China Worries About Tight Money

Caixin: Reform's Response to the Money Supply Warning
Warning lights are flashing in the context of a widening gap in growth rates for two key measures of money supply – M1 and M2 – and fears that policymaker efforts to boost the real economy are falling flat.

China must now heed the warning by putting into practice long-discussed but largely unimplemented structural reforms. Indeed, the divergence between M1 and M2 highlights an urgent need for reform measures that lift the policy restraints now holding back the Chinese economy.

M1, which includes cash and short-term bank deposits, and M2, which includes long-term deposits, have been growing at different rates since last October. The gap indicates that a People's Bank of China effort to expand the money supply hasn't effectively benefitted the real economy.

M1 grew 25.4 percent in July compared to the same period last year, underscoring a central bank effort to pump liquidity into the market as a way to bolster the slowing economy. The year-on-year rate was only 6.6 percent in July 2015.
Credit money systems only grow when there are willing borrowers. When peak debt is reached, as it was in the developed world and China, credit deflation begins. The PBoC can pump away, but it ends up flowing into temporary asset bubbles. The latest, which did generate some credit growth, was housing. It peaked in July with residential mortgages making up more than 100 percent of bank lending, as credit to the rest of the economy contracted. With real estate slowing, the next target is....:
Meanwhile, speculators are moving in. The property market in the first half of this year was flooded with cash from companies, especially SOEs, and household savings that pushed up real estate prices in many cities.

After several city governments responded to the mini-boom for real estate by tightening property investment controls, investors started diverting capital into the bond market. But that move triggered concerns about a bond bubble and excessive leverage, prompting analysts to predict that the stock market might become the next favorite investment target.
Your bubble recap: real estate, stocks, bonds, real estate, bonds and now possibly stocks. All the while, China's real economy is slowing. This could go on for years as investors are distracted by the shiny bubbles.

Related: Chinese Real Estate Sector Has Turned, Economy to Follow
Adios Easy Money, China Slowdown Coming

Bubble Bursts on Middlesex Water

Adios Easy Money, China Slowdown Coming

Earlier today in Chinese Real Estate Sector Has Turned, Economy to Follow, I looked at the cyclical turn in real estate. The main factor driving real estate growth was credit growth and in July, residential mortgages were more than 100 percent of bank lending. Credit growth has slowed over the past few months though, and the PBoC Pre-Announced M2 Growth for August and September in order to calm the market. As I explained in that post, very slow monthly growth figures roll off over the next three-months, such that the PBoC could effectively slow money supply growth while reporting a rise in the 12-month growth rate. I wrote:
In order to achieve 12% growth by September, M2 would have to grow at 1 percent mom for the next two months. Whether a boost in growth is coming, or the PBoC plans to baffle the market with BS remains to be seen. Year-on-year comparisons will raise the growth figure, but a growing flow is needed to maintain GDP, not simply a more favorable year-on-year comparison.
Now it seems the PBoC is indeed jawboning, but the market isn't buying it.

Reuters: China surveys demand for 14-day reverse repos for first time since Feb
China's central bank queried domestic financial institutions for their demand for 14-day reverse bond repurchase agreements on Tuesday, traders told Reuters, the first query for such a tenor since February.
The market reaction was swift, interpreting the survey as indicative of tight money, of no interest rate or RRR cuts on the horizon.
Reuters: UPDATE 2-China treasury futures tumble as cbank eyes adding short-term liquidity
China bond futures posted their sharpest fall in three months on Tuesday as the prospect of more liquidity injections by the central bank into the financial system reduced expectations of more aggressive policy easing.

Traders said the People's Bank of China (PBOC) asked banks about demand for 14-day reverse bond repurchase agreements for the first time since February, suggesting it may be expanding its strategy of using targeted, short-term injections rather than cutting interest rates or banks' reserve requirements (RRR).
ZH: China Has Its First Taste Of "VaR Shock" As PBOC 14 Day Repo Sparks Treasury Dump
As a result, and confirming once again that fundamentals are dead even in China where only liquidity injections matter just like across the entire "developed" market, the price of Chinese 10- Y treasury futures tumlbed 0.38%. This was also China's first glimpse of what a VaR shock in government bonds will look like once yields spike from recent record lows.
A senior trader at a major Chinese state-owned bank in Shanghai, cited by Reuters, said that "the market interprets the move as another sign that the central bank won't cut interest rates and RRR for now as it injects more short-term money into the banking system." He added that the PBOC announcement "is likely to set a floor for the fall of the yields of government bond futures, and thus investors sold the futures on the news."
Slowing investment, falling home prices and then slowing GDP growth to follow.

