2021-03-28

Every Single Time: China Tightens Lending Rules as Housing Speculators Feast on SME Loans

Demand for credit in China is driven by housing speculation. Stop housing speculation, credit growth slows and the economy slides towards collapse because credit bubbles do not deflate slowly. Force lending and it flows into housing, which only delays the bust and increases the fallout. China has been trapped in a stop-start economic cycle since 2008. Each cycle was marked by surging government investment or credit growth, following by a housing or stock market bubble, tightening of conditions and varying degrees of near-misses with recessions or financial collapse before the govenrment loosened again. Global ommodities have followed a similar path with price peaks in 2011,2014 and 2018.

Caixin: China Tightens Crackdown on Illicit Borrowing for Property Speculation

Three central government ministries jointly launched a sweeping clampdown on illicit borrowing for property speculation, expanding efforts made by several local regulators to contain risks in the white-hot housing market.

The China Banking and Insurance Regulatory Commission (CBIRC), the Ministry of Housing and Urban-Rural Development (MHURD) and the People’s Bank of China (PBOC) issued a joint statement Friday announcing a nationwide inspection of business loans, targeting borrowers illicitly using individual or corporate business loans to speculate in the housing market.

The inspection is set to be completed by May 31, said the regulators in the statement, pledging to toughen punishments on violators.

Regulators in localities including Beijing, Shenzhen and the province of Guangdong are already working to stop business loans being used to invest in real estate amid mounting risk concerns on the overheated market.

China, along with the developed world, is constrained by a combination of excessive regulation and demographic headwinds. They also all have massive credit bubbles the require repressive financial regulation such as negative interest rates in Japan and Europe, capital controls in China and ZIRP in the United States. Most countries are fighting either a housing bubble, a stock market bubble or both. All fear a wave of defaults that would be unleashed if credit growth ceases.

The general bull assumption is the U.S. will break the global trap by doing some type of infrastructure spend that sends U.S. Treasury debt soaring. (I'm ignoring stagflation/inflationary collapse arguments because whether they agree with the specific causes or not, they essentially agree with the idea that government attempts to force growth will destroy the value of state-created fiat currencies.) There's also some hope that China will do it, but the above (and other comments about bubbles) suggest they cannot or will not.

The assumption about the U.S. leading comes with additional assumptions. One is that the U.S. dollar declines. If the growth cycles are broken, perhaps the U.S. dollar cycles is broken too. I have previously discussed how the U.S. Dollar Index is "out of time" by the cycle clock. Many bearish forecasts that come with hyperbolic claims about inflation and the dollar are on par with the bear markets in 1985 and 2002, neither of which were accompanied by disaster. The U.S. Dollar Index should decline now. There should be a multi-year round of growth led by emerging markets, accompanied by strengthening non-U.S. dollar currencies. If there isn't, something is up.

There are more assumptions. One is that spending by the U.S. government will be enough. If the U.S. government spends X and the economy "needs" X+1, the result is recession. A second is that the U.S. outspends/outpumps the world. A normal growth cycle is driven by rising U.S. dollar credit growth (as the reserve currency, the dollar inflates as it fuels the system). If government credit replaces private credit, it's not immediately clear that the U.S. will be the most profligate nation. Or lacking a conduit into private borrowing, perhaps U.S. spending fizzles out. There's no multiplier effect. A third assumption is U.S. government spending is productive, but government spending is more likely to be unproductive. An additional assumption is that a shift to electric cars and alternative energy would be productive, rather than a giant tax on the economy, or at best a zero-sum that leaves the economy worse off because of the debt required. My assumption is that it will take a collective mania similar to the housing bubble, except centered on "green" energy, low carbon, electric cars, etc. all accompanied with infrastructure spending to get the ball rolling.

Something like a Green New Deal will lead to a bust down the road, but that type of mania would induce commodity inflation, which in turn sparks emerging markets, it sparks price inflation that makes borrowing attractive. Urban residents are leaving cities for rural areas in response to the lockdowns already, fueling home price rises. Lockdowns also damaged global supply chains. Now central bank printing is further damaging supply chains. The blockage of the Suez Canal by the Ever Given is a major economic problem because of central bank activity over the past year. We will see an ongoing series of "Ever Givens," singular events that are one-offs in disinflationary times that become stepping stones to ever higher inflation in inflationary times.

Long story short, the evidence for organic economic growth is thin. After years of screaming for more credit, Chinese SMEs obtained more credit and immediately it was funneled into housing speculation, either by the SMEs themselves or speculators posing as SMEs. The former tells us credit demand isn't really that high (or that banks still don't want to lend), the latter that China's credit creation is too dysfunctional. I also believe China's "decommunization" dividend is gone. China is running into the hard problem of CCP political control conflicting with economic freedom. The economy remains overly reliant on real estate (state infrastructure) investment and exports.

From the perspective of markets, the risk is that the bullish economic case is priced in. I see a growing risk of real growth peaking. If real growth peaks and governments continue with stimulus, gold and similar assets (monetary) will eventually win out. If stimulus sparks growth, industrial commodities and related investments in politically-favored (directly or indirectly) industries will win. An example of an indirect winner is oil because it will take a lot of it to fuel the massive mining effort that will be part of a GND.

Last but not least: the chart. One thing I've focused more on in recent years is the charts because as great as the macro thesis may be, timing is of the essence. Moreover, as I've tried to lay out above, more than one outcome is possible. The charts help strip away whatever attachment I may have to a particular macro thesis. I have annotated the chart with the popular arguments at the time. There is a clear basing pattern on the chart that, were it to complete, would strongly argue that commodity prices will rise one way or another. I'm not confident in forecasting a full blown deflationary collapse yet (that would require a bearish breakdown of charts like the one below), but macro forces are starting to indicate another deflationary scare might come before the next round of stimulus. Which as I said above, would be good news for monetary metals and related assets.

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