By Jeff J. Brown

Pictured above: Eurangloland’s worst nightmare is a fearless, committed, visionary communist-socialist leader of the world’s biggest economy, who fights tirelessly for all his country’s citizens. That would be Chinese President Xi Jinping. Thanks to Axios China for a great graphic (https://www.axios.com/newsletters/axios-china)

Downloadable SoundCloud podcast (also at the bottom of this page), as well as being syndicated on iTunes and Stitcher Radio (links below),

[dropcap] T [/dropcap]he article below published in the Financial Times has a title that makes you look twice. Yes, venerable, uber-capitalist, ultra-establishment FT has allowed a guest contributor to state the obvious: communist-socialist China can make miracles happen. What was left unsaid is that Eurangloland simply cannot do the same thing.

During last fall’s 19^th Party Congress, Xi talked about China’s three tough battles to win by the year 2020, in order for the country to be a successful, prosperous, largely middle class society (http://www.ecns.cn/2018/04-02/297907.shtml). These are poverty, the environment and the financial sector.

I have written on several occasions about Baba Beijing’s incredible efforts to not just reduce, but eliminate severe poverty across the land by 2020, which is on schedule to be realized (http://chinarising.puntopress.com/2017/12/18/in-china-s-is-for-savings-from-gold-to-tea-to-art-china-rising-radio-sinoland-171217/). Meanwhile, people all over Eurangloland are falling into deeper and deeper destitution, homelessness and starvation (http://www.presstv.com/Detail/2018/05/20/562376/US-households-poverty-). Life expectancy is even declining in the United States (https://www.vox.com/science-and-health/2018/1/9/16860994/life-expectancy-us-income-inequality).

Xi has mapped out his amazing vision for ecological civilization (https://www.greanvillepost.com/2018/05/08/chinas-determined-march-towards-the-ecological-civilization-updated/). China will not be a pristine national park by 2020, but the transformation and improvement in the environment across the country is manifest for anyone living here, like Shenzhen replacing its fleet of 15,000 public buses with 100% battery powered, electric vehicles (http://chinarising.puntopress.com/2017/09/28/empire-is-1-in-everything-including-public-bus-systems-right-china-rising-radio-sinoland-170928/). Our younger daughter is going to university in Beijing and since we moved to Shenzhen from there two years ago, she says improvement in the capital’s air quality is clear, pun intended (https://www.reuters.com/article/us-china-pollution-beijing/beijing-meets-2017-air-pollution-target-set-under-2013-clean-up-plan-idUSKBN1ES0J6).

But everybody knew, including Xi himself, that the big kahuna, the succubus on any national leader’s back is the bankers. Yes, all of China’s banks are state owned and all of the big ones’ CEO’s are members of the Communist Party of China (CPC), including probably every banking boss down to the provincial level. Like everywhere, banks are rich, have tremendous influence in the economy and given the chance, will subsume the political process in a nanosecond. In fact the four largest banks in the world are Chinese people owned, so Baba Beijing has to be bigger and more powerful than these behemoths, to keep them focused on their shareholders, the citizens, and not on personal aggrandizement and the bottom line (http://chinarising.puntopress.com/2017/05/13/so-called-communist-china-by-jeff-j-brown-in-the-all-china-review/).

As the article below describes, in the void of effective laws and regulations, banks are prone to be greedy and irrational, even communist-socialist ones. Just like in the West, Chinese banks have been packaging dubious debt into all kinds of derivative products and selling them to less sophisticated smaller banks, insurance companies in search of interest income, along with hungry investors in China and around the world.

Then there is the shadow banking system that exists in every market economy. These are unlicensed lenders and licensed banks that create legal entities that have found loopholes in the regulations to loan money of less than solid quality to borrowers of equally shaky credentials. In the US, think of high interest consumer debt, payday loans, subprime real estate, car loans, and the like. Here in China, I routinely get handed flyers and brochures while walking around town, from financial investment companies offering too good to be true returns on investment. These are prime examples of shadow bankers.

As the second graph shows below, China’s scary-as-shit shadow banking system was allowed to spawn in about 2000 and rose steadily until 2013. The fact that Xi Jinping was elected president and this house of cards began to shrink like a radiation-zapped tumor is no coincidence. The first graph indicates that in the first four months of 2018, Baba Beijing strangled US$274 billion out of the monster, as China’s shadow banking continues to head toward oblivion.