Chinese Real Estate Sector Has Turned, Economy to Follow

An article from the China Finance 40 Forum covering China's real estate market has lots of good charts. The second one below is the most important. It shows real estate investment as a share of GDP, falling and then picking up. In 2015, real estate investment slowed to 1 percent and in 2016, it is slowing a again, down to 5.3 percent YTD. Real estate investment grew faster than GDP at the start of 2016 though, to reach its highest share of GDP since 2013. This propped up Chinese GDP in the first half, but a downturn is already underway.
This next chart shows the turn in sales growth and then price (dotted line, NBS 70-city survey) clearly. The second shows real estate area under construction and prices (dotted line, NBS 70-city survey).
This chart shows the Chinese real estate cycle. A decline in prices should begin in the next month or two, followed by a drop in investment. Real estate investment fell to 1.4 percent growth in July 2016 and the slowdown hasn't even really begun yet.
And former three different cycles, 2015 to start sales and housing prices do not rise quickly bring new construction area. Until the end of 2015, new construction area is still negative growth year on year, real estate development and investment amount are at historic lows.

This is partly due to the country's overall housing stock market is still in the accumulation of business prospects for the real estate industry to determine differences, on the other hand is due to lack of developer's own investment capacity.

By the end of 2015 the real estate industry, the average asset-liability ratio of 70%, far higher than other industries. Excessive leverage at developers make operating conditions more difficult in the market downturn. The real estate industry average ROE of 8% in 2010 fell to 5% in 2015, interest coverage fell from 4 to 2.5 times. Even after sales picked up in 2015, Days sales outstanding also largely used to repay debt rather than invest further.

Until the end of 2015, real estate companies listed on the current ratio and quick ratio have rebounded, showing short-term debt burden eased. 2016 first quarter real estate development funds grew 15%, ending two consecutive years of single-digit growth in real estate investment rebound quickly, the performance of new construction area in April cumulative increase of 21.4%, real estate development and investment in the amount of the cumulative increase of 7.2%.
Speaking of the relationship between credit and real estate:
As the real estate investment plays an important role in GDP growth, while real estate prices and rental costs will be passed to end enterprise thus affecting the overall price , thus creating a mutual feedback effects (Figure 7 between the real estate cycle and interest rates in the credit cycle shown). When monetary policy easing, buyers get a boost demand for new loans and rising sales area, within a few months of real estate investment and housing prices rose, led directly to GDP and is conducted to the overall price.

According to experience, the CPI within six months after the formation of the inflection point of monetary policy began to shift, interest rates (or interest rates) cycle lasts several months to a year (Figure 8). When the CPI upward for some time, monetary policy tightening, the incremental credit contraction, real estate sales and prices, real estate investment decline put pressure on economic growth, price slowdown (or even deflation), then trigger another round of currency policy easing. Overall, since 2006 behind the wheel of the real estate cycle is the credit cycle.
The message is a stark warning for China:
Summary and Outlook

After the export-led economic growth mode is terminated, the role of real estate investment in China's GDP growth in the increasingly prominent. The real estate cycle is driven by credit policy since 2008, including the total amount of the monetary policy and macro-prudential policies for the real estate. Although the short term do not see the CPI and monetary policy shift upward signs, but the downside is the interest rate has also been limited. Considering the skyrocketing housing prices in some cities and residents purchase loans surge, macro-prudential policy for the real estate market has clearly turned.

In the medium term, to the economic downturn and expected future revenue growth slowdown does not support a substantial increase in the household sector continued to leverage, which means increased demand for home loans is likely to have peaked.

Whether from the policy level or demand perspective, the real estate market turning point has come, the last two quarters of promoting economic stability factors will soon disappear. Real estate investment growth will slow or even negative growth in the fourth quarter and bring downward pressure on the economy next year.
iFeng: 机构:房地产市场拐点已经到来 投资增速或负增长

This was exactly the warning sent by Liaoning in 2014. It relied on real estate investment to drive economic growth following the commodities slowdown (which began in 2011), but once that market slowed too, it was game over. Liaoning Shows Path to Chinese Recession, Global Depression
There's nothing particularly special about Liaoning beyond its reliance on basic industries. Instead of a slowdown spread out nationally, it is concentrated in a few provinces. Yet in its use of real estate and government-led fixed asset investment, Liaoning is like most provinces. The same strategy is deployed all over China, it simply wasn't enough in Liaoning because the slowdown in the "real" economy was so great and so long, now running into its 5th year.

