CHINA - Fortune Cookies

1. BEIJING BANK-RUPTS:  Bad banks create Good banks

Notes from a review by Hung Ho-Fung New Left Review (Nov-Dec 2011) 

of Carl Walter and Fraser Howie,

Red Capitalism, The Fragile Financial Foundation of China’s Extraordinary Rise

The authors are veteran investment bankers with Morgan Stanley and J.P. Morgan with years of experience in China helping to float major State Owned Enterprises (SOEs) in overseas stock markets; both are fluent in Mandarin. Their 2003 book was Privatising China.

In 2004, the average profit rate for State Owned Enterprises (SOE) was 2.4 per cent compared with 6.7 for private enterprises. By 2009, the ratio had expanded to reach one to four, 2.4 per cent and 10.6.

In 2007, 20 per cent of corporate profits from stock trading.

The weak spot in the financial structure is that the Party ‘can tell the banks not to loan to the SOEs, but it seems unable to tell the SOEs to repay the loans’.

The 1997-8 Asian crisis led to the 1999 creation of ‘bad banks’. They are officially called Asset Management Companies. They took in the problems from the four big state banks. That allowed them to become ‘good banks’. The AMCs were not properly capitalised. The Ministry of Finance put in RMB40bn. The other RMB858bn came from 10-year bonds. This arrangement was just creative accounting. The good banks still had the debts but they were now called bonds. This device postponed the crisis from non-performing loans for ten years.

            The following are extracts from the review.

Meanwhile, the SOEs became ‘cash machines’ of the oligarchic CCP families, today’s ruling elite. Heads of the largest SOEs are equal in rank to provincial governors and ministers of state; many are members or alternatives on the Party’s Central Committee. P. 141

Nor has this elite been shy about squeezing resources from these companies, which became increasingly unable or unwilling to repay their lingering loans. As of 2006, the Asset Management Companies had only been able to recover about 20 percent of the non-performing loans, and the cash thus generated could barely pay the interest on the 10-year bonds held by the major state banks. In 2009, it became clear that the Asset Management Companies would not be able to repay their maturing bonds, which constituted up to half the capital of the Big Four. As a remedy, the government extended the AMC bonds’ maturity for another ten years. This is no more than a further postponement of the crisis. Indeed by 2019 China’s financial system will be far more vulnerable: many of the massive loans from the emergency ‘Great Leap Forward Lending’ in response to the 2008 global financial crisis will deteriorate into a new wave of non-performing loans, much larger than that of the 1990s. 141

To the extent that a market for bonds exists, it functions as a clearing house to move money from the one arm of the state to another, resembling a pyramid scheme with household savers at its base.  142

The 2009 stimulus package required municipalities to come up with two-thirds of project spending, so they leveraged utilities, infrastructure and assets to borrow from banks and then issue bonds. 142

With declining saving deposits as buffers, the coming of a homegrown financial crisis is just a matter of time.  142

Public debt

The figure at the end of 2009 could be at least 76 per cent of GDP (as of 2010 it was 63 per cent for the US).

Such a proportion indicates a heavy interest burden, which will eventually limit the state’s ability to invest in growth. Thus far the government has been leveraging China’s domestic balance sheet, borrowing ‘expensive RMB now to build projects’ with the intention of making ‘repayment at some point in the distant future using inevitably cheaper RMB’.  142

The demystification of American-style corporations as solidly profitable, transparent and well governed in the wake of the Enron scandal of 2001 and the financial crisis of 2008 only redoubled the Party’s determination to kick away the ladder from American investment banks.  143

The review ends on a limp note:

Whether, when and how China’s working-classes will become a key political force and assert their own independent voices in actual political struggles remains to be seen. 144

That’s rot. The ferment has been going on for nearly 25 years and has sky-rocketed in the past three years.

2. extracts from ‘Bubble trouble threatens to break China’

By Paul Krugman, Australian Financial Review, 20 December 2011, p. 20.

Consider the following picture: recent growth has relied on a huge construction boom fuelled by surging real estate prices, and exhibits all the classic signs of a bubble.

There was rapid growth in credit – with much of that growth taking place not through traditional banking but rather through unregulated ‘shadow banking’, neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting – and there are real reasons to fear financial and economic crisis.

            Am I describing Japan at the end of the 1980s? Or am I describing the US in 2007? I could be. But right now I’m talking about China, which is emerging as another danger spot in a world economy that really, really doesn’t need this right now.

