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Monday, 5 May 2014

A belief in the supernatural

Following the last post it emerged that there are another class of investors already taking losses (and expect more of these to appear).  In perhaps what could be termed the ending of the Xiaochan put (a corollary of the Greenspan put, by which US markets had been supported by intervention by the Federal Reserve), so a report from Morgan Stanley detailed the vast sums wagered by speculators positioning for a continued rise in the Chinese currency (the Yuan/Renminbi) which came to an end as the Central Bank in China, the PBOC (led by Zhou Xiaochan) sought to stunt speculation in the currency:
The seemingly incessant strengthening trend of the Chinese Yuan (much as with the seemingly inexorable rise of US equities or home prices) has encouraged huge amounts of structured products to be created over the past few years enabling traders to position for more of the same in increasingly levered ways. That was all going great until the last few weeks which has seen China enter the currency wars (as we explained here). The problem, among many facing China, is that these structured products will face major losses and as Morgan Stanley warns "real pain will come if CNY stays above these levels," leading to further capital withdrawal, illiquidity, and a potential vicious circle as it appears the PBOC is trying to break the virtuous carry trade that has fueled so much of its bubble economy.
and losses were estimated to be in the billions of dollars, and worryingly (given the deterioration going on in the Chinese economy) many of the holders of the loss-making positions were Chinese corporates:
In their previous note, MS estimated that US$350 billion of TRF have been sold since the beginning of 2013. When we dig deeper, we think it is reasonable to assume that most of what was sold in 2013 has been knocked out (at the lower knock-outs), given the price action seen in 2013...."Given that, and given what business we’ve done in 2014 calendar year to date, we think a reasonable estimate is that US$150 billion of product remains."...
...The potential for US$4.8 billion in losses for every 0.1 above the average EKI could have significant implications for corporate China in its own right, as could the need to post collateral on positions even if the EKI level is not breached... 
On the latest check this trend seemed set to continue with weak economic statistics, regulatory concern and weakness in the currency all referenced in a Bloomberg report.  As mentioned in that report, the spectre of capital flight and further destabilisation of Chinese financial markets is a not shallow risk.
Hope and dreams
Notwithstanding some less than pleasing numbers and off-message disclosures of some key figures in China's dynamic property sector and prices of apartments starting to be discounted in a way described as "crumbling" (and here), the facade of the great China miracle continues for the time being, even with the recent announcement of a passing of the US on one economic measure (not without criticism, including from the Financial Times).
As an example of the continued hopefulness and ambition the recent report of an ultra-fast lift to be incorporated in a new development in Guangzhou is a reminder of the Middle Eastern style optimism which has driven the China urban development story.  Of course reality throws up questions such as the need for a giant financial centre development in somewhere like Guangzhou but the need to maintain a motivating ideology for the continued reckless and unsustainable growth seems still to be a concern of those in power and with commercial interests.
This was noted by my recent reading of modern Party mouthpiece China Daily whilst transiting at an airport, which dedicated an issue to President Xi's own notion of the "China Dream", a new guiding vision for youthful and emerging China (with the cover story "Dream Debate").  While well composed and quite glossy, the feature section was disappointing as it fell into predictable patterns, including:
  • a piece by American China apologist Robert Kuhn, who earlier said that the Bo Xilai scandal was only of interest to Westerners because it was "salacious";
  • an advocacy of the status quo by Zhou Feng that contained such wonderful statements as "drastic measures are not necessary" and
  • "by withstanding the global financial crisis in 2008-09, the Chinese economy has become more resilient in its ability to deal with slower growth. Its trade sector, for example, has become used to operating with wafer-thin profit margins."
    (that would be resilience by going bankrupt!) 
  • a wonderfully titled piece by Yu Yongding "No financial meltdown to worry about", which argues that China will be fine because it does not have US subprime mortgages (trust loan anyone?)
and so on.
Over at Zerohedge, hyperbole notwithstanding there was a far more grim picture being painted of the situation in China currently:
China is a case of bastardized socialism on credit steroids. At the turn of century it had $1 trillion of credit market debt outstanding—-a figure which has now soared to $25 trillion. The plain fact is that no economic system can remain stable and sustainable after undergoing a 25X debt expansion in a mere 14 years....
...The borrowing, building and speculating mania in China has obviously gotten so extreme that even the new regime in Beijing has been desperately trying to cool it down. But this will end up as a catastrophic failure—not the “soft landing” brayed about by Wall Street bulls who do not have the slightest comprehension of the difference between free market capitalism and the phony “red capitalism” that has been confected by the party-controlled apparatus of the massive, intrusive, bureaucratic and hierarchically-driven Chinese State..
At bottom the fatal error among China bulls is the failure to recognize that the colossal boom and bust cycle that China is undergoing is not symmetrical. The much admired alacrity by which the state guided the export boom after 1994 and the infrastructure boom after 2008 is not evidence of a superior model of governance; its only proof that when credit, favors,  subsidies, franchises and speculative windfall opportunities are being passed out freely and to everyone, when there are all winners and no losers ( e. g. China’s bankruptcy rate has been infinitesimal), a statist regime can appear to walk on water....
...In short, the Chinese population “can’t handle the truth” in Jack Nicholson’s memorable line. They by now believe they are entitled to a permanent feast and have every expectation that they party and state apparatus will continue to deliver it. As a result, Beijing has resorted to a strategy of tip-toeing around the tulips in a series of start and stop maneuvers to rein-in the credit and building mania....
To the fireflies
That last paragraph raised an interesting aspect (contrasting public expectations and management by the authorities).  Exactly how well will China's population handle the transition which is to arrive once credit markets turn?  On the basis of one unlikely tourist venture, possibly not well.  The below picture (and final image of the post) is from angry holidaymakers who invaded the office of a tour company after a display of firefly insects did not materialise at an organised event:

Visitors shout at organizers during an event to release fireflies in Hangzhou, Zhejiang province, April 30, 2014. According to local media, about 10,000 people protested for a refund of their tickets, claiming they could not find fireflies to release at night. Picture taken April 30, 2014. REUTERS


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