If I am wrong, then Liaoning is a special case of a long-term concentrated slowdown. Other provinces will not see a similar economic depression and will be able to paper over their recessions with real estate and fixed investment for a few years, by which time the economy will have recovered.

If I am correct and the slowdown works through the rest of the economy, many provinces will end up in a situation similar to Liaoning because fixed asset and real estate investment was the only play in the stimulus playbook since 2008. Provinces with more diversified economies can manage for a time, but eventually they too will see the core economy weaken and investment collapse.
We are months away from seeing the effects of the latest real estate slowdown and Liaoning sends a stark warning for any province relying on real estate to make up for real economic shortfalls. Once real estate investment declines, the bottom drops out:
The world is in the middle of a slow motion depression unfolding over years instead of months. There's no evidence any of the current trends are reversing. China's national real estate investment will eventually follow Liaoning and move into contraction, followed by fixed asset investment, followed by GDP. It could take another couple of years to unfold if the markets continue discounting the decline in global economic activity, but eventually the moment of realization arrives. The central bank created fog will lift, revealing the global economic depression.

Related posts on Liaoning.


Vancouver Popped, Is China Next?

To suppress the real estate bubble, July 25, where the Vancouver, BC (British Columbia) announced that from August 2, overseas real estate investors will impose a 15% additional housing transfer tax. After the entry into force of new regulations, Zhou Ranbian cold Vancouver property market, a sharp decline in market volume, foreign investors choose to abandon the purchase, instead of paying taxes.

According to the British real estate agency Knight Frank Knight Frank research report, from June 2015 to June 2016, with 34.6% of Vancouver annual increase, prices rose fastest growing cities in the world. Shanghai ranked second, prices rose 22.5%. Guangzhou and Beijing in the same column tracking Knight Frank cities, housing prices were up 8.8% and 6.4%.

There is no doubt that Canadian housing prices, in order to reduce the burden on public buyers, boosting social spending power, extended enterprise profit margins. Any national housing boom, there were not based on sound economic development entity basis. If the cart before the horse, will pay a heavy price.
The central bank is caught with a no-win situation:
From an economic deleveraging and stability of the Renminbi considerations, the central bank needs to return to sound monetary policy. But reality environment, in order to prevent corporate debt default and a substantial decline in housing prices, the central bank will need to release liquidity, sustained social ample liquidity. In stabilize the exchange rate and economic underpinning between the central bank is facing a dilemma.

...Although many industry authority appealed to "squeeze bubble", but in reality, the real estate relating to the common interests of local governments, banks, supporting industries. If house prices fall, on the one hand it would lead to a sharp contraction of local finance, on the other hand will also have a dramatic impact bank asset side. More importantly, the economic fundamentals are unable to improve the environment, the Chinese house prices setback, will induce the RMB exchange rate volatility, which is unbearable pain.

Overall, regardless of the downward pressure on the economy to curb or prevent financial risk, at the necessary time, the central bank may cut interest rates drop quasi shortage. At the same time, the government should make great efforts in the tax level, the only large-scale tax cuts, reduce the burden on enterprises, the real economy in order to improve the environment radically maximize boost market confidence. I believe the government necessarily know this, the key is transferring interests to let go.
The answer then is no, China's market won't pop because it has policy support, even if the government is working to slow price rises. Whether the central bank and credit system also support it remains to be seen. The PBoC can support housing or the yuan, not both.
iFeng: 温哥华楼市遭遇冰崩 中国楼市大拐点来了?

China Reserves: Enough or Not Enough?

China's reserves are adequate if the risk is solely driven by foreign imbalances and short-term (maturing) debt. If the economy and financial markets are chaotic systems driven by waves of human emotion, the less adequate are China's reserves. Everyone thinks of outflow from the currency in literal terms because it has immediate impact in the market, but outflow from the currency is also done within the currency, through high rates of inflation. Government attempts to ban the purchase of foreign currency, gold, commodities or other alternative assets may only serve to fuel a desire to exit the currency. Markets are also reflexive and tend to work through multi-year cycles. The yuan peaked in 2014 and measured by time alone, likely has at least a couple of years of decline left (whether it joins a declining U.S. dollar or diverges from a rising dollar is the trillion dollar question). Throw in fundamentals and various anecdotes such as China's historic debt buildup, and you have at least the seeds for an historic move in the currency market.

Over at the CFR blog, Brad Sester looks at China's reserve adequacy: $3.2 Trillion (Actually a Bit More) Isn’t Enough? The Fund on China’s Reserves
Reserves are over 400 percent of short-term debt (way more than enough). ***

Reserves are now “only” 15 percent of broad money (not enough; 20 percent of M2 is the traditional norm).

