are we in 2006 again, or is it 1996? Tally ho!


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Click here for comments
February 1, 2018 at 5:54 AM ×

No wonder they call racing the "sport of kings"'s the last sport they know of.

February 1, 2018 at 7:54 PM ×

Thanks for heads up on Pettis' piece. My guess is they keep the shell game going awhile longer, to the point that investors assume there's no problem and address their massive under-weights of Chinese assets.

US Treasury Securites Held in Custody Foreign Offical & Int'l Accounts. We'll be getting another report today a/o yesterday. The divergence between these and frequently-reported EM reserves has me concerned that there's some change to reserve allocation behavior. This may also be manifest in the lousy US bond market behavior (30Y going through 3.00% as I write). One school of thought has it that prices (EURUSD) will just quickly move to reflect the ultimate re-allocation flows, not to mention, eventual convergence in US and EUR rates. While it did work that way on the way down (EURUSD) and up (USDJPY), the difference here is the ECB doesn't want EURUSD up at some eventual clearing price for that new economic regime and/or reserve allocation. The Riksbank has been effective in keeping SEK from trading where it's macroeconomic drivers indicate for years and years, and so my guess is the rate hikes in Europe will just get pushed further out (and perhaps even QE, to the extent possible/consistent with the capital key). The Riksbank didn't have to contend with reserve re-allocation, however, which has me focused on clues like the custody holdings. Why would these banks be re-allocating? The direction of US fiscal deficits? The mulling of a new price-level target? An easing in perceived Euro-zone existential risks? All-of-the-above?

SEK reminding me of CAD a year ago. Lots of hand-wringing over house prices. Stockholm high-end got over-built. Big deal. Stocks like OP SS, BONAVA SS, and JM SS stopped crashing a couple months ago, now. Meanwhile, Ingves (who is the only guy who matters, since he breaks the ties on the Riksbank board) has changed his tone. Everyone is sick of SEK. They've lost too much money in it and are having too much fun in EUR (for now). Anyway, you're not going to miss much by missing a tightening cycle in Sweden because the Riksbank has credibility that they'd just kill FX speculators if things got too spicy. But you are going to miss something. That something has to be weighed up against the possibility of an inflation disappointment between now and lift-off. Anyhow, thought I'd just say this looks something like the Canada set-up last year.

February 1, 2018 at 9:18 PM ×

agree totally on SEK. see also CZK...the de-pegging was foreshadowed by foreign bond flows--but those guys got punched in the face when they kicked it up a notch and hiked rates. I dunno, seems like one of those kind of trades.

I'm dubious there has been any change in reserve allocation patterns, but ya never know, I guess. No evidence to suggest any deterioration in the fundamentals and you are still being paid a hefty premium to buy UST over bunds or JGBs. Trumpphobia again, maybe?

February 1, 2018 at 11:01 PM ×

Looks like WTI ain't done yet. No adding to the short up here in the name of averaging in. Losers average losers. Stop above the high. Make me right or stop me out.

February 2, 2018 at 4:05 AM ×

your commentary has devolved into cliche platitudes. Take a deep breath. You got this.

February 2, 2018 at 5:42 AM ×

Indeed! My apologies. Putting my lucky tennis shoes on. They won't get me now :)

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