Has China set off the unravelling of the great global Ponzi Scheme?

Manufacturing activity in China contracted in January, for the first time in six months and signalling that the high-flying Chinese economy may be preparing for a hard landing sooner rather than later.

Confirming this cooling in the economy is the most recent GDP growth rate which was announced at 7.7% last Monday, actually the slowest since 1999. But the main problem for China is certainly not a 7.7% growth rate. Even half that rate in Europe would have the politicians opening the champagne bottles. No, the problem relates to what is behind that growth, in particular when the Chinese economy has been growing at a rate north of 8% for decades…

Unfortunately an economy is such a complex network of connections that it is impossible for any Government or Central Bank (take note Ms Yellen!!) to engineer a growth rate of x% no matter how hard they try. Still, the Chinese Government instructed the PBOC to do whatever is required in order to keep the growth pace steady. Something which has been a tremendous task, in particular in looking to avoid the negative effects deriving from the global financial turmoil during 2007-2010.

In terms of the countries money supply, M2, this increased by 13.6% during 2013, coming on top of a 13.8% growth rate in 2012,as the PBOC was prepared to allow liquidity issues to be dealt with another day in order to keep growth motoring. But if 13%+ growth in M2 seems high to you then the 1,000% increase in the same measure that occurred between 1999 and today is positively gigantic (and would go a long way towards explaining not only the GDP growth rate but also all those recently minted Chinese billionaires!!). That’s right, in 15 years the PBOC multiplied by 11x the existing M2, which makes the monetary expansion in the US look positively mild as you can see in the chart below.

Of course with the M2 expansion other problems arose. Private credit expanded from $9 trillion to some $23 trillion since 2008 as pointed out in ths Telegraph piece  –http://www.telegraph.co.uk/finance/china-business/10123507/Fitch-says-China-credit-bubble-unprecedented-in-modern-world-history.html

“The ratio of credit to GDP has jumped by 75 percentage points to 200pc of GDP, compared to roughly 40 points in the US over five years leading up to the subprime bubble, or in Japan before the Nikkei bubble burst in 1990. This is beyond anything we have ever seen before in a large economy. We don’t know how this will play out. The next six months will be crucial,”

The expansion in credit is so bold that it seems difficult to predict the future. However, we do have some clues. When too much credit is created, instead of the excess credit going into productive projects, it is invested elsewhere in the world across every thinkable asset. One of the little known reasons behind the U.S. housing bubble of 2004-2007 period was as a consequence of the Chinese central-bank-led expansionary policies. The Chinese were also investing their excess money in the US housing market (as they are now in the ludicrous bubble that is the London housing market), and so played a primary role in the price pressure that ended in tears in 2008. This situation is now much worse however as we have the PBOC, the BOJ and the FED all massively injecting money into their respective economies, flooding the world with linen that is looking for a home. Rather than being a solution to economic crisis, central banks have just made the problem much worse…

When we saw the story that that a troubled high-yield investment product sold though China’s largest banks will not be able to repay $500 million at its maturity date on January 31 that raised our eyebrows… If that is the case, it may mark the beginning of the end of the excessive monetary experiment in China this last 15 years. Ultimately, all Ponzi schemes collapse…

By Filipe R Costa