Archive for March, 2010

Forecasting GDP figures from Internet transactions

Tuesday, March 30th, 2010

GoldMoney. The best way to buy gold & silverRecently, we received an email from the guys at the Consumer Metrics Institutes (and we have NO affiliate relationship with them other than mutual favours of mentioning each other on our web sites). They have a very interesting methodology of data collection on the demand-side of the US economy. You see, the GDP data that comes out of the government data office are always backward looking by a few months. Worse still, they are always revised. As Consumer Metrics Institutes wrote,

… many ‘leading’ economic indicators are published, but few (if any) are sufficiently ‘leading’ to be meaningful to investors. In fact, many ‘leading’ indicators use the prior month’s equity market results as a key component of their indexes. Investors may find their last month-end account statement more timely.
To remedy this, the Consumer Metrics Institute has developed (and is continuing to develop) techniques for monitoring ‘up-stream’ economic activities on a daily basis.

What the guys at Consumer Metrics Institutes do is that they collect data based on real-time US consumer Internet transactions (see this document for more information).

Of course, their metrics are not perfect and they are aware of some potential biases. For those who are interested in statistics, you may want to look into that here.

One question we asked them is this: how do they capture the consumers’ purchase right at the transaction level on a web site? Their answer was,

Unfortunately I can’t comment, since obviously the only way to do that is to keep a very low profile. We have been working on the methodology for a long time, and we have been facilitated by a lot of sloppy coding at the? commerce sites.

We like their style! 😉

We remember some of our readers (“Anon”) express their belief that the US GDP figures will soon show contraction (i.e. a double-dip) as the stimulus money are withdrawn from the economy. Here, is what the data from Consumer Metrics Institute shows:

Consumer Metric Institute's Daily Growth Index vs BEA's Quarterly GDP over the past 4 years

Consumer Metric Institute's Daily Growth Index vs BEA's Quarterly GDP over the past 4 years

Assuming that their data is more forward indicator than BEA’s figures, we will see the lagging GDP shrink in the second quarter of 2010.

Fingers crossed!

Black Swans lurking around Australia’s banking system

Sunday, March 28th, 2010

We must confess, we are getting more and more nervous about the potential for a Black Swan hitting the Australian economy. Particularly, we are looking at a vulnerability in the banking system. Here are some facts about Australian banks:

  1. As at December 2009, around 75% of the Australian mortgage market is held by the Big 4 banks. 50% are held by Commonwealth and Westpac while 25% are held by ANZ and NAB. (source: CoreData’s Australian Mortgage Report Q1 2010)
  2. 60% of Commonwealth’s lending books are residential mortgages.
  3. 50% of Westpac’s lending books are residential mortgages.

Now, here’s an interesting news report from almost two years ago:

The Reserve Bank of Australia has a dark worry about our banks: they get 90 per cent of their cash from each other. If one bank gets into trouble, the Australian financial system could be snap-frozen overnight.

The question is: how true is this today? Since we are not banking analysts here, we are guessing that the situation in 2008 is not much different today. If Commonwealth Bank’s balance sheet is representative of the banking system, then judging from the fact that only around 1% of its total assets are government bonds, it seems that this is still true today. If we have any more information about this peculiar nature of the Australian banking system, we will inform you.

GoldMoney. The best way to buy gold & silverAssuming that this is true, then think of the implication: All it takes to paralyse Australia’s banking system is for some mortgage debts to go bad. Why? That’s because by nature, banks are highly leveraged. As we explained in Effect of write-down on bank balance sheet, bad debts will have more than proportionate effect on the equity of banks. For example, take a look at Commonwealth Bank (CBA) 2009 Annual Report– you can see that its leverage ratio is almost 20 times (total assets of $620.4 billion against $31.4 billion of equity). Among the the $620.4 billion of assets, $473.7 billion are loan assets. That means, if around 6.6% of CBA’s loans go bad (any loans, not just mortgages), 100% of its shareholder equity will be wiped out. In reality, long before that happens, alarm bells will be ringing in APRA (the banking regulator).

