Live report from Hong Kong, China
One month ago we reported that you can feel it in Hong Kong. The economy is sluggish. The question is – is the slowing Hong Kong Economy related to the protests which clearly have negatively impacted the local Hong Kong businesses or is the Hong Kong downturn related to a slowing China economy. We now know the answer.
The BBC reported this week that official China figures are out and the news is scary:
China’s economy grew last year at the slowest pace in almost three decades.
Official figures show that the world’s second largest economy expanded by 6.1% in 2019 from the year before – the worst figure in 29 years.
The country has faced weak domestic demand and the impact of the bitter trade war with the US.
The government has been rolling out measures over the past two years in an attempt to boost growth.
It comes after almost two years of trade tensions with the US – although hopes of a better relationship with America have seen improvements in manufacturing and business confidence data.
We’ve reported for months that President Trump had the US in the position that it can only win in a deal with China and he did. The US economy is on fire – more Americans are working than ever before, unemployment is at 50 year lows, wages are way up and the stock market is at record highs. But China was moving in the opposite direction.
China could either give the US what it wanted in a deal or implode.
China needed a Deal with the US (i.e. they don’t just want it) –
As we reported in a post in August President Trump recognizes that China is in an all out war with the US in regards to information and economics. For years Western leaders have done nothing but negotiate into weak positions, never standing up to the Communist regime. Former US Presidents treated China like they did Russia 50 years ago, as their superior always giving them what they wanted and never standing up to their abuse and criminal acts.
President Trump knew that China needs the US now more than ever but the US didn’t need China.
We posted a presentation from former Trump Chief Strategist Steve Bannon regarding China. He discussed how China is in an economic war with the US. He said America was losing until President Trump. Then he added this:
Well here’s the game and right now we are converging on a point and they understand this. We could take the whole thing down. We can take, the whole thing’s built on a house of sand…
If they [China] devalue their currency they are just going to flood more out. They got $3 trillion of reserves and trust me, in a New York second that thing would flood out in a second. That’s what their own people think about their economy. We’ve allowed these guys to push us around. We’ve allowed these guys to take the South China Sea…
This trade war is going to end in victory and what you’re going to see is a reorientation of the entire supply chain out of China…
Bannon is right. We reported in May that just like the US in 2008, a perfect storm is building in China. The excessive and extravagant construction projects, cash-flow challenges and lack of demand in China all could combine for a major financial disaster. Trump is right – now is the time to make a deal with China.
As the movie ‘The Big Short’ revealed, in 2008 few individuals saw the US sub-prime crisis before it raised its head.
The cause of the 2008 sub-prime crisis is discussed in (my book) Falling Eagle, Rising Tigers:
Politicians would have you believe that the 2008 financial meltdown was related to the more recent actions of one party or the other, but the roots of the 2008 housing market crisis really began in the 1930s with the creation of the Federal Housing Administration (FHA), which guaranteed banks’ mortgage risks and the Federal National Mortgage Association (FNMA), which effectively insured mortgages by purchasing mortgages from lenders. Both shifted risks from the lenders to the US taxpayers. Then in 1977, the Community Reinvestment Act (CRA) was signed into law by President Jimmy Carter. This law was designed to promote home ownership for minorities by prohibiting banks from refusing mortgages in poor areas due to the loan’s high risk. In addition, mortgage lenders were required under the 1975 Home Mortgage Disclosure Act (HMDA) to provide data about who they lent to. Then in 1991, HMDA rules were tightened and included specific demands for racial equality in the institution’s lending.
Credit-worthiness was no longer relevant in the US and the volume of subprime loans exploded. The government had inserted itself in the mortgage business. Like most government initiatives, their plans were doomed. Americans lacking the ability to pay for mortgages were provided mortgages at teaser rates that when fully adjusted would never be paid. This ultimately climaxed in 2008 with the subprime crisis that sent shock waves around the world and put financial markets in a tailspin.
A financial meltdown is in the works in China
Over the past few decades, China opened its borders and corporations around the world fled to China due to its cheap capital and meager payroll costs. As a result, China’s economy exploded. Again, from Falling Eagle, Rising Tigers:
While the US is moving more and more towards a welfare state, China is moving more and more towards prosperity. “Since the launch of economic reform in 1978 more people (in China) have been made materially better off in a shorter span of time than ever before in human history.”
