Posts Tagged ‘Patrick Chovanec’

Warning: China MAY be near an economic crisis

Monday, October 3rd, 2011

More than a month ago, we were listening to a video interview with Victor Shih, of Northwestern University, and Carl Walter, co-author of Red Capitalism, on China?s banking system. It is a very interesting interview by experts who really know their stuff.

In this interview, one thing stuck in our mind. The question was put forth to Victor Shih on what he thought may be the trigger for a financial/economic crisis in China. The usual suspects of what the trigger may be usually comes in the form of an external shock (e.g. collapse of Euro-zone, global recession) that crunch China’s export industry. Surprisingly, that wasn’t his consideration. Victor Shih offered his favourite theory (though he emphasised that it is by no means a prediction) that when it comes to the point when China’s elite begin to pull its vast wealth out of China, that will be the thing that trigger a crisis. This could happen, for instance, when the elite find that the returns on/of their investments inside China is floundering.

Indeed, we notice that one of our favourite China experts, Patrick Chovanec is getting more and more nervous about China over the course of past several months. Today, we read from his latest blog post,

For the moment, I?m reminded of that song: “Something?s happening here; what it is ain?t exactly clear.” But ? and this is the real point ? something is happening, and people both inside and outside of China are right to be nervous.

My experience, talking to numerous investors and economists, is as follows: the closer you are to running an econometric model, the better you feel about the Chinese economy; sure, there may be bumps along the road, the models tell us, but fundamentally the momentum is so strong that growth will stay on track. The more you go out and look around, and listen to your gut, the more worried you become. Something?s happening here, what it is ain?t exactly clear ? but it feels bad, very bad. The problem with models, and the reason I?m inclined to stick with my eyes and my gut, is that models work very well when prior patterns of perception and behavior remain constant, but are very poor at noticing inflection points where the way people think and act undergo a shift. In other words, they are very poor at identifying moments of crisis.

Indeed, some sort of a credit meltdown is brewing in Wenzhou. If you have friends in China, you can ask them about Wenzhou because it is in the Chinese media lately. We are heard a story that the Bank of China is offering an extremely high overnight interest rate for high net-worth investors with a big sum of cash.

There is another interesting observation that is quite unusual. China’s RMB is widely perceived to be undervalued. This can be seen by the fact that the RMB is always bumping against the upper band of the government-imposed US dollar exchange limit. But today, the RMB is bumping against the lower limit of the band. It looks like the RMB ‘wants’ to depreciate against the US dollar.


As Patrick Chovanec wrote,

Presumably because the capital account had flipped, and speculators were now rushing to turn their RMB into dollars in order to take their money out of China.

What the new downward market pressure on the RMB does indicate, however, is that China ? for so long a no-brainer destination for investment ? has turned into a big question mark. And it suggests that at least some domestic Chinese investors who have been inclined to sock their money into empty villas and condos ? or big stockpiles of raw materials ? are now looking for a way out.

That’s exactly Victor Shih’s pet theory about a possible trigger for a financial/crisis in China. Although Patrick Chovanec reckons that this does not mean a collapse in the RMB because China’s vast hoard (US$3 trillion) of US dollar reserve can allow it to defend the RMB, we aren’t so sure.


As we wrote early last year at Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?

According to the chart provided by Pivot Capital?s report, only a little over 20% of China?s total currency (plus gross external debt) are ?backed? by their US dollar reserves, which isn?t spectacular compared to other emerging economies. In fact, South Africa is the winner in this aspect because their reserve coverage ratio is almost 160% i.e. it has $16 of reserves for every $10 of currency.

Since China had been printing copious amount of money too, the People’s Bank of China’s (PBOC) liabilities (RMB) far exceeds its asset (US dollars). If say 30% of China’s RMB wants to exit China, this could easily trigger a currency crisis for China. Is this too far fetched? We don’t know and we do not have the data to give a definitive answer. But this is something you have to watch out for.

It is no secret that Australia’s economy is highly reliant on China. In light of what’s happening in China, Australian investors better be prepared. By the way, in this Youtube video, Marc Faber advised that some sectors of China’s economy may crash.

Credit problems in China

Sunday, August 8th, 2010

Last Friday, we asked our readers: Do you think China will crash soon? The results are pretty interesting. Almost 29% of you reckon that China will crash in a few years time. Almost the same number reckon that China will not crash as far as the eye can see. The rest are scattered throughout the other response. From what we can see, most of you do not think that China will crash anytime soon.

Today, we will talk about credit in China?s banking system.

In Western countries, central banks cannot force the private sector to borrow.  As we wrote in What makes monetary policy ?loose? or ?tight??,

To understand why, we have to remember that the central bank cannot control the demand for money and credit. It can supply whatever amount of them that it wants, but it cannot force business and people to desire them. Put it simply, you can lead a horse to the water, but you cannot force it to drink.

Apparently, this is not so in China. The Chinese government, which has greater administrative powers than Western governments, can force feed credit into the economy. The result: bad debts.

Professor Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management in Beijing, has concerns about the Chinese banking system. He wrote two articles detailing its weaknesses:

Chinese Banks At Risk, Part 1
Chinese Banks at Risk, Part 2

The question is, can there be a Western-style credit crisis in China?

Will a crashed Chinese property market lead to an embrace of gold? Part 2- Store-of-value function

Sunday, May 16th, 2010

Today, we will continue from Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market. As we discussed in that article, our question was,

What if the Chinese government succeeded (whether accidentally or deliberately) in smashing the store-of-value function of property?

