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Is China’s Debt Higher Than We Thought?

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Is China's Debt Higher Than We Thought?

Goldman Sachs Group Inc. has been doing its math, and it suggests an increasing discrepancy between what credit creation in China may actually be and what the Chinese TSF thinks it is. 

The question is, how big is the difference and how worried should you be?

Growing Debt in China is No New Phenomenon

According to this chart from Business Insider, in the last five years China has gone up more than 50 percentage points worth of debt:

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Business Insider says that having debt that’s over 200% of the GDP is not so unusual, but how fast it happened to China is concerning, especially when economic growth is not keeping up with the trend.

What is the TSF, and How Does It Relate to Debt?

The TSF, or total social financing, is a number that Chinese authorities created in 2011 to measure credit creation in China. 

Until now, many have been using the figure to try and get a grip on just how much financing really is happening in China. 

However, M.K. Tang of Goldman Sachs has just published a note that seriously undermines trust in the measure’s reliability.

He and others at Goldman Sachs say that the figure simply does not match the numbers turned out by their proprietary way of measuring credit and suggests that the discrepancy is part of a larger trend of China being less than forthright about the financial situation.

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What Goldman Analysts are Doing to Get Their Numbers

Money in China is complicated, as are China’s ways of measuring it. 

Given the TSF’s apparent inaccuracy, analysts with Goldman are taking a different route to finding the information they seek. 

They look at the money flowing from households and companies into investments.

Measured this way, China created 24.6 trillion yuan—the equivalent of ($3.7 trillion) in the past year. 

According to the TSF, they only created 19 trillion yuan. 

It’s a huge difference and more than enough to cast doubt on the TSF as an accurate measure.

The following chart illustrates the point quite clearly:

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As you can see, the dark blue line indicating Goldman Sachs’s estimate far outstrips the light blue bars of the TSF’s estimates.

So, China Almost Certainly Has an Issue with Truthfulness in its Economy

CNBC points out that it has come to light that Beijing is making every attempt to control what China and the rest of the world believe is going on with its economy, which they would like to portray as bullish. 

Also, even reports that are more accurate about bearish tendencies have taken the line that numbers like the TSF are accurate. 

Be it cultural differences or outright dishonesty, the Chinese have not represented themselves accurately, and their numbers are now in doubt.

Also, said numbers are almost certainly worse, rather than better than China purports.

How Much of a Problem Is This Really?

In the same report, CNBC posits that basic differences in the way China operates will prevent the kind of collapse that many fear. 

The Chinese are much more collectivist in culture, and their financial system is expected to follow instructions from the top—in this case Beijing—more than it is to be profitable. 

Since the top is also supposed to look out for the bottom, China is much more likely to restructure its debt in ways the United States simply wouldn’t.

On the Other Hand, Fitch Believes that China is Headed for Big Trouble

According to the Telegraph, Fitch believes that China will experience instability and stunted growth if it does not cut back on issuing credit.

Fitch analysts believe that current lending practices are making the country’s system more vulnerable. 

And China is definitely not growing its GDP much right now, as demonstrated by the following graph:

p4.3

The GDP has not really grown since 2010—indeed it has mostly dropped or narrowly maintained.

Goldman Also Cites Circular Lending as a Problem

China currently has a scheme going where banks lend to nonbank financial institutions instead of actual people or businesses. 

It’s good for the bank’s profits but keeps the money trapped in the financial system instead of moving it out into the real world to strengthen the economy.

Clearly, Goldman has a number of concerns about China’s credit system and economy, and they are not alone in their concerns.

Goldman is Only Getting More Worried and Says So Outright

Goldman says they are more concerned than ever about China’s credit problems and sustainability, and the so-called shadow-lending that the TSF failed to measure at all makes them even more nervous. 

They consider it to be poor regulation and an invisibility of possible breaking points in the system.

Conclusion

While there is a possibility of China restructuring its debt, it is starting to look more and more like it is cruising for an economic bruising. 

The latest news from Goldman Sachs, while somewhat dismal, only confirms fears that people already have—that China is headed for a massive collapse due to the way it is running its economy.

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Dollar Will Plunge 35%, Lose Status As World Reserve Currency

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The US dollar is on the verge of a 35% collapse. It could also lose its status as the world’s reserve currency. This is according to Stephen Roach, a senior fellow at Yale University and the former chairman of Morgan Stanley Asia.

