2018-10-31

Global Asset Inflation Fueled By Chinese Investors Avoiding Yuan Devaluation

In a utopian, free market system, credit inflation doesn't show up in prices. Credit is used for productive purposes and production repays the debt. Humans in this utopia do not exhibit herd behavior. They are all independent individuals pursuing profit in very different ways. Credit rises with the economy in a relatively consistent ratio with GDP. In reality, even a free market has bubbles because people herd. Everyone wants in on the most profitable sectors. Many loans are made for consumption. Governments intervene in the credit creation process or themselves borrow and finance via the central bank. The end result is a transfer in wealth from savers to borrowers while credit expands, followed by a reversal of this transfer (or destruction of it) in the bust.

The worst examples are states such as Venezuela or Zimbabwe that print money as the economy implodes. But what if instead of economic incompetents running the show, the guys in charge are swapping their "strong" currency for all sorts of real assets? What if they're strategically funneling credit creation into their own pockets? What if Gordon Gekko owned the central bank?

I've sometimes imagined Chinese activity this way, especially when firms such as HNA went on their buying sprees. Although it wasn't a straight line, they were effectively funneling Chinese "QE" overseas. HNA and other firms were shut down because of maturity mismatches. They were borrowing at 1 to 2 years and buying long-term assets such as prime real estate. If they ever ran into a funding crisis, the whole thing blows up. But what if HNA could call up the PBoC and ask for a little more credit at any time? It would never go bust. Moreover, imagine HNA was intentionally "shorting" the Chinese yuan (borrowing it) because it planned to let it depreciate. Prop up the yuan while buying assets, then guarantee a positive return by devaluing your own debt.

I used this thought experiment as a way of simplifying and understanding China's impact on the world stage. Whether you think China is doing it purposefully or as an unintended consequence of monetary policy the impact is the same. Whether its coordinated and the CCP orders assets home to defend the yuan or if the yuan devalues first and overseas assets avoiding devaluation come back, the impact will be a deflationary shockwave around the globe.

Deep Throat: When will Xi click the "SELL" button?.....
So what exactly does the USCC report say that I fundamentally disagree with? Again, the report hits on the main issues, but, for reasons we'll discuss shortly, badly misses the scope and magnitude of the problem. The report fails to recognize the global scale of the "Ants Moving House" phenomenon, treating all Chinese off-shore/tax-haven money as independently managed, when, in reality the world should be treating these assets as one gigantic China Inc. "Blob" of PBOC/SOE directed Assets Under Management, subject to the will/whim of the CPC.

We must think of China Inc. as the equivalent of several thousand Warren Buffetts working in concert as a well-oiled machine. Could you imagine what might happen if the world gave this incredible team of brilliant Warren Buffetts the ability to print their own currency? Providing instant, virtually unlimited financing? And finally, what if the world's bankers based their participation and "partnering" with China, Inc. on ludicrous, incomplete, concocted and contrived financial information, in exchange for a small commission, just to get the deals done?

No need to imagine what might happen, it already has. The only thing to ponder is how the world will eventually recover from it.
China likely has invested substantial sums in U.S. assets.
Further note, as I mentioned, that the page 93 chart also lists an interesting figure, that the third largest issuer of FPI's [Foreign Private Issuers] is "Tax Havens". The "Tax Haven" FPI's listed have a Market Cap of roughly $900 Billion. So, humor me here, what if the lions share of this money is actually Chinese money anonymously invested in US Stocks and FPI's through "Tax Haven" Shell Corps.? So now we're talking about roughly $2 Trillion (Amazon AND Apple) worth of Chinese influence on US Stock Markets. Can we say that if $2 Trillion in Market Cap disappeared overnight, the equivalent of both Amazon and Apple going under simultaneously, it would be just a minor market hiccup....can we really say that?
Chinese money could be far greater than believed because it is passing through tax havens:
So now let's take a look at another Tax Haven, most specifically, Luxembourg. Although the Caymans model is generally the blueprint for the China Inc.'s global effort, i.e.) set up Offshore Shell Corps. and "buy cool assets", the scale of what's gone on in Europe is incredible as well. A few years ago (2014) PWC issued a document entitled Where Do You Renminbi?, which I've referenced in prior posts, promoting Luxembourg as "the" EU financial center for Chinese Investors. More recently (2017) PWC issued a follow up report, Luxembourg-A location Ideally Suited to Chinese Investors, again intended as a marketing piece to attract Chinese money to Luxembourg.