This is all great news, but as the article states, China is a long way from solving its debt problems. However, what is so impressive about it is that Baba Beijing is actually going after this banking beast like a tiger on a sheep and making amazing progress. Like China’s serious environmental concerns, will the debt issue be 100% resolved by 2020? Probably not, but the critical point to make here is that Baba is moving steadily and forthrightly in the right direction, while it is going in the exact opposite direction in Eurangloland.

In the West, going back centuries, the bankers have owned their governments and rulers like playthings and profit points, and thus own the citizens as well. One only has to see the absurd depredations of taxpayers bailing out Western banks, starting in the 1980s, with deregulation of Eurangloland’s financial industries. That can’t happen here, since the citizens already own the banks. If Baba Beijing forced its people to shell out trillions of dollars and euros to keep corrupt, venal billionaire bankers fat and happy, they would overthrow the government and demand a new Heavenly Mandate. That’s how China’s very participatory and vibrant communist-socialist democracy works (http://chinarising.puntopress.com/2018/01/30/60-seconds-over-sinoland-selling-breast-milk-as-public-protest-is-chinese-democracy-in-action-china-rising-radio-sinoland-180131/). We know all too well how the West’s Potemkin “participatory democracy and free market economy” does not listen nor respond to the demands and needs of the people. Hillary Clinton called them society’s deplorables and the 99% don’t count. Euranglolanders exist to serve the elite 1% and their henchmen class that runs their global organized crime cartel (http://chinarising.puntopress.com/2017/11/17/i-can-see-for-miles-in-china-what-do-you-see-from-your-vantage-point-china-rising-radio-sinoland-171117).

I have great respect for brilliant economists like David Stockman, Paul Krugman, Joseph Stiglitz and others. They are way smarter than I am. The rub is with Baba Beijing attacking its debt problem head on and succeeding, which is beyond their scope of training and experience, because China is communist-socialist and Western economists are capitalists. They have zero understanding of Marxist-Leninist-Maoist economic theory and practice (http://chinarising.puntopress.com/2017/10/25/how-can-western-capitalism-beat-this-thats-the-rub-it-cant-china-rising-radio-sinoland-171022/). It’s like asking them to speak fluent Chinese and at most, when they have only had one or two college classes in Mandarin. Yet, they all rail about China’s explosive, timebomb debt and real estate house of cards, and how the country is on a divebomb to disaster.

You can take it from me, as someone who has lived in and studied this country since 1990. It is simply not going to happen, because China is everything that capitalism can never be.

There was an underlying and unspoken theme of China’s 19^th Party Congress. Baba Beijing is governing and guiding the country with Karl Marx, Vladimir Lenin, Mao Zedong, Deng Xiaoping and now Xi Jinping as sources of knowledge and experience, and you can go ahead and add Jiang Zemin and Hu Jintao in between. The Congress said that thanks to this, the Chinese people can have their cake and eat it too. And it’s true, they are. You just have to travel around urban and rural areas of China to see it everywhere you look, and you have to wear ideological blinders to deny it (http://chinarising.puntopress.com/2017/08/26/china-is-the-most-plugged-in-big-economy-in-the-world-china-rising-radio-sinoland-170824/).

Westerners’ unwillingness to stop putting capitalism on its rose-colored, idealized, fantasy pedestal, like it is a perfected dogma or religion that can’t be questioned, while ideologically refusing to honestly interpret China’s 180-degree communist-socialist differences, are brainwashed habits that are hard to change. I recently talked to a popular American economist who was here to give a presentation and they were saying that China’s debt and property bubbles were destined to pop, just like every other one in recorded history. I told this person, who I greatly admire, that if there was any country in the world that could successfully pull off letting the inflated air out of its debt and real estate bubbles, then China, being communist-socialist was the one that could do it. Their reply was that it was highly unlikely, but who knows, anything could happen.

Now we all know. It is happening – right here in China.

China’s lending bubble is history

PAUL HODGES MAY 22, 2018

President Xi Jinping clearly knows he faces a tough battle to control leverage China’s shadow banking sector has been a major source of speculative lending to the global economy. But 2018 has seen it entering its end-game, as our first chart shows, collapsing by 64 per cent in renminbi terms in January to April from the same period last year (by $274bn in dollar terms).