The reason, according to Roach, is the slow decoupling of the US from its trade partners. Along with this, another reason is the rise of China. He says China’s structural reform goes away from a manufacturing economy. Instead, it comes into a more service-oriented economy with a stronger consumer base. This could mean the days of the US dollar being the world’s reserve currency are numbered.

Merely suggesting that the US losing its reserve currency status is enough to bring out the critics. In an opinion piece he wrote for Bloomberg, Roach addresses those critics.

“Scorn has long been heaped on those daring to question the supremacy of the U.S. dollar,” he starts. “As the world’s dominant reserve currency…the counter-arguments were strong and highly political, basically boiling down to the so-called TINA defense – that when it comes to the dollar, ‘there is no alternative.'”

The Role of The Dollar

Roach says that even those that believe there is no alternative to the US dollar when it comes to international trade. The same goes for when the financial markets are being shortsighted.

“Alas, the TINA argument doesn’t stop there. The counter to my case for dollar weakness also rests on the reserve status of the U.S. currency as the linchpin of world financial markets. All trading nations, goes the argument, have to hold the dollar as the price for doing business in an increasingly integrated dollar-based world economy.

“Even so, the dollar’s share of official foreign-exchange reserves has declined from a little over 70% in 2000 to a little less than 60% today, according to the Bank for International Settlements. That downtrend could gather momentum in the years ahead, especially with the U.S. currently leading the charge in de-globalization and decoupling. With America’s share of reserves well in excess of its share in world GDP and trade, such a correction might well be inevitable in an increasingly fragmented, multi-polar world.”

The natural instinct for a weak dollar is to buy hard assets like gold. However, Roach says those markets are simply too small. They will not be able to absorb the tsunami of dollars looking for a new home.

“And although cryptocurrencies and gold should benefit from dollar weakness, these markets are too small to absorb major adjustments in world foreign-exchange markets where daily turnover runs around $6.6 trillion.”

Gold and cryptocurrencies are too small to benefit. Although, Roach says he does expect two currencies to strengthen as the dollar weakens: the Chinese renminbi and the euro.

Can It Be Replaced?

“On this basis, a forecast of a weaker dollar requires some combination of a strengthening in China’s renminbi and the euro…

“The China call is very contentious. From the trade war to the coronavirus war to the distinct possibility of a new Cold War, the negative case for China has never been stronger in the U.S. than it is today.”

“The call on the euro is also counterintuitive, especially for a broad consensus of congenital euro-skeptics like me… I now have to concede that reports of the euro’s imminent death have been greatly exaggerated. Time and again, especially over the past 10 years, Europe has risen to the occasion and avoided a catastrophic collapse of its seemingly dysfunctional currency union. From Mario Draghi’s 2012 promise to do “whatever it takes” to save the euro from a sovereign debt crisis to the recent Angela Merkel-Emmanuel Macron commitment to a Next Generation European Union Fund of 750 billion euros ($855 billion) to address the coronavirus crisis, the great European experiment has endured extraordinary adversity… there is unmistakable upside for the most unloved currency in the world.”

Roach ends his article by pointing out that no country has ever devalued its currency and enjoyed prolonged prosperity.

“If TINA is the dollar’s only hope, look out below… Yes, a weaker dollar would boost U.S. competitiveness, but only for a while. Notwithstanding the hubris of American exceptionalism, no leading nation has ever devalued its way to sustained prosperity.”

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Fed Keeps 0% Rates Until At Least 2022

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Fed Keeps 0% Rates Until At Least 2022

Confirming what many expected, the Federal Reserve announced yesterday that it will keep rates at zero percent for the foreseeable future, perhaps well into 2022.

During a press conference, Fed Chairman Jerome Powell said, “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”

The Fed did acknowledge that economic conditions “have improved” in the last few months. However, none of the members indicated an urgency to raising interest rates. In “dot plots,” each member plots their forecast for interest rates. However, in this case, only two of the 17 members saw a case for hiking rates in 2022.

The decision to keep rates at near-zero percent indefinitely is an attempt to get the economy back to where it was before the coronavirus pandemic. During the said pandemic shut down our country and plunged our economic output by an estimated 50% this quarter.

Optimistic Outlook

The outlook from Fed members is for real GDP to contract by 6.5% in 2020. This comes with an unemployment rate of 9.3% by the end of the year. The members are much more optimistic about 2021. Members projecting an unemployment rate down to 6.5% and real GDP reaching 5%.

There are already positive signs, with last week’s controversial jobs report showing 2.5 million jobs were added in May.