When we look at where we are today we can see that PWC and the government of Luxembourg were remarkably successful and prophetic in their projected appeal of Luxembourg to Chinese Investors. The flow of funds into Luxembourg is described in the FSB Report. OFI Assets have increased to $14.6 Trillion in 2016, up 46% from 2015. An astonishing rate of growth given the relatively stagnant European economy. Again, there is no data or source I am aware of which would describe the origin of the gigantic increases in these assets, but, based on what we've seen in the Caymans, it wouldn't be much of a stretch to think that a big chunk of this increase was from Chinese funding as well.
And then there's real estate:
To get a feel for what's going on at street level, so to speak, we need look no farther than.....drum roll....Quontic Bank in Queens NY! For years Chinese home buyers were showing up in NYC and buying homes and apartments in all cash deals. Those "Crazy Rich Asians! But once the CPC put the clamps on capital flight after the 2015 RMB hiccup, clever Chinese buyers were forced to start looking at alternatives to get the deals done. From The Real Deal:

"As a result, the Chinese investment market in New York City, which for years was defined by splashy all-cash purchases, has morphed into one grounded by more traditional financing. The shift offers a growing opportunity to a handful of lenders such as Quontic, HSBC, Guardhill Financial, Cathay Bank and Abacus Federal Savings Bank."

Because of the ever creative US Banker and the ability to package and securitize mis-rated risk, the deals didn't slow down. According to the National Association of Realtors, Chinese individual purchasers remained the #1 foreign purchaser of US residential real estate in 2018.

NAR’s 2018 survey results suggest that Chinese buyers were not as adversely affected by rising prices and dwindling inventory when compared with other foreign buyers. Note, that the NAR survey includes individual purchases only and does not include "Shell Corp" purchases, the preferred structure for more expensive deals. Here are a few of my favorite lines from the March 2017 "The Real Deal" article along with a pithy Banker-Speak-Translation (BST). I'd invite you to read the entire article:

In the days that followed, numerous callers told Ho, a senior loan officer at Queens-based Quontic Bank, that they were unable to get their money out of China to finance real estate investments in New York. “They’re saying, ‘What’s the max I can borrow?’ and they’ll figure out other means [for repayment] later,” Ho said.

BST Comment: That's just what I'd want to hear right before I make someone a loan.

Most large retail banks don’t lend to foreign buyers because it’s harder to comply with “Know Your Customer” regulations, but also because they already command so much market share. Sensing an opportunity, smaller banks have made lending to nonresident – especially Chinese – buyers their specialty.

BST Comment: Yup....totally agree....just another example of government red tape keeping really smart business people from making a buck.


Astoria-based Quontic will finance 65 percent of a purchase if the buyer has a green card. Without a green card or passport, the figure drops to 50 percent and the bank requires employment documentation and proof of local funds. To mitigate the bank’s risk, Quontic also requires foreign buyers to open an account holding at least six months worth of mortgage payments. Ho said he recently had a client who was prepared to pay more than $700,000 for an apartment in Flushing, but had to slash her budget by $200,000. She still wound up borrowing 60 percent. “She wasn’t able to get that much [money] over, so getting a mortgage was her option,” he said. “Unfortunately, it was her only option.”

BST Comment: This is an outrage!.....bankers are forced do extra paperwork to make six figure loans to illegal aliens? (no passport or green card)....and they must ask if they have a job and/or any money in America? I had no idea that mortgages were so tough to get and that bankers were under such duress. Things have changed a lot since I got my last mortgage....I thought it was a moral victory when I was able to negotiate my way out of the cavity search,

Some banks, like First American International Bank, founded by Chinese immigrants in Brooklyn in 1999, have begun to offer what they call “portfolio loans” to grab new customers. Those mortgages don’t require tax returns or pay stubs, and instead the bank requests a letter from the borrower’s employer certifying how much the applicant makes. Buyers are required to put down 40 percent. The bank had $382 million in residential mortgages on its books as of Sept. 30, 2016, up from $296 million a year earlier, due in some part to such loan programs. “People pay; it’s a tremendous thing,” CEO Mark Ricca told The Real Deal last year.

BST Comment: Absolutely right again. It is "a tremendous thing"....people will always pay....until, of course, they can't/don't/won't.....I'm getting pretty scared right now.

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