At the current state of affairs, the health of Australian banks’ mortgage loan books is very dependent on Australia’s unemployment rate. Once the unemployment goes up to a certain level, a tipping point will be reached whereby mortgages will start to default. When enough mortgages default, any of the Big 4 can become insolvent. With that, the solvency of the banking system will be threatened.? As we wrote in RBA committing logical errors regarding Australian household finance,

As unemployment rises, it will eventually reach a critical mass of prime debts turning sub-prime. Once this critical mass is reached, the deterioration in the Australian economy will accelerate (see what?s happening in the US and UK today).

Of course, economists, politicians, media will harp about how ‘safe’ the banks’ mortgage debts are. A quick read on the Reserve Bank of Australia (RBA)’s latest Financial Stability Review will give you a feel that they are not worried about the solvency of mortgage debts.

But that is beside the point.

The issue is not how ‘safe’ or ‘risky’ mortgage debts are- on paper, they are ‘safe.’ The issue is this: Why on earth is Australia concentrating the risks to its banking system? Every financial adviser will counsel you on the importance of diversification. Yet, when it comes to the Australia’s banking system, the opposite is happening.

The greater the concentration of risks, the less the margin for error is. If you live life with less and less margin for error, that’s when accidents are waiting to happen. That is where Black Swans lurks (see Failure to understand Black Swan leads to fallacious thinking).

We are getting more and more nervous.

Hoodwinked by Craig James’s “CommSec National Performance Gauge”

Thursday, March 25th, 2010

Just this week, CommSec’s Chief Economist, Craig James released a CommSec National Performance Gauge that purportedly declared that Australia have never had it so good (as at end of 2009). According to this news media article, Craig James was quoted as saying,

The CommSec National Performance Gauge attempts to fill the void by focusing on issues that matter to ordinary Aussies. That is, financial decisions like buying a car or house, filling up the car with petrol, the state of the job market, wages and confidence levels.

That gauge takes seven measures, of which four of them involves spending capacity. Among the four, one of them is on car affordability. As that article reported,

The gauge shows that car affordability is the strongest in 35 years, taking a person on the average wage just under 30 weeks to buy a new Ford Falcon, down from 36 weeks five years ago.

The idea is that as the number of weeks an average worker earns to buy a car decreases, the ‘better’ and ‘more’ well-off’ this measure indicates. A car is probably chosen because it is representative of the material well-being of Australians. According to our friends at FN Arena (please note that the original article has an overall air of sarcasm against Craig James’ gauge),

But in the wider cohort, income per capita is up 6% over five years and retail spending up 7%. Today it takes 30 weeks of average wages to buy a new Falcon, down from 36 weeks five years ago and the most affordable level in 35 years. It takes 1.58 weeks of average wages to make one average mortgage payment, which despite ?unaffordability? cries is the same level of five years ago. And despite rising oil prices, drivers can afford 7% more petrol from the average wage than five years ago.

That sounds correct right?

Unfortunately, if you’re not careful, you can fall for a mental pitfall here. Even Craig James was reported to qualify his exuberance by saying, “that is probably a big call and one that would attract a lot of discussion.”

So, what is the mental pitfall trap hidden within this performance gauge that can lead you astray?

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Watch April 15 2010: simmering tensions between US and China

Tuesday, March 23rd, 2010

April 15, 2010 is a day worth watching. It will be the day when the US Treasury will issue a report, designating whether China is a “currency manipulator” or not. While the repercussions of China being labelled a “currency manipulator” are worrying, this issue is hardly new. In fact, as we wrote in US shooting own foot with tariff on Chinese goods three years ago,

At present [April 2007], the US Congress is simmering in antagonism against China for her trade surplus against the US. They see China as a convenient scapegoat for America?s economic woes, accusing her of misconducts that includes currency ?manipulation,? unfair trade practices and so on.

For the past three years, both sides seem to be going round in circles regarding the Chinese currency peg issue. It seemed that China was repeatedly on the verge of officially being accused of currency manipulation, only for that charge to be withdrawn from the final assessment. Based on statistical probability, the chances for that charge to be issued again are slim. But as our long-time readers know us, we are no fans of using statistical probabilities to ‘predict.’

One thing is clear: the pressure for officially labelling China as a “currency manipulator” is much strong today than three years ago. Firstly, President Obama is more inclined towards that than former President Bush. Secondly, the US economy today is at a more advanced stage of deflation (i.e. unemployment, fall asset values, economic stagnation) than three years ago. Thirdly, mid-term elections are coming and consequently, there are a lot of domestic pressures for Obama to get tough on China.