Powell cautioned, however, that the millions of jobs lost will unlikely return quickly, if ever.

He says that many businesses may simply not reopen. Alternatively, he also says that jobs eliminated during the pandemic may not exist in the “new world order.”

The Federal Reserve keeping rates low while printing trillions of dollars to help the country recover from the coronavirus pandemic. With this, there are some very real fears that inflation is going to spiral out of control. Many fear that this will soaring well above the Fed’s target of 2%.

Thus far, the Fed members seem unconcerned about the possibility of runaway inflation.

Plans and Expectations

The average Fed member expects inflation (as measured in core personal consumption expenditures) of just 1.0% in 2021, increasing slightly to 1.5% in 2021.

The Fed will also continue to do its part to keep liquidity in the markets by buying up assets including mortgage-backed securities and Treasurys. The FOMC told the New York Fed to keep purchases “at least at the current pace,” which indicates about $80 billion per month for Treasuries and about $40 billion per month for mortgage-backed securities.

These actions along with other quantitative easing measures have inflated the Fed balance sheet to a record $7 trillion, a number that Powell has indicated he is comfortable with.

During a webinar hosted by Princeton University a few weeks ago, Powell said that the Federal Reserve has “crossed a lot of red lines that had not been crossed before and I’m very comfortable that this is that situation in which you do that and then you figure it out afterward.”

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Stocks Rally as Oil, Jobless Claims Rocket Higher

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Stocks Rally as Oil, Jobless Claims Rocket Higher

The stock market rally continued yesterday with the Dow Jones Industrial Average jumping 2.24%, the S&P 500 gaining 2.28% and the Nasdaq up 1.72%.

Investors felt optimistic after President Trump tweeted that he had spoken with Saudi Arabian Crown Prince Mohammed bin Salman. Many were hoping that both Saudi Arabia and Russia were willing to end the price war and mutually agree to cut production by at least 10 million barrels per day.

“Just spoke to my friend MBS (Crown Prince) of Saudi Arabia, who spoke with President Putin of Russia, & I expect & hope that they will be cutting back approximately 10 Million Barrels, and maybe substantially more which, if it happens, will be GREAT for the oil & gas industry!” Trump tweeted.

However, some experts are doubting the reality of cutting production by such a significant amount.

Edward Marshall, a commodities trader at Global Risk, told The Wall Street Journal, “It’s physically impossible for Saudi Arabia and Russia to get 10 million barrels a day off the market—they’d burst their onshore storage and fill every ship in sight.”

News also broke that Saudi Arabia called for an emergency meeting of OPEC and other oil-producing countries. The country called for a meeting to talk about how they can stabilize the oil market. Prices have been in freefall since the last meeting ended without a production agreement beyond April 1.

This was enough to send oil prices rocketing higher. West Texas Intermediate crude gained as much as 34% intraday before settling at $25.32 per barrel, a 24.7% jump. This is its largest single-day percentage gain in history.

Even with prices moving higher, it may not be enough to prevent bankruptcies in the oil and gas sector. This wave of bankruptcies was kicked off by shale driller Whiting Petroleum Corp. on Wednesday.

Jobless Claims Set Record

The market’s rally yesterday came in spite of some very bad news early in the day. Initial jobless claims for the week ending March 28 came in at 6.6 million. This figure is nearly double the previous week’s then-record of 3.2 million.

To put this number in a historical perspective, prior to the last two weeks, the previous record number of claims in a single week sat at 665,000 in March 2009 during the Great Recession.

To put it simply, this week’s initial jobless claims number was equal to the total claims filed during the entire Great Recession.

Chris Rupkey, chief financial economist for MUFG Banks, wrote in an email, “We knew that massive job losses were coming because of reports that many workers were unable to file a claim for benefits even after waiting on line for hours. Everywhere you look Washington and state governments were not prepared for the rapid spread of the virus and the devastating damage that would be done to the economy if businesses were shut down and workers sent home.”

He added “In a normal recession, job layoffs build over the many months of recession until they peak. In this pandemic-based recession, the job losses are immediate where the economy’s weakest hour is right now.”

Why was the market able to rally despite historically bad jobless claims?

JJ Kinahan, chief market strategist at TD Ameritrade, says it’s possible that the market knows it’s going to get worse. He also mentioned that this number won’t seem as bad in the coming weeks.

“Overall this is a little bit of a victory in and of the fact that it was such a bad number and the market did kind of shake it off. It is also the market preparing for a lot more bad numbers.”

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