You cannot really fudge the difference; you have to tilt one way or the other. (Hat tip to Emma Smith of the Council on Foreign Relations’ Greenberg Center for Geoeconomics, who prepared the charts).

...I personally put more stock on balance sheet indicators, and reserves to short-term external debt is the most important. From a balance sheet point of view, there is also a strong case for paying attention to reserves relative to domestic sight deposits (a measure of liability dollarization). The Fund though sees things differently; in the design of the new reserve metric the Fund leaned strongly against balance sheet indicators of reserve need (see the discussion of liabliity dollarization here), and instead went with a composite of the three traditional indicators (short-term debt, m2, and imports—though the Fund prefers using exports), with an additional factor for longer-term external liabilities.

The Fund’s reserve metric effectively says China needs to hold more reserves, relative to its GDP, than a typical emerging economy. Especially if China opens its financial account before its currency floats freely.

Bloomberg: Why We Still Need to Worry About China's FX Reserves
China's pile of foreign exchange reserves has long been touted as a bullish signal for the country's ability to weather economic storms. But China is now in a policy trap as it expands the domestic money supply in order to funnel liquidity into the banking system to roll over its bad debts.

Data released in July throws into sharp relief the cost of Beijing's approach: a depleting war chest of foreign-exchange reserves relative to its expanding domestic money supply, which could prove insufficient in the looming battle against capital outflows.
Where people go wrong on China reserves is failing to understand that every dollar of reserves in spoken for by renminbi in circulation. China has restrictions on capital outflows, but it doesn't change the fact that the renminbi is convertible into U.S. dollars at a current exchange rate of about RMB 6.64 to $1. If everyone wanted to exchange their renminbi for dollars and the PBOC decided everyone would receive and equal amount of dollars, they would hand out dollars at a ratio of 46 yuan per greenback.
People aren't rational. A market is more "rational" than an individual because it is a system that ruthlessly punishes mistakes (where markets are allowed to work...), but it doesn't prevent markets from being from overshooting reality. Markets also tend to trend, swinging from irrational optimism to irrational pessimism. Back in the late 1970s and early 1980s, people were genuinely worried the U.S. dollar could collapse and gold climbed above $850 an ounce. At that point in time, U.S. gold reserves covered more than 100 percent of base money and more than 40 percent of M1 money supply. Markets can and will go to extreme valuations at the end of long-term cyclical moves.

China is currently below the IMF required reserves given it's money supply. The ratio is also heading in the wrong direction as money supply grows faster than reserves. Even if China can maintain its reserves at current levels, the growth in money supply will push the ratio of reserves to M2 lower. The target for M2 growth is 13 percent and the economy risks deflationary crisis if M2 slows below 10 percent. Reserves are stable, so at current trends, M2 will be at least 10 percent larger a year from now, but reserves will probably be the same or lower. Instead of 14 percent coverage of M2, China will be below 13 percent coverage.
The risk of an "accident" in the currency market is rising.

State Council Still Focused on Lowering Business Costs

Reuters: China eyes broad business cost cuts to underpin growth
Authorities aim to cut financing and labour costs, energy and logistics costs as well as reduce the annual tax burden for firms over the next few years, according to guidance published on a government website on Monday.

...Companies have been complaining about rising wages and land prices, in addition to tighter environmental and safety regulations, and some foreign manufacturers have moved to neighbouring countries to cut costs.
Demographics are impossible to solve in the short-run, but like rising land prices, are a direct result of government policy. Tax and regulatory cuts can have a long-term positive impact, but in the short-run, the economy's biggest problem is government intervention, which leads to reactionary policies. The boom-bust cycle in the real estate market is the best example of this endless policy trap.

iFeng: 国务院放大招!实体经济企业要减负了

Betting on Trump

Trump remains about 4.5:1 odds at the Iowa Electronic Markets. The contract is a winner-take-all option. It expires worthless if the candidate loses, or pays $1 if they win. The much smaller and very thinly traded Vote Share Market has Clinton up 60-40. The VSM pays out based on the two party share of the two-party popular vote, excluding any other candidates. Recent polls have third-party candidates around 10 percent; a 60-40 split is 54-36 percent split of the two part vote. If third parties received 20 percent of the vote, it puts Clinton at 48-32 percent, but polls show she falls to about 41 percent in a 4-way race, with Trump at about 37 percent, or about 52-48.

The market is betting on the race not narrowing at all and actually widening into the fall.