In the face of further economic stagnation, the US is sliding downward towards mob rule. With a clear understanding of Irving Fisher’s debt deflation theory of the Great Depression, we can easily understand that for an economy heavily addicted to debt, all it takes for the economy to slow down is a slowdown in credit growth. As we wrote in Australia?s credit growth is still falling,

Marc Faber once said that for an economy that is addicted to debt, all it needs to tip it into a recession is for credit growth to slow down- no contraction of credit is required. Also, as Professor Steve Keen explained, at this stage of the debt cycle, the aggregate spending in the economy is made up of income plus change in debt. In the absence of income growth, a slowdown in credit growth implies declining aggregate spending by the private sector.

Currently, the US is in the midst of a generational shift in culture/mindset from borrowing to saving. That is, in economic terms, the US private sector is de-leveraging. The symptoms of de-leveraging will be asset price deflation, economic stagnation, rising unemployment and so on, which will be counteracted by increase in government debt and spending (which itself is limited by market’s confidence in government debt).

In lay-person’s terms, the US is suffering because they are on cold turkey from debt. In contrast, the Chinese are postponing their pain by going further into debt (i.e. policy of inflation and force-feeding of credit into the economy). This result in an illusion that America is suffering while China is ‘prospering’ (which is worsened by Chinese government’s propensity to doctor the figures to look good in order to save ‘face’).

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China’s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America’s unemployment rate. By implication, it is perceived that with China’s official unemployment rate much lower, China is ‘prospering’ at America’s expense.

The problem is that if China is to acquiesce to America’s demands today, it will not solve the America’s problem tomorrow. In fact, the immediate effect will be to worsen America’s (and China’s as well) economic woes. Price inflation will rise and market based interest rates will go up, worsening America’s debt deflation problem. The reason is because the Chinese currency control had been in place for too long and that resulted in long-term structural changes to both the US and China’s economies. Removing the control immediately means that both economies will have no time to adjust, compounding the current level of pain for both sides.

For China, if the words of its Vice Commerce Minister Zhong Shan are accurate, the profit margins of many Chinese exporters were less than 2%. By appreciating the yuan, many Chinese exporters will go under, which by implication will have serious impacts on unemployment in China, and by extension, on social stability.

SEO Secrets e-bookBut as we wrote before in Chinese government cornered by inflation, bubbles & rich-poor gap, China has their own inflation problem that will eventually threaten social stability. They are already taking tentative steps to rein in inflation (see Is China going to allow its banks to fail in the upcoming (potentially gigantic) wave of bad debts?). Letting their yuan appreciate is very likely part of their overall plan to re-balance their economy. It will happen eventually. But the problem is, the Chinese wants to do it gradually. But the US politicians, on the other hand, want China to do it quickly in order to appease their electorates. Already, we have American economists like Paul Krugman (who is of the same ideology as Ben Bernanke with regards to money printing to solve economic problems) writing inflammatory articles and egging for a economic fight with China.

So, April 15, 2010 will be an interesting date to watch. If China gets labelled as a “currency manipulator,” then trade tensions jump up a level. If left unchecked, that will result in trade war. If trade war is left unchecked, the gloves will come off and there will be more unsportsmanlike actions from both sides (i.e. covert dirty war). If dirty war goes unchecked, there is a risk of shooting war. We are not saying all these things will happen- our point is that there will be a time and sequence for things to happen.

How To Foolproof Yourself Against Salesmen & Media Bias

Sunday, March 21st, 2010

Over the weekend, we have released a new instant download, PDF report, “How To Foolproof Yourself Against Salesmen & Media Bias” at only US$4.95. In addition, we had set up a Facebook Group related to this report for those who want to discuss more on the topic.

