HowWealthWorks.com

[Suresh]

Government-directed bank loans in the short term may foster an economic boom. The short term may be long enough to convince people that economic growth inuring from such loans are actually independent of cheap and easy credit. That is what may be happening in China right now. Up until now, nonperforming loans were a non-issue because the story of economic growth overwhelmed any story of increased risk from bank loans made at the behest of the Chinese government. Consider, as examples, the stories we've read about the surplus of college construction, the rampant construction of villas, townhouses and high-rises, and the oversupply of shopping malls.
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Bloomberg: China Banks Surge to World’s Biggest May Be Too Good to Be True
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While Industrial & Commercial Bank of China Ltd., China Construction Bank Corp. and Bank of China Ltd., three of the world’s four largest banks by market value, led an increase in lending focused on investments in railways, roads and ports, similar state-directed loans caused bad debts to snowball in the 1990s. The resulting rescue cost $650 billion and took 10 years.

“We suspect some of the banks may have compromised their risk-management and risk-aversion attitude to meet targets and government expectations,” said Wen Chunling, a Beijing-based analyst at Fitch Ratings. “That will lead to a rebound in non- performing loans in the next few years.”

Chinese banks tripled first-quarter lending to $670 billion as part of a government stimulus package designed to help the economy recover from its slowest growth in almost a decade.

ICBC advanced 636.4 billion yuan ($93.3 billion) of new loans in the first quarter, almost quadruple the amount extended in the same period a year ago and more than the bank’s total lending last year. China Construction offered 521 billion yuan of new credit in the first three months, compared with 161 billion yuan a year earlier. Bank of China made 511 billion yuan of new loans, more than twice the amount a year earlier. All three banks are state-owned and based in Beijing.

Three-Year Wait

It may take as long as three years before the increase is fully reflected in bad-debt statistics, twice as long as in other countries, according to Wen
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Liu Mingkang, chairman of the Beijing-based China Banking Regulatory Commission, said April 18 that bad loans will continue to drop this year as lenders tighten scrutiny. ...

The decrease in delinquent debt is surprising, considering the surge in bankruptcies among small and mid-size companies in coastal areas, said Peng Xingyun, director of the monetary policy division at the Chinese Academy of Social Science in Beijing. At least 7.5 percent of the country’s 42 million small and medium-size enterprises had closed or suspended operations by the end of last year and about 30 million migrant workers have lost their jobs, according to official statistics.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Bloomberg: China Banks Said to Submit Capital Raising Plans
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Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd., Agricultural Bank of China and Bank of Communications Ltd. told the China Banking Regulatory Commission how they can bolster capital ratios after the watchdog evaluated their finances last week, the people said. Lenders were told to estimate potential deficits in 2010 based on their own loan forecasts and capital ratio targets, they said.
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The five lenders extended a record 4.7 trillion yuan ($688 billion) of loans in the first nine months, driving China’s economic growth to an annual 8.9 percent rate in the third quarter even as rivals worldwide reined in credit.

“With China’s pace of credit growth, banks’ capital will be drained very quickly and that leaves little room for cushioning if asset quality worsens,” said Sheng Nan, a Shanghai-based analyst at UOB-Kayhian Investment Co.
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Capital adequacy ratios, or capital as a percentage of risk-weighted assets, fell by between 5 basis points and 1.8 percentage points at ICBC, Construction Bank, Bank of China and Bank of Communications in the first nine months, even as they raised a combined 165 billion yuan selling subordinated bonds.

Capital Ratios

ICBC, the world’s largest bank by market value, had a capital adequacy ratio of 12.6 percent as of Sept. 30, while Construction Bank was at 12.11 percent. Bank of China’s capital adequacy ratio stood at 11.63 percent and the ratio at Bank of Communications was 12.52 percent. Their Tier 1 ratios were all above 9 percent except for Bank of Communications.

China’s government encouraged a $1.3 trillion credit boom this year to complement its monetary and fiscal stimulus plans, propelling the economy to the fastest growth in a year last quarter. The nation’s 11 largest publicly traded banks may need to raise about 300 billion yuan by selling shares and bonds to ensure they have adequate capital for continued loan growth, BNP Paribas SA said in a report last week.

Chinese lenders would need as much as a combined 368 billion yuan to keep their capital adequacy ratios at 12 percent, according to BNP Paribas. Bank of China, the nation’s third- largest by market value, would require 137 billion yuan, BNP Paribas estimated.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

According to the Bloomberg article below, over the past decade China’s government has spent more than $650 billion recapitalizing state banks weighed down by government-directed, nonperforming loans loans. China has $2.4 trillion in foreign exchange reserves. No need to get the IMF involved; China can afford bank bailouts multiples larger than it has already provided in the past decade.

