Author : John E. Charalambakis
Date : June 1, 2017
Moody’s downgrade of Chinese debt a few days ago was treated like a non-event. Chinese domestic bond prices did not change and Chinese equity prices actually rose. Is that a sign of complacency?Chinese corporate sector debt exceeds 165% of China’s GDP. Of course when we add government and household debt, then the figure (the official one) exceeds 260%.
The shadow finance sector in China with its WMPs (Wealth Management Products) entails a dangerous architecture since it involves close to $10 trillion worth of liabilities. If cracks appear in the Chinese money markets, then interest rate volatility will shake up the WMPs making the refinancing of debts a challenging exercise.
In a country where central control is thought to be the king-maker, defaults necessitated by market forces (as the country opens up) include the possibility of contagion, especially in a system that lacks proper collateral, and where debts are extended based on political criteria. Moreover, the fact that companies guarantee each other’s debts make the situation very complex. Therefore, the credit risks involve multiple levels of securities (bonds, equities, WMPs) especially when we take into account that global debt woes are at record high.
We have seen lately some encouraging economic signs in Europe. Actually, we have increased our exposure to European holdings. However, as we dig deeper into the European dynamics we raise the possibility that it might just be an aberration/reaction to US developments and things could revert back to dismal performance by year’s end. Our concern is based primarily on Europeans trying to revive the Eurozone via securitization measures without plans for capital investments.
Prosperity bought on credit does not tend the garden of growth. The sad reality that in the US close to $10 trillion of debt has been added since 2010, making the debt-coverage ratio weak, especially if a tidal wave were to come from Chinese waters. The Congressional Budget Office estimates that within the next 25-30 years, US total market debt would exceed 350% of the GDP, making it unsustainable. Therefore, the question is: Are we slouching towards another debt crisis and what precautionary measure should we take?
Monetary manipulations (such as the $10 trillion worth of negative yielding bonds) can only affect monetary variables while leaving real economic variables (such as employment, productivity and growth) wanting. Investors hungry for yield pile up in securities of emerging markets (EM) and the total stock of foreign currency EM debt exceeds now $15 trillion!
We are not saying that a crisis is imminent. However we do say that a crisis is brewing and the situation becomes precarious when we take into account four things, namely: Currency manipulations and their sensitivity to interest rate changes; volatility in commodity prices; Chinese tremors; and political instability.
As for the other garden called cosmos and our future in it, may the politics of it discover not in the distant future the old command of “tending the garden”.