Basically, this report is an expansion and rehash of the mental pitfall series of articles (some of which are still available in this web site) and written from a different perspective. This report is divided into two parts. The first part is the most important part- it expands from the common mental pitfalls ideas on this web site:

  1. Accuracy-Precision Confusion
  2. Anchoring
  3. Bigness Bias
  4. Confirmation Bias
  5. Correlation-Causality Fallacy
  6. Endowment Effect
  7. Herd Behaviour
  8. Lazy Induction
  9. Ludic Fallacy
  10. Mental Accounting
  11. Money Illusion
  12. Narrative Fallacy
  13. Overconfidence
  14. Recency Bias
  15. Status Quo & Loss/Regret Aversion Bias
  16. Sunk Cost Fallacy
  17. Survivorship Bias
  18. Turkey Thinking
  19. Wishful Thinking

The second part is on some of the common tricks employed by biased media:

  1. Context Twisting
  2. Headline Judgement
  3. Images
  4. Names, Titles, Word Choice & Tone
  5. Selection & Omission
  6. Source Bias
  7. Story Placement

This report is in the PDF format and the total number of pages is 50 pages. It is specially designed to look well as a slide presentation, which means the larger fonts will be easier on your eyes. That makes it an ideal e-book. You can also print this PDF report but we would urge you not to do so for the sake of the trees.

For those who had already donated to this web site, this report will be given to you free of charge. You will receive an email from us (sent via e-Junkie) with the download link.

Click here to get this report now!

Hedging against currency crisis with electronic gold

Thursday, March 18th, 2010

Back in January this year, we talked about protecting yourself against currency crisis in Protecting yourself against currency crisis. The basic idea of that article is that the time to prepare for such an eventuality is before TSHTF. Once it happens, it is too late.

For our Australian readers, this seems to be less of a worry because there is still an air of optimism (relatively) among the population. But for our American readers, the nagging feeling of fear and brooding seems to be permeating among the masses. As the author of this book, The Ultimate Suburban Survivalist Guide: The Smartest Money Moves to Prepare for Any Crisis, wrote in the introduction,

Do you have a pervasive sense of anxiety, as if our modern world is on thin ice? Do you have an uneasy feeling that Wall Street seems to be collapsing under the weight of bad debts and bad decisions- and dragging your job along with it? Or, maybe you feel our society is coming apart at the seams, and that our civilization could actually break down and collapse.

You are not alone. A lot of people are worried. In fact, there is a growing movement of people who are preparing for the end of the world as we know it (TEOTWAWKI).

That book is written in an American context. If you are an American reader, please let us know how true or accurate this is in the comments below.

Now, for this article, we will stick to the original point (currency crisis) and not venture to the theme of TEOTWAWKI (survival skills/gears, self-sufficiency, guns, supplies stockpiles, etc). We hazard a guess that the TEOTWAWKI theme is of more interest to our American readers than to our Australian readers. But if enough readers express their interests in TEOTWAWKI, we may do more research and write more about it. If not, let’s stick to the topic. (By the way, contrarians like Marc Faber are alluding to the TEOTWAWKI theme).

Okay, back to currency crisis. There are two components to hedging yourself against currency crisis:

  1. Diversify your assets overseas.
  2. Prepare a cache of physical monetary assets (e.g. physical cash and physical gold/silver).

For the second component, our book How to buy and invest in physical gold and silver bullion would cover it very well. But for this article, we will look at the first component.

One of the ideas (and note, they are ideas- nothing in this blog should be taken as financial advice) that is floating around in our mind is electronic gold. We first touched on this idea two years ago in What is the future of silver?,

Today, we have a very powerful technology that can solve the convenience and sub-divisibility problem (see Properties of good money) associated with [using] gold [as] money- computers. All we need is a trusted central repository of gold (perhaps today?s central bank can change its institutional role for this purpose) and let computer systems keep track of ownership and transfer flow of gold money. In other words, the gold is physically kept in a secure central location while the finer sub-divisions and change of ownership of gold money is recorded as bookkeeping entries on computers. No physical movement of gold is necessary.

This passage was written to refute some of the views that gold can never ever function as money again because it will be physically inconvenient (or beyond imagination) to carry minuscule amount of physical gold as money to buy small items (e.g. bread).

Well, two things against this argument:

  1. In Zimbabwe, people were already used flakes of gold to buy bread (see the video at Rural Zimbabweans are desperately panning for gold powder to ward off starvation).
  2. The same problem of inconvenience existed two hundred years ago and that’s why mankind invented the use of warehouse receipts for gold as a proxy for money (the history of money is written in more detail in our book, How to buy and invest in physical gold and silver bullion). Warehouse receipts for gold are the precursor to the paper money we have today.

In this current age of information technology, this problem can be easily solved with electronic gold. In fact, there are quite a few electronic gold solutions currently implemented today. One of them is (which we disclose that we have an affiliate interest with them).