In a sense, China's foreign exchange reserves could be used as a reset button for banks. At the right time, China could recapitalize banks damaged by losses on nonperforming loans and charge them with stricter lending standards. China would then left with fixed assets purchased with the nonperforming loans, a skilled workforce trained to use the fixed assets, and recapitalized banks. These resources would have two options: serve a shrinking or stagnating export market, or serve a 700 million member rural population that heretofore has not benefited the way the urban population has from modern banking, from access to asset markets, and from modern products and services.
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Bloomberg: China Defaulting Loans Soar, Insolvency Lawyer Says
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“We work really closely with SASAC, the state-owned enterprise regulator in China, and there are literally trillions and trillions of renminbi of, frankly, defaulting loans already in China that no one is doing anything about,” Neil McDonald, a Hong Kong-based business restructuring and insolvency partner with Lovells LLP, said at an Asia-Pacific Loan Market Association conference yesterday.
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Chinese banks issued a record 9.6 trillion yuan ($1.4 trillion) of new loans last year as part of a 4 trillion yuan stimulus package aimed at bolstering growth through the global financial crisis.

“At some point in China, maybe it will be two, three or five years, but at some point there will be in the property markets and in the markets generally, there will be rationalization of very poor lending practices,” McDonald said during the panel discussion on restructuring and refinancing at the Global Loan Market Summit in Hong Kong.

Bad Loan Ratio

Over the past decade China’s government has spent more than $650 billion bailing out state banks after years of government- directed lending caused bad loans to balloon. The average non- performing loan ratio at Industrial & Commercial Bank of China Ltd., China Construction Bank Corp. and Bank of China Ltd. dropped to about 1.6 percent as of Sept. 30 from more than 20 percent before each bank was bailed out, according to earnings reports.

New loans last year helped ignite a Chinese real-estate boom, with prices in 70 cities rising at the fastest pace in 18 months in December.

Should property prices fall 10 percent in Shanghai, China’s second-most-expensive property market, the ratio of delinquent mortgages would almost triple for the city’s banks to 1.18 percent, according to the Shanghai branch of the CBRC yesterday, citing a stress test based on Sept. 30 figures. A 30 percent decline would cause the ratio to jump almost fivefold, the agency said.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

If the reading of Chinese sentiment in this article is correct, then China's political elite may be weighing the cost of shifting from an export economy to an economy primarily servicing domestic demand and possibly a partially gold-backed yuan. The political elite may be thinking that the cost may not be so great and indeed the benefits may be worth the cost. That is, not only would a stronger yuan and a focus on domestic demand benefit and pacify the Chinese populace, it would take a competing power, namely, the U.S. down a notch.
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TimesOnline: China’s hawks demand cold war on the US

MORE than half of Chinese people questioned in a poll believe China and America are heading for a new “cold war”.

The finding came after battles over Taiwan, Tibet, trade, climate change, internet freedom and human rights which have poisoned relations in the three months since President Barack Obama made a fruitless visit to Beijing.
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Now almost 55% of those questioned for Global Times, a state-run newspaper, agree that “a cold war will break out between the US and China”.

An independent survey of Chinese-language media for The Sunday Times has found army and navy officers predicting a military showdown and political leaders calling for China to sell more arms to America’s foes. The trigger for their fury was Obama’s decision to sell $6.4 billion (£4 billion) worth of weapons to Taiwan, the thriving democratic island that has ruled itself since 1949.

“We should retaliate with an eye for an eye and sell arms to Iran, North Korea, Syria, Cuba and Venezuela,” declared Liu Menxiong, a member of the Chinese people’s political consultative conference.

He added: “We have nothing to be afraid of. The North Koreans have stood up to America and has anything happened to them? No. Iran stands up to America and does disaster befall it? No.”
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But Chinese analysts think the leadership, riding a wave of patriotism as the year of the tiger dawns, may go further.

“This time China must punish the US,” said Major-General Yang Yi, a naval officer. “We must make them hurt.” A major-general in the People’s Liberation Army (PLA), Luo Yuan, told a television audience that more missiles would be deployed against Taiwan. And a PLA strategist, Colonel Meng Xianging, said China would “qualitatively upgrade” its military over the next 10 years to force a showdown “when we’re strong enough for a hand-to-hand fight with the US”.

Chinese indignation was compounded when the White House said Obama would meet the Dalai Lama, the exiled spiritual leader of Tibet, in the next few weeks.

“When someone spits on you, you have to get back,” said Huang Xiangyang, a commentator in the China Daily newspaper, usually seen as a showcase for moderate opinion.

An internal publication at the elite Qinghua University last week predicted the strains would get worse because “core interests” were at risk. It said battles over exports, technology transfer, copyright piracy and the value of China’s currency, the yuan, would be fierce.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Back in 2007, Jim Jubak brought to our attention China's demographic time bomb. In 2015, the Chinese work force will begin to shrink. Absent productivity gains, GDP will shrink. With a shrinking GDP will go the material well-being of the populace. If the material well-being of the populace fails to improve and indeed deteriorates, the political elite risk popular overthrow. To counteract the shrinking work force post-2015, China's economy needs productivity gains by moving up the value chain in its various sectors. Moving up the value chain often entails converting unskilled labor to skilled labor and employing more automation. The machinery required for automation may be made overseas, in which case an easily tradeable yuan would be an asset.