            I’ve been reluctant to weigh in on the Chinese situation, in part because it’s so hard to know what’s really happening. All economic statistics are best seen as a peculiarly boring form of science fiction, but China’s numbers are more fictional than most.

3. China Grounded

James Fellow published China Airborne in 2012 on how the Chinese have not been able to make a commercial aircraft and related barriers to growth.

The government plans to spend $200 billion on airports, planes and systems in the text five years. China has only 175 commercial airports compared with 1,000 in the USA. All the other airports are controlled by the military. The armed forces also the control airspace. They let out a few corridors for civilian flights.

            The Chinese have not been able to build a marketable airliner. Fellows says they will get a rocket to the moon before they get a commercial airliner. So far have built two models. Both are built on imported technology. Neither could operate profitably. They are too heavy on fuel consumption to be profitable.

            So why not pirate the 737? Fellows says they cannot copy so complex a system. The bulk of the manufacturing sector profits because customers for cheap goods are ‘happy with crappy’. But that is not true with airliners. You don’t want the first models to fail.

            Entrepreneurs and engineers face problems from rigid education, and also from controls and censorship of mobiles and the web. 

4. Lenovo

This Chinese firm overtook HP as the world’s top computer maker in the third quarter of 2012. Lenovo had 15.7 percent of all shipments, against 15.5 percent for HP. Lenovo has done so by penetrating emerging markets and through Mergers and Acquisitions. It bought IBM’s PC in 2005 for $1.25bn. and two US tech companies with data management and the cloud, and a Brazilian manufacturer. However, this advance is taking place while the PC market is gloomy. Can Lenovo turn its PC into a smart phone, I-Pad and tablet?

            Beijing Review, 22 November 2012, pp. 36-7.

5. Chinese steel  

During the first four months of 2012,  large and medium sized steel makers were off 34%. Their total losses of $1.65bn., was 32 times than the losses in same period last year. The whole sector made profits of $2.9bn in first quarter, which was 68% less than last year. One reason was that Iron-ore import prices went up by 28% in 2011 over 2010.

Between 2001 and 2010, output rose by 15% per year. In 2011, it was up by half that, only 8%. During 2012, the industry expects a mere 4% growth, which is virtual stagnation. Indeed, industry consultant warns that in the near future: ZERO growth in demand.

Capacity is now 900 million tons but 2011 effective demand, domestically and for exports, was at 700m tons. That should mean more than 20% over–capacity. But the situation is more complicated. Because of shoddy statistics and lack of enforcement of central government instructions, the excess might be more. Because of shoddy production, however, the effective excess might be less. 

Upgrading and consolidation

Most of the capacity is fragmented and outmoded, concentrated on low-end products. For example, out of 10,000 stainless-steel makers, only 10 can make high-end products. Therefore China imports 1m. tons a year. In April 2010, the central Government ordered the shut-down of blast furnaces smaller than 400 cubic metres. But even state-owned big firms violated command. Ever since 2005 the central plans for rationalisation have never been met. One reason is that additional capacity is kept off the books in small and private mills.

The current five-year plan repeats these commands to improve and cut-back. Grim market outlook might do it more than commands???

However, the government has just approved two new projects. Each will make about one percent of the economy’s demand for crude steel. But that extra capacity is supposed to be more than matched by closing down existing inefficient works. Will that happen this time?

Beijing Review, 21 June 2012, pp. 30-31. 

6. Shadow banking

Fears that shadow banking could turn into China’s subprime crisis were debated at the Party Congress in November. China has no definition or statistics for non-bank loans. The sources range from family and neighbours up to the major banks trading off the books to avoid Central commands. In the first nine months of 2012 it was guesstimated to be $US1.86 trillion. The world figure for 2011 was $67 trillion. Small and Medium Enterprises cannot get funds from the big banks. The sector is supposed to be supervised by local authorities but they are up to their armpits in the cover-ups and backdoor financing. That lack of control is key to the rise of loan sharks and unregistered banks.  Meanwhile, the central authorities promise more of the regulation that the local governments circumvent.

            Beijing Review, 29 November 2012, pp. 32-33.

7.   Spending power

For those who think that internal demand can save China and the rest of us by taking up the slack from the EU and the USA.  The urban average income is $3,500 and rural of $1,119 per annum. The former is a third of the aged pension here. The latter is as much as the New Start poverty level for one month.

8. Manufacturing prospects

Sales at the Canton Trade Fair were down 7.7 percent.

8.  GOSPEL TRUTH

Meanwhile, Chinese firms printed 100 million bibles, with 40 million in 90 languages.

See also: Economics

BACK TO CHINA