One very important thing to remember: the whole point of owning gold is to own an asset that is nobody’s liability (if you want to understanding the reasoning behind it, please read How to buy and invest in physical gold and silver bullion). That will eliminate most gold ETFs, gold futures, gold CFDs, etc because they are basically financial assets disguised as ‘gold’ as they exist as a liability in someone else’s balance sheet. As for other types of gold that you do not take physical possession for yourself (e.g. kept in vault storage on your behalf), you have to look at them on a case-by-case basis to ensure that

  1. You own the legal title to the gold (i.e. your gold is really yours and not belong to the liability column of someone else’s balance sheet), and
  2. Trust that they are able to physically deliver your gold to you on demand.

So, if you trust, then they fulfil these two criteria. But do not let us tell you who to trust or not to trust- seek advice, do research and decide for yourself.

When we first heard of, we imagine a world whereby gold becomes money and payments can be made back and forth electronically as conveniently as PayPal. If you have a full-holding account in, you can certainly do that with their patented technology. We don’t see why it can’t be done.

But we talked to those guys and found out something interesting. Apparently, most of their clients do not use as electronic gold money (as we imagined in our fantasy). In reality, most of them link their full-holding account with their bank accounts all over the world. Why would someone do that? Here is what we think (bear in mind, this is just our opinion)…

Remember, back in Protecting yourself against currency crisis, we wrote

Personally, we feel that the best way to protect you from a currency crisis is to leave the country before TSHTF.

If you believe that all paper fiat currencies will eventually depreciate significantly against gold, then it makes sense to hold gold. Let’s say you have a cache of physical gold and you decide to leave the country? That means you have to lug your physical gold to that country where there’s always a danger of loss in transit from bandits, thieves, corrupt officials, ship-wrecks, air-crash, etc. Or maybe the custom officers in both the source and destination country may not look in favour of anyone bringing in physical gold. Whatever the reason, you may not feel comfortable having so much valuables in your physical possession while you’re on transit to another country. For a big fat filthy rich person, it is physically too demanding to lug around his large stash of gold.

GoldMoney. The best way to buy gold & silver So, here come the folks at Since you have already set up links between your full-holding account and the various overseas bank accounts all over the world, you do not have to worry about hauling physical gold around. (Of course, having some physical gold coins in your pocket will always be useful for things like paying for a space on a leaky boat to travel to that country- jokes aside, we mean it is not wise to completely do away with having some physical gold in your physical possession).

So, the next time you visit a foreign country, you may want to open a bank account over there!

Meanwhile, please vote on the poll below:

Black Swans lurking because Uncle Sam has less margin for error

Tuesday, March 16th, 2010

Yesterday, we can’t help but notice newspapers headlines reporting that China’s Premier Wen Jiabao warned of a double-dip recession in the global economy. The reason is simple- governments all over the world are expected to scale back their ‘stimulus’ spendings for fear of price inflation and/or blowing a bigger hole in their budget. This goes to show that the word ‘stimulus’ is a weasel word that only has value as a propaganda tool. As we wrote in Will governments be forced to exit from ?stimulus??,

In fact, the word ?stimulus? is the most misleading word in economics lexicon because it conveys the idea of a surgeon ?stimulating? a heart into self-sustained beating. In reality, what government interventions did was to put the economy on a crutch.

If the right word is used (e.g. “crutch,” “prop up”) to describe the counter-productive government policies of spend, spend and spend, then it will do wonders to increase the economic IQ of the masses (see Are governments mad with ?stimulating??). Consider this very simple chain a logic:

  1. Someone is falling.
  2. You place a crutch to prevent him from falling.

Isn’t it plain common sense to see that once you remove the crutch, that person will crumble? From this, it follows that government crutch (‘stimulus’) lifts government expenditure to a higher plateau. Once we have bigger government, it is very difficult to shrink it as the difficulty currently faced by Greek government shows. Consequently, with a government budget already in deficit, there’s very every chance for it to go deeper into debt. Sooner or later, the bond vigilantes will doubt the credit worthiness of the government, which means the interest rates on government debts will rise, which in turn makes debt servicing even harder. Eventually, this will result in a currency crisis.

This time, governments are cornered with very little margin for error. As Moody’s warns about diminished margin for error on U.S. debt reported,

Cutting back on public spending too soon risks a double-dip recession, Moody’s said, while leaving stimulus measures in place too long could lead to a sharp rise in interest rates “with more abrupt rating consequences a possibility.”