2015 gives China's central planners five years or so to make the yuan a convertible currency. Over the coming years, a rising domestic consumer price inflation rate may be an intended part of the domestic policy. Foreign exchange reserves may get repatriated as they mature and turned into yuan, adding to the money supply. More Chinese citizens may note that it takes more and more yuan to buy necessities. They may then buy gold and silver from state producers, from which the yuan perhaps can be taken out of circulation. In due course, China could start minting gold and silver coins, inviting the public to swap gold for new coins with a face value. Presto! An at least partially gold-backed yuan . . . and by extension, a convertible yuan.

On a related topic, so far, we've assumed that an IMF SDR rebalancing could include gold as early as rebalancing meeting in 2015. But, suppose the IMF SDR rebalancing in 2015 does not include gold. That is, suppose the financial elite try to effect a Bretton Woods-style agreement, using the IMF SDR as the world's reserve currency to which national currencies may be convertible and keeping the IMF SDR composed of purely fiat currencies. That is, the financial elite may underestimate the attractiveness or even likelihood of a gold-backed yuan as a competing store of wealth. If that happens, gold may not be a part of the IMF SDR composition until 2020. Moreover, if that happens, then Keynesian monetary and fiscal policies would run rampant in developed economies until exploding debt dynamics crushes the governments implementing the policies. The deleveraging of the government debt bubbles would take years to resolve. In the U.S., for example, it wouldn't be surprising to see the deleveraging, typical of a Kondratieff Winter, to occur through the early 2020s.
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Seeking Alpha: China's Plan for Economic Conquest
by Stephen Leeb
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Until last year, the Chinese public was officially forbidden from owning precious metals. Now, in a stark reversal, the Chinese government encourages its people to buy gold and silver – to the point of broadcasting television programs promoting these metals as savings vehicles.
We also note that China has recently become the largest producer of gold in the world.
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[W]e have to wonder what China is up to with this new precious metal policy?
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At the moment, China has some $2.4 trillion in reserves, most of which are in U.S. dollars. At the same time, everyone in the West complains that the Chinese yuan is undervalued and should be allowed to move higher (meaning the U.S. dollar would move lower). In addition, China clearly believes that American financial policies (debt, deficits, money creation, etc.) will be bad for the dollar over time. Before the dollar falls too far, China might like to trade some of its dollars for something less likely to lose value, but there aren't many alternatives, apart from … gold.

Let's also consider that China thinks long-term. It looks at the trends for the next two decades, while caring little for this year or next. So although the dollar has had a small bounce recently and may even go a little higher this year, China can see that the greenback’s long-term prospects are poor. While China is not likely to sell its dollars or switch to a free-floating currency tomorrow, it will prepare itself for what is coming.
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The real bubble China would want to avoid isn't a bubble in commercial real estate, but a bubble in housing. By encouraging people to put their life savings into precious metals, rather than real estate, China may prevent such a housing bubble from arising. After all, every yuan invested in gold is a yuan not invested in real estate speculation or buying bigger homes. However, that's only a short-term objective. Longer term, China faces the problem of not owning enough gold to effectively hedge against a downtrend in the dollar.
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Let's say Chinese consumers start buying large amounts of gold in exchange for yuan. The yuan will be deposited into Chinese banks, which creates bank reserves that can be used to increase lending, which adds liquidity.

At some time in the future, the Chinese government could decide to turn the silver and gold held by the public into currency (as it once was). China could start minting gold and silver coins and invite the public to swap their old gold for new coins with a face value. Or perhaps create a paper currency fully exchangeable for gold (as the U.S. once did).
This two-part process would expand the money supply – making the Chinese currency liquid enough, while at the same time attaching it to the timeless solidity of gold. The result would be a very strong currency. The main challenge would be getting enough gold to sufficiently back a highly liquid currency.

Right now, 20% of the world's gold is owned by central banks. It adds up to roughly $1 trillion. Yet, China has $2.5 trillion in reserves. China would have to sell its dollars slowly over time while acquiring gold. But it has the money to buy as much gold as the rest of the world's central banks put together. Even if some of that gold is sold to the public as currency, China could have the world's hardest currency a decade from now.
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Author's post script reply to a commenter: you can buy gold at most banks and the mark-up is virtually zero. Silver, however, which the Chinese will need for industry including solar is sold with a 100 percent mark-up.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

When a bank pays a low savings rate and effectively uses the funds to absorb the cost of its nonperforming loans, wealth is transferred from savers to debtors and the lender itself, neither of whom have proved to be good financial stewards. The less savings, the less capital. In the long run, the less capital, the less productive capacity in the economy.

The end run for citizens around the banks as repositories of savings is, of course, precious metals. Sooner or later, Joe Six-Pack in China will figure out the game, and will buy gold and/or silver hand over fist.
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naked capitalism: Three ways to keep NPLs down, recapitalize banks, and socialize losses all at the same time

Michael Pettis is out with another great piece [entitled Who will pay for China’s bad loans?] on the likelihood that non-performing loans (NPLs) will rise in China when the present spate of malinvestment comes a-cropper. What caught my eye were his statements about the hidden ways in which government pays for bank recapitalization in order to deal with the threat of NPLs. Here’s what he had to say about interest rates.