China’s rise out of poverty has been dramatic. For example, considering a consumption threshold of $1 a day using the 1993 Power Purchasing Parities (PPP), the World Bank tracked a reduction of poverty from 652 million Chinese people in 1981 to 135 million in 2004. China’s anti-poverty performance is even remarkable with a standard of $1.25 a day at 2005 PPP. “The numbers in poverty by this measure dropped from 848 million in 1981 to 351 million in 2004. This denotes that there were 517 ($1 standard) or 497 million ($1.25 standard) people who had escaped from absolute poverty during 1981-2004.” A half a billion Chinese citizens have risen out of poverty due to China’s changing policies!
The Chinese were relentless in their efforts to obtain Western technology and grow their economy. They set up trade barriers and manipulated their currency in ways that helped China. The US was at a disadvantage in trade resulting in massive deficits in the billions.
Along comes the Trump Administration, the first administration to address China’s unfair trade advantage. The timing of Trump’s tariffs was not good for China as there are more pressing issues that had to be addressed. China had no choice but to go with what the US offers to keep its economy afloat.
The more pressing issues for China surround real estate, in a manner similar to the US in 2008. As China grew, it invested in its infrastructure and in addition, it invested in large housing projects throughout the country. These efforts helped bolster China’s already fast growing economy.
The problem is that China over invested in these random properties all over China and these properties today remain empty.
(See below pictures of real estate projects in the middle of China (Hubei Province) – massive but mostly empty.)
There simply are not enough people in the area where these massive complexes were built that make enough money to afford living in these communities. It appears that the Chinese communists’ misunderstanding of supply and demand economics may be their downfall.
Some say, no problem, China will just move all the peasants to these massive complexes. This will be devastating. First of all China needs to feed them. Secondly, as we have learned in the US, people on the dole with no work tend to get involved in drugs and crime. The human spirit needs a purpose – idle hands are the devil’s workshop!
These many properties throughout China sit unoccupied, and there is a cost to this. Bloomberg reported in September 2018 –
Cash-to-short-term debt levels at more than 80 publicly traded real estate companies tracked by Bloomberg were 133 percent on average in the first half, the worst since the first six months of 2015 and down from 297 percent a year earlier. Almost a quarter of developers sport a ratio below 50 percent.
In addition, Bloomberg noted:
But while business has been booming, developers have also been piling on the debt. Firms have been selling more bonds in the domestic market — and at the cheapest rates as investors shrug off default concerns. Those with dollar-denominated obligations, meanwhile, face higher borrowing costs as the U.S. Federal Reserves continues on its tightening path.
The amount of debt related to China’s over development is massive. The total amount is unknown with S&P estimating the amount not reported by local communities and banks being over $6 trillion:
China may be sitting on a hidden debt pile of as much as 40 trillion yuan ($6 trillion), concealed off-balance-sheet by the country’s local governments, according to research from S&P Global Ratings.
Many local governments in China raise debt and hold it off their balance sheet, in order to avoid lending limits imposed by central authorities. S&P says that this is a growing problem within the country, and that the amount of debt held this way has likely ballooned in recent years.
The government may have to take over these debts as they become insolvent –
Not only is the level of hidden debt held by local governments in the world’s second largest economy rising, but so too is the risk of those debts being defaulted on. Much of the debt is held by so-called local government financing vehicles (LGFVs), and S&P reports that central government may be willing to let these vehicles file for bankruptcy in the future.
“Default risk of LGFVs is on the rise. China has opened up the possibility of insolvent LGFVs filing for bankruptcy, but managing the default aftermath is a formidable task for top leadership,” the report noted….
The country’s total non-financial sector debt, which includes household, corporate and government debt, will surge to almost 300% of GDP by 2022, up from 242% in 2016. Fears abound that if this debt pile continues to grow, a spectacular blow up could be imminent.
We’ve said for nearly a year that China’s financial crash may make the 2008 crash in the US look small. The implications will no doubt impact the entire world. This is why China couldn’t afford to mess around with President Trump and had to make a deal.
(On a personal note I spoke with one China CEO who said that a fellow manufacturing CEO in China said the economy there was “terrible”. I also spoke with another head of a manufacturing company in China and he moved his operations to Thailand. He said that there was no more room in Vietnam for his company at a reasonable cost because Vietnam was full as companies from China are filling it up.)