Enzio's Clock

Background

1. What gives?

Headlines were festooned with strong growth rates and the hope that growth had bottomed. But in the same breath, these very same economists predicted more stimulus measures in order to bolster private consumption.

What gives?

Urban fixed asset investment rose by 30% - but industrial overcapacity expanded; industrial production rose by  8.3% this March - but exports fell, and retail sales rose by 14.7% - but unemployment and thus the potential for social unrest picked up.

So what do you believe?  How can profits rise if turnover is falling because of slackening domestic demand? How can profits rise if productivity is waning, eating into margins? Indeed, according to Bloomberg's report today, producer prices fell by six percent, the most since 1999.

We thus are left with the nauseating feeling that the market is interpreting the numbers too rosily - and ignoring that train racing down the track (see next). 

2. The problem with lending

We alluded to this in our recent Economic Clock® update on China: in a nutshell, the lending is of "involuntary' nature in a twofold sense. First, banks have to keep sickly customers afloat, and secondly, we would be amazed if there is no arm-twisting going on at a governmental level. Both observations are not critiques: indeed, even in America the government has been coaxing and financing banks in the hopes of getting them to lend again, so fair is fair. All that we query is the extent to which this lending is of "real" (versus "forced") nature. If this lending is being forced by circumstances and by the government, it cannot be profitable - nor can it be sustainable.

Hence our long-held worries about the viability of the banking sector.

In yesterday's South China Morning Post, page B1, the vice chairman of the China Banking Regulatory Commission (CBRC), Jiang Dingzhi, "...did not specifically mention bad loans. But while the Central Bank and other government authorities have called for banks to increase their lending, the CBRC has repeatedly cautioned against the risk of rising non-performing loans."

Indeed, according to the same article, banks already have lent 92% of Beijing's total lending target for the whole year. This was done because the government - understandably - is chasing high growth in order to avert social unrest. So if the banks already have lent 92% within the first third of the year, the remaining eight percent are going to be spread very thinly over the next eight months, would you not agree?

Next to this issue of lending probably having to slow down from here on in, we read in the same article of falling loan standards: one anonymous loan officer stated that "We are competing with each other to extend loans...Sometimes my colleagues approve  loans with lower standards." Indeed, according to the 21st Century Business Herald, cited in said article, "...the CBRC is checking to see whether new loans from October last year to the end of February by the biggest lenders were granted properly..."Apparently the CBRC is examining the loans made by these banks:

• Commercial Bank of China;
• Bank of China;
• Agricultural Bank of China;
• China Construction Bank Corp., and
• Bank of Communications
  

I cannot tell you what power the CBRC wields in China's overall power structure, but the fact that its recent concerns have been aired so publicly in the Western press suggest that Beijing must be worried. Of course, you could find that China follows Washington's  footsteps and ends up baling these banks out. Then we will see Beijing, and not Boston Tea Parties. 

In any instance, beware of buying these banks: their lending quotas are basically fulfilled, their standards have slackened, and Beijing is getting worried about lower loan quality.  

How to Make Money Off This Idea

1. Always consult your financial adviser first.
2. Look at an ETF through which you can short China's FTSE/Xinhua China 25 Index.
3. Short those banks that I have just mentioned above.