Wherever there’s very little margin for error, Black Swans (see Failure to understand Black Swan leads to fallacious thinking) will be lurking. You see, it is open knowledge that the United States government is heading towards where Greece is in right now (see Currency crisis: UK, Japan and US). What if, there’s another macroeconomic shock? It could be a meltdown in the Credit Default Swap (CDS) market, trade war with China, another wave of mortgage default (see Next wave of defaults to come?), or something else. With the United States government already stretched thin on faith and credit, any additional macroeconomic shock that requires further faith and credit of Uncle Sam will simply be unavailable.

GoldMoney. The best way to buy gold & silverTo understand what we mean, consider what a typical bond vigilante will be thinking. The only reason why he is still lending money to Uncle Sam is because Europe is a worse debtor. Since it is open knowledge that the US is heading towards a Greek tragedy, he knows that it is only a matter of time he will stop lending to Uncle Sam (assuming that Uncle Sam remains unrepentant of his spendthrift ways). But what if Uncle Sam is hit with an unexpected huge bill (macroeconomic shock) today? Will he continue to lend to Uncle Sam? Perhaps he may even demand his money back straight away? After all, if he worries whether Uncle Sam can repay his debt in 10 years time, wouldn’t that unexpected bill bring forward the day of reckoning? Or perhaps that will be trigger for giving up on Uncle Sam?

That’s where another macroeconomic shock can potentially descend into a USD currency crisis. We are not saying it will happen. But given that we are in a situation whereby the margin for error is getting smaller and smaller, it pays to watch out for Black Swans.

All quiet on the Greek front?

Sunday, March 14th, 2010

It’s less than a couple of months ago, financial markets around the world were panicking over Greek government debt default. Speculators like George Soros were probably short-selling Greek government bonds, which in itself will result in rising interest rates for the Greek government. That in turn would increase its debt servicing burden, which would make it even more likely for the Greek government to default. This is like the positive feedback loop that we talked about in Thinking tool: going beyond causes & effects with systems thinking. Those speculators holding Credit Default Swaps (CDS) will have a perverse hope of seeing a Greek Government default.

Today, it seems that this story is a non-issue for the market. Has the story ended?

We afraid this is just the beginning. The Greeks had merely just announced on an austerity plan and some of its people are taking to the streets in protest. As you can read from European politicians hammered from both sides, there will be many parts to this story. Much of the ugly political and legal sausage making process will be happening behind closed doors, which means you wouldn’t get to read them in the media. That will lull many into a false sense of calm.

But make no mistake, this story is like a trench warfare that will play out over a period of years (see Currency crisis: first countries in the line of fire- PIIGS). It will engulf more than Greece- vulnerable? countries include Portugal, Italy, Ireland and Spain. While the Euro may stage a counter-rally here and then, it is most likely to be in a secular down-trend.

As Marc Faber said, the Greek austerity measures will cripple the Greek economy:

Austerity measures may end up making the Greek economy weaker, which means tax receipts will be reduced. That in turn may even make it harder for the Greek government to service its debt. When that happens, you will see speculators moving in again, resulting in another panic quite some time later. This is what we will call the Part 1, Act 2 of the story.

In the meantime, even if the speculators’ hands are tied from touching Greece (by government regulations), they may be setting their sights at countries like Spain or Portugal. That’ll be Part 2, Act 1 of the story.

Interesting chart: Number of home loans vs Size of home loans

Thursday, March 11th, 2010

Today, we will show you a few interesting charts.

The first chart is this:

Number of loans vs Size of loans (Total)

Number of loans vs Size of loans (Total)

It shows the total number of home loans and the size of loans. As you can see, from September 2009, the number of loans crashed, but the size of loans still remained in a steady up-trend.

Now, let us break it up the numbers into First-Home-Buyer (FHB) and non-FHB:

Number of loans vs Size of loans (FHB)

Number of loans vs Size of loans (FHB)

As you can see, since the doubling of the First-Home-Owner-Grant (FHOG), the number of FHB home loans surged to a record high. But still, the size of loans still remained in a steady up-trend

Number of loan vs Size of loan (Non-FHB)

Number of loan vs Size of loan (Non-FHB)

For the non-FHB, it is clear that the total number of loans remained in a down-trend despite the surge in 2009.