There?s no guarantee that the Chinese government will be strong-willed enough to let the property bubble burst. Some China pundits reckoned (e.g. Michael Pettis) that its policies will vacillate from one extreme to another, switching between the brakes and accelerator quickly, as the reality on the streets veer from inflation to deflation and back to inflation. If this is so, the developments will become unpredictable and volatile, which is where we will expect negative Black Swans to spring surprises.

Also, there is a risk that the Chinese government may react one second too late, letting the property market fall into a tipping point whereby price deflation becomes irreversible. This can happen because according to Patrick Chanovec (an associate professor at Tsinghua University’s School of Economics and Management in Beijing), supply and demand do not drive property prices in China (see China: gigantic property bubble in the midst of exploding supply of vacant brand new homes). Instead, property serves a store-of-value function, which is a function that is supposed to be served by money (traditionally gold, but it?s fiat currency today). Once property no longer serves this function, prices will fall to reflect supply and demand.

The problem is, if the Chinese currency does not serve the function as store of value, and there are limited investment avenues (e.g. stocks are too volatile), then what else can take that function? Logically, the answer is gold. Already, according to a recent report from China?s CCTV, some Chinese investors are switching from property to gold. In a recent interview, this is what Patrick Chanovec commented regarding this new development:

It?s open knowledge that since last year, the Chinese government encouraged its people to invest in physical gold, even to the point of letting TV ads do the talking. Will the Chinese turn their attention to gold as a store of value? This is a very interesting question. We will see.

How to buy and invest in physical gold and silver bullion

Will a crashed Chinese property market lead to an embrace of gold? Part 1- Chinese characteristics of property market

Tuesday, May 11th, 2010

In our previous article, What if China crashes?, we wrote,

? the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst.

Will the Chinese then rush to gold should their government succeed in cracking down in property speculation? To answer this question, we must first understand some things about the Chinese mindset on property and investments. Currently, interest rates in China are pathetically low- so low that they are below the price inflation rate. Because of their currency peg, the People?s Bank of China (PBOC) is constrained from raising interest rates (see Can China raise interest rates to control its property bubble?). Also, the Chinese are known to be savers.

So, that creates a problem. Imagine you are a typical Chinese saver. What if you want to save and the cash at bank is yielding returns that are below the rate of price inflation? That results in a very great disincentive to save your money in the bank and pushes you to ?invest.?

The next question is where can you ?invest? your money? Remember, a lot of other people are facing the same problem because the Chinese government?s policy of force feeding credit into the economy is creating a gigantic rain of freshly printed money- a lot of people are having too much money on their hands. Unfortunately, in China, with its underdeveloped financial system, there is not much avenue to ?invest? your money.

The range of financial instruments in the stock market is limited. There are hardly any derivatives available for you to short the market (but currently, stock index futures are on the trial phase). Not only that, the standard of disclosure and reporting has too much to be desired. Most average mum and dad stock investors in China can only take long positions on a stock market that is highly volatile and speculative (due to lack of disclosure). No wonder investing in stocks is not that popular in China.

Thus, the only investment outlet for this mountain of freshly printed money is the property market. There are a few characteristics of the Chinese property market that most foreigners will not know. Perhaps these characteristics explain why the property bubble in China is so enduring.

Firstly, the Chinese property bubble is definitely bigger than the property bubble in Australia. But you may be surprised to learn that the consumer leverage in the residential property market in China is in fact smaller than Australia. In China, you need at least 40% deposit to qualify for a mortgage loan. As Patrick Chovanec wrote here,

According to the latest statistics I?ve seen, approximately 50% of all residential purchases in China today are financed with mortgages, which are mainly provided by the big state banks.  That?s a sharp increase from just a few years ago, when nearly all such purchases were made in cash.  In theory, the rules allow 30-year mortgages, but anything longer than 20 years is rare, and the presence of high prepayment penalties tend to push buyers towards mortgages with even shorter terms (our own mortgage was, believe it or not, 3 years, which is more like an instalment plan!).

A lot of residential real estate transactions in China are made in cash!

Secondly, the secondary market for residential real estate in China is extremely weak. As Patrick Chovanec wrote here,

What we see in China, though, is an extremely weak secondary market.  In the U.S., the ratio of secondary to primary residential property transactions for the first half of 2009 was 13.45; in Hong Kong it was 7.25.  In China as a whole, that ratio was 0.26 (four times as many new home purchases as secondary sales).  Even in China?s most developed markets the ratios were just 1.30 for Beijing, 1.56 for Shanghai, and 1.35 for Shenzhen.

If you combine these two characteristics together, you can conclude that a lot of real estate purchases in China are made with relatively little borrowing (or none at all) on brand new homes. As a result, the Chinese are, as Patrick Chovanec wrote,

? in that sense, the people using real estate as a store of value, a place to stash their cash?

That explains why there is a lot of idle and empty apartments in China as more and more of them are being built by property developers.

But the fact there is relatively little consumer leverage in the Chinese property market does not mean that there?s little leverage in the property sector. In China, the leverage is placed on the shoulders of property developers. In other words, the Chinese property ?investors? are de-leveraging the developers!

Now, what if the Chinese government succeeded (whether accidentally or deliberately) in smashing the store-of-value function of property? We will go into that in the next article. Keep in tune!