Living on Credit
Pfäffikon SZ, Switzerland – “There’s no such thing as a free lunch” is a famous saying in the financial world. This seems to apply to China now more than ever. The first cracks in the so-called economic wonder-child are slowly starting to show. In the meantime the first interest payment default by the Chinese Chaori Solar Energy Science and Technology is now a fact. I will leave investing in China up to others for the time being. Investing in solar in China would, in this respect, be taking it a step too far.
First Default
The first default of a bond in China makes it clear that the bond market should be reformed. For years now, I have been amazed by the pricing of various loans. State banks own the bulk of bonds. They generally do nothing with them and obediently go along for the ride. The secondary market is extremely thin because of it. The government uses the banks as an ATM without worrying about their credibility. In a fiercely competitive market as we know it, better pricing is established and this in turn improves liquidity. China still has a long way to go. For this reason, the Chinese bond market carries much more risk than we may have first thought.
Lehman Moment
With the default of Chaori Solar Energy Science and Technology, the question arises, ‘When will China get its own ‘Lehman Moment?’’. In 2013, China’s total debt stood at approximately 238% of GDP. This is serious but as yet, not uncontrollable. The Chinese government can still take various measures to bring the debt, slowly but surely, to normal levels.
The Chinese leadership is well aware of the current situation, which is an advantage, because living on credit is no longer an option. Loosening the flexibility of the Yuan as we have seen recently is a good first step, so long as it is done in a controlled way. Reforms are still required in this process. The Chinese government is in a hurry in my opinion, especially now that the economy of this vast country is continuing to cool down.
When China get its ‘Lehman moment’, this should better take place sooner rather than later. It will shake everybody up and make the need for reforms acute. Needless to say, the communists must keep a cool head should this scenario develop. A search for the Chinese Hank Paulson would be a good idea. Incidentally, it may be years before the real problems come to light. Indeed, the Chinese are masters at masking their financial mess.
Inflation hunt
Finally, we should also pay attention to Janet Yellen’s first interest rate decision as chairman of the FED. I have previously pointed out that the FED is looking for inflation. Because the U.S. cannot live on credit forever. And inflation is the magic bullet that will make debt disappear like snow in summer. Interestingly, Yellen indicated that an interest rate hike may occur in late 2015. This will not come as a surprise to you. There are entire generations who have never had to deal with rising interest rates and have no idea how to act accordingly. Cheap money always comes to an end and this will shake up the financial landscape. Living on credit is no longer an option.
It remains for me to wish you a good weekend.
Jan Dwarshuis is a senior asset manager at Thirteen Asset Management AG, where he is responsible for the Thirteen Diversified Fund. Dwarshuis writes his columns in a personal capacity and is not paid for them. Nor is he paying for his columns to be placed. Professionally, he holds positions in major European, American and Russian stock funds. The information in his columns is not intended as professional investment advice or a recommendation to make certain investments. At the time of writing, he has no position in the above shares and has no intention of doing so in the next 72 hours.