There is a common characteristic among these 3 charts: despite the number of loans declining, the size of loans keeps on growing.

What do you think this means?

Is China going to allow its banks to fail in the upcoming (potentially gigantic) wave of bad debts?

Tuesday, March 9th, 2010

Last month, we reported that Marc Faber commented that China is going to slow down in 2010 (see the video in Is China going to dump their excess metal stockpiles?). The question investors should ask themselves is that whether China is going to slow down to say, 3% to 6% GDP growth or is it going to crash?

We will come to the question later. But first, the current mainstream forecast believes that China will grow 8% to 9% in 2010. Why? Because last Friday, Premier Wen Jiabao announced that he is targeting growth to be 8%.? China is the only country in the world where the government knows in advance what the GDP growth figures will be. If they declare that target for GDP growth is 8%, it will be at least 8%. The question is (1) how much the statistics are tortured and fudged to get arrive at the intended figure and (2) the quality of the GDP growth.

Now, here comes the question: will China crash in 2010/2011?

We don’t know the future, but this is a possibility. According to Marc Faber, the reason is because the Chinese government is clamping down on rampant credit growth. For debt-addicted Western economies, a significant slow down in credit growth will have serious negative impact on the economy. Correspondingly, a clamp down in credit growth will have unpredictable results to the Chinese economy.

The clamp down in credit growth is part of bigger picture. Unlike prior to 2008, China seems to be getting more serious about restraining the economy from overheating. All they have to do is to look across the ocean and look at Japan as an object lesson for not reining in credit and asset price bubbles early on. Since today’s Chinese economy is still developing (unlike the developed Japanese economy in 1990), the consequences of a burst bubble will be much more damaging than Japan’s long-term stagnation. Two months ago, in Chinese government cornered by inflation, bubbles & rich-poor gap, we were pondering what will China choose- voluntary slow-down or an involuntary inflationary melt-up.? As we wrote,

But there will be a day when they have to tackle the inflation problem.

There are signs that the Chinese government is getting more serious about doing so. However, it must be noted that the Chinese government is still on a capitalistic learning curve. That’s why the government’s economic edicts veer from one extreme to another extreme, which is pretty erratic (and authoritarian) relative to Western standards. There’s a chance that they may make a misstep and crash the economy.

The BookDepository

One very important development was reported yesterday: China is nullifying loan guarantees of local governments (see China to Nullify Loan Guarantees by Local Governments). To understand the implication of this, a little background is necessary. China’s local governments are not allowed to borrow directly. In order to raise funds for the stimulus infrastructure projects, they set up special investment vehicles to borrow from banks. Then they guarantee the debts of these vehicles. Through this means, Northwestern University Professor Victor Shih calculates that local governments have already accumulated RMB 11 trillion (US$ 1.7 trillion) in outstanding debt, with RMB $13 trillion (US$ 1.9 trillion) in available credit lines, belying China?s deceptively low reported levels of public debt (see Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?). In one swoop, the central government’s planned edict will nullify the loan guarantees and ban future ones.

Now, since many of the stimulus projects were not creditworthy by themselves in the first place, the removal of local government guarantees implies that many of these debts will become bad debt. According to Professor Victor Shih, a crackdown on such loans at the end of 2009 could trigger a ?gigantic wave? of bad debts as projects are left without funding. Not only that, ?By striking the fear of God into lenders, regulators hope to get them to turn off the [credit] tap,? said Patrick Chovanec, a professor at Tsinghua University in Beijing.

Since this is a serious systemic risk to the Chinese banking system, how will the central government deal with the likely gigantic wave of bad debts? We don’t know. But in 1998, it allowed Guangdong International Trust & Investment Corp (GITIC), a major bank, to collapse. According to Bloomberg,

The 1998 collapse of Guangdong International Trust & Investment Corp., which borrowed domestically and overseas on behalf of southern China?s Guangdong province, left creditors including Dresdner Bank AG of Germany and Bank One Corp. in the U.S. with $3 billion of unpaid bonds. It marked the first time that Chinese authorities failed to bail out one of the nation?s state-owned trusts.

Our guess is that, some of the hundreds of less important (or less well-connected) Chinese banks could be allowed to fail.

Only time can tell.