Tuesday, June 18, 2013
Stop Worrying About China
The media is once again banging on the “China Bubble” story. This happens about once a year. Today’s China scare has to do with debt build-up in the private sector, the shadow-banking sector, and local governments. Look out below!
Remember the Tienanmen crisis in 1989? That was supposed to blow a hole in China’s finances; it didn’t. Remember the East Asian financial crisis of 1997-98, when the common wisdom was that “China’s next”? That was because Chinese banks and provincial authorities (known as “ITICs”) were thought to be full of nonperforming loans, which indeed they were. Somehow this was supposed to lead to a financial crisis, but it didn’t. China sailed out of the East Asian crisis completely unscathed.
We are once again being told about how awful China’s financial system is, how overleveraged, how poorly regulated, how unreliable the accounting, etc. It all has to come tumbling down sooner or later.
Here’s why you can cross China off of your “The Next Black Swan” list: China operates in two currencies, one of which she prints, and the other of which she holds $3.5 trillion in reserves. The Chinese government is indebted in neither RMB nor dollars. China cannot have an external financial crisis because she has no external creditors. China cannot have a domestic financial crisis unless the Centre decides that it should have one. China has unlimited resources in domestic currency, and the Centre decides who is Too Big To Fail. (The Centre is the Politburo of the CCP and/or the State Council, the government. The CCP controls the government.)
In looking at Chinese credits, one should always assume that their intrinsic financial condition is unknowable, because Chinese accounting is a joke. But that is not the source of credit risk. The source of credit risk is that, for whatever reason, the Centre decides that a particular entity should disappear. Only then can you have a default. It’s your guess who is inside the magic circle and who isn’t. Entities controlled by the Centre are all within the circle. Other entities may or may not be. The decision who’s in and who’s out is political, not financial.
One should also remember that there is constant tension between the Centre and the provinces. Sometimes the provincial governors act like independent warlords until the Centre decides to intervene, as was the case recently in Chongqing. Entities that are controlled by the provinces may or may not be TBTF. You can never know. Everyone thought that the Guangdong ITIC was TBTF until it defaulted; it turned out that Guangdong was out of favor in Beijing that month.
Moody’s has the term “Government Related Entity” to describe state organs. Generally speaking, such credits are best analyzed as political institutions, as opposed to stand-alone entities requiring fundamental analysis. There are many insolvent GREs in the world, but very few debt defaults. Credit analysis of Chinese credits principally involves understanding the entity’s relationship to the Centre, a ministry or a province, not fundamental analysis.
Caution: When I say that the Chinese edifice is solid and crisis-proof, I am not referring to the stock market. That’s a different kettle of fish. I have no idea how anyone can claim to be able to analyze Chinese stocks; that’s a form of astrology as far as I’m concerned.
The problem of excessive debt buildup is a problem for China, not us. China will sort it out if, as, and when it decides to do so. There are no financial accidents in China, unless they are planned. If I showed you China’s numbers without telling you whose they were, you would say “Sure looks AAA to me”. The reason it isn’t is political risk, nothing else. Stop worrying about China.