The Chinese Banking Problem is Sending Major Warning Signs

by John Galt
January 8, 2017 17:10 ET

Bloomberg sent the first warning signal on December 27, 2016 with this article:

No Happy New Year in China as Currency, Liquidity Fears Loom

And this excerpt was a major hint as to why:

“You have Chinese New Year quite early, and because of that one-month window, most of the banks will try to lock the money in a three-month cycle,” said Arthur Lau, Hong Kong-based head of Asia ex-Japan fixed income at PineBridge Investments. “The current situation in the bond market is partly because of year-end and because of Chinese New Year.”

The week-long Lunar New Year holidays are traditionally a time when people give out cash gifts and companies pay employee bonuses.

China’s 10-year government bond yield has surged 21 basis points in December, poised for its biggest monthly increase since August 2013, and its first annual gain since that same year, Chinabond data show. The yuan’s 6.6 percent decline in 2016 puts it on course for its worst year since 1994, while the Shanghai Composite Index is headed for its largest drop in five years.

While that sounds like a perfectly logical explanation, the problems extend far beyond year end juggling and cash management. The Epoch Times highlighted this crisis in a story on New Years Day:

Chinese Bond Defaults Could Accelerate in 2017

From the story above:

Historically, bond defaults have been unheard of in China. But in 2016, 55 corporate defaults were recorded, more than double the number for 2015. And 2017 will likely see even more defaults.

More than 5.5 trillion yuan ($800 billion) in bonds will mature in 2017, or 1.8 trillion yuan more than 2016, according to China Chengxin International Credit Rating Group. That’s a significant amount of cash Chinese companies must come up with during the next year.

Sichuan Coal’s default—assuming the local government declines to extend another bailout—could signal that Chinese Communist authorities are willing to allow more bond defaults going forward. In truth, analysts have expected massive bond defaults for years, while Beijing has been selective in choosing which SOEs to bail out. Regardless, the number of such bailouts has decreased, underscoring authorities’ increasing comfort level with letting companies fail. With the significant amount of bonds due in 2017, a spike in bond defaults will likely result.

Furthering the challenge facing Chinese companies is the economic backdrop, which doesn’t look friendly for the Chinese bond market.

The money line is further down in the same article:

China’s rickety financial system is built entirely on overleveraging with cheap debt. It is especially susceptible to rate hikes and without the type of economic growth required to withstand such rate increases.

In an era where it would appear global central banks are anticipating a doubling down on failed policies and reflating fiat currencies and economies with even more spending and investment, some wise, some not so much, the idea that interest rates are going to accelerate but still lag inflation is not totally insane. The Federal Reserve has become a political partner with globalists and other non-U.S. central banks where the idea is that coordinated policy decisions create economic stability, however the past decade has blown that theory sky high. Now add in the ideas of using Bitcoin and precious metals as insurance against central bank blunders and the War on Cash is now going to become the catch phrase of 2017, as the Bank of India has well demonstrated.

Meanwhile in China where the PBOC has been desperate to stop investors from moving their cash overseas, this article from the China Daily is a direct shot at those investors attempting to secure a safe haven away from the illiquid and unstable Chinese banking system:

PBOC warns of bitcoin volatility

(excerpt)

China’s financial services authorities required major executives of the Shanghai-based bitcoin trading platform BTCC on Friday to rectify misbehavior in the trading of the virtual currency – and to raise awareness of risks as the value of bitcoins experienced wild fluctuations.

The value of each bitcoin jumped more than 14 percent on Friday, after hitting an all time high of $1,180 on Thursday. The currency’s value fluctuated by more than 30 percent within the past two weeks.

A statement of the People’s Bank of China Shanghai Head Office released on Friday called the changes in the virtual currency “abnormal”, and said authorities have required the trading platform to operate in compliance. They urged the platform to probe investors’ behavior and to rectify misbehavior.

The statement said authorities would like to reaffirm that the bitcoin as a virtual currency which cannot and shall not be regarded as currency in circulation.

Translation from Chinese to bureaucratise to plain English:

They want to block Chinese citizens from exchanging a plunging Yuan into a virtual currency with little if any offshore regulation or control by Chinese authorities.

Sort of like “gold” but not quite as good.

Meanwhile the reason people should worry? China has spent over $1 trillion of its Forex Reserves in the past two years as part of a desperate attempt to keep the economy and banking system liquid; the problem is that between corporate and provincial debt, the system could collapse without warning. The story became such a major part of 2016, it actually made the Monday January 9, 2017 Shanghai Daily:

10yr_china_forex_reserves_jgfla

Forex reserves drop US$320b last year

(excerpt)

China’s foreign exchange reserves fell to near six-year lows in December, but held just above the critical US$3 trillion level.

China’s reserves shrank by US$41 billion in December, slightly less than feared but the sixth straight month of declines, data showed on Saturday, after a week in which Beijing moved aggressively to punish those betting against the yuan and make it harder for money to get out of the country.

Analysts had forecast a drop of US$51 billion.

For the year as a whole, China’s reserves fell nearly US$320 billion to US$3.011 trillion, on top of a record drop of US$513 billion in 2015.

China’s vast foreign exchange reserves, the largest in the world, slipped to US$3.011 trillion at the end of December, the State Administration of Foreign Exchange said on its website.

Reserves had slipped by US$46 billion in October and nearly US$70 billion in November, falling to levels last seen more than five years ago.

The central bank’s efforts to stabilize the yuan is the major reason for China’s falling foreign exchange reserve, the forex watchdog said Saturday.

Since the Yuan is no longer stable, the economy is totally dependent on an acquiescent globalist policy from Washington, D.C., and the fiat currency game is on its way to expiration, at least in the Bretton-Woods post gold based currency form of the past 50 years, odds are China will burn through paper like Sears wastes real estate.

Buckle up because the biggest, baddest, and ugliest black swan of 2017 only tastes good with cashews and orange sauce.

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