The start of the year is usually a peak period for lending, with banks getting new quotas for the year.

The downturn was also noteworthy as it marked the end of China’s lending bubble, which began in 2009 after the financial crisis. Before then, China’s total social financing (TSF), which includes official and shadow lending, had averaged 2 times gross domestic product in the period from 2002 to 2008. But between 2009 and 2013, it jumped to 3.2 times GDP as China’s stimulus programme took off.

It is no accident, for example, that China’s Tier 1 cities boast some of the highest house price-to-earnings ratios in the world or, indeed, that Chinese buyers have dominated key areas of the global property market in recent years.

The picture began to change with the start of President Xi Jinping’s first term in 2013, as our second chart confirms. Shadow banking’s share of TSF has since fallen from nearly 50 per cent to just 15 per cent by April, almost back to the 8 per cent level of 2002. TSF had already slowed to 2.4 times GDP in 2014 to 2017.

The start of Mr Xi’s second term has seen him in effect take charge of the economy through the mechanism of his central leading groups. He has also been able to place his supporters in key positions to help ensure alignment as the policy changes are rolled out.

This year’s lending data are therefore likely to set a precedent for the future, rather than being a one-off blip. Although some of the shadow lending was reabsorbed in the official sector, TSF actually fell 14 per cent ($110bn) in the first four months of the year. Already the economy is noticing the impact. Auto sales, for example, which at the height of the stimulus programme grew more than 50 per cent in 2009 and by a third in 2010, have seen just 3 per cent growth so far this year.

The downturn also confirms the importance of Mr Xi’s decision to make “financial deleveraging” the first of his promised “three tough battles” to secure China’s goal of becoming a “moderately prosperous society” by 2020, as we discussed in February.

It maps on to the IMF’s warning in its latest Global Stability Financial Report that:

“In China, regulators have taken a number of steps to reduce risks in the financial system. Despite these efforts, however, vulnerabilities remain elevated. The use of leverage and liquidity transformation in risky investment products remains widespread, with risks residing in opaque corners of the financial system.”

The problems relate to the close linkage between China’s Rmb250tn ($40tn) banking sector and the shadow banks, through its exposure to the Rmb75tn off-balance-sheet investment vehicles. The recent decision to create a new Banking and Insurance Regulatory Commission is another sign of the changes under way, as this will eliminate the previous opportunity for arbitrage created by the existence of separate standards in the banking and insurance industries for the same activity, such as leasing.

As the IMF’s chart below highlights, lightly regulated vehicles have played a critical role in China’s credit boom. Banks, for example, have been able to use the shadow sector to repackage high-risk credit investments as low-risk retail savings products, which are then made available in turn to consumers at the touch of their smartphone button. This development has heightened liquidity risks among the small and medium-sized banks, whose reliance on short-term non-deposit funding remains high. The IMF notes, for example, that “more than 80 per cent of outstanding wealth management products are billed as low risk”.

Mr Xi clearly knows he faces a tough battle to rein-in leverage, given the creativity that has been shown by the banks in ramping up their lending over the past decade. The stimulus programme has also created its own supporters in the construction and related industries, as large amounts of cash have been washing around China’s property markets, and finding its way into overseas markets.

But Mr Xi is now China’s most powerful leader since Mao, and it would seem unwise to bet against him succeeding with his deleveraging objective, even if it does create short-term pain for the economy as shadow banking is brought back under control.

As Gabriel Wildau has reported, the official sector is already under pressure from Beijing to boost its capital base. Analysts are suggesting that $170bn of new capital may be required by the mid-sized banks, whilst Moody’s estimates the four megabanks may require more than double this amount by 2025 in terms of “special debt” to meet new Financial Stability Board rules.

Essentially, therefore, China’s lending bubble is now history and the tide of capital flows is reversing. It is therefore no surprise that global interest rates are now on the rise, with the US 10-year rate breaking through 3 per cent. Investors and companies might be well advised to prepare for some big shocks ahead. As Warren Buffett once wisely remarked, it is “only when the tide goes out, do you discover who’s been swimming naked”.

Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.

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