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29.3.

2014

The China Ponzi Scheme LewRockwell.com

LewRockwell.com
anti-state anti-war pro-market
Chinas Monumental Ponzi: Heres How It Unravels
By David Stockman David Stockman's Contra Corner March 29, 2014 China is the greatest construction boom and credit bubble in recorded history. An entire nation of 1.3 billion has gone mad building, borrowing, speculating, scheming, cheating, lying and stealing. The source of this demented outbreak is not a flaw in Chinese culture or characternor even the kind of raw greed and gluttony that afflicts all peoples in the late stages of a financial bubble. Instead, the cause is monetary madness with a red accent. Chairman Mao was not entirely mistaken when he proclaimed that political power flows from the end of a gun barrel-he did subjugate a nation of one billion people based on that principle. But it was Mr. Dengs discovery that saved Maos tyrannical communist party regime from the calamity of his foolish post-revolution economic experiments. Just in the nick of time, as China reeled from the Great Leap Forward, the famine death of 40 million and the mass psychosis of the Cultural Revolution, Mr. Deng learned that power could be maintained and extended from the end of a printing press. And thats the heart of the so-called China economic miracle. Its not about capitalism with a red accent, as the Wall Street and London gamblers have been braying for nearly two decades; its a monumental case of monetary and credit inflation that has no parallel. At the turn of the century credit market debt outstanding in the US was about $27 trillion, and weve not been slouches attempting to borrow our way to prosperity. Total credit market debt is now $59 trillion-so America has been burying itself in debt at nearly a 7% annual rate. But move over America! As the 21st century dawned, China had about $1 trillion of credit market debt outstanding, but after a blistering pace of borrow and build for 14 years it now carries nearly $25 trillion. But heres the thing: this stupendous 25X growth of debt occurred in the context of an economic system designed and run by elderly party apparatchiks who had learned their economics from Maos Little Red Book! That means there was no legitimate banking system in Chinajust giant state bureaus which were run by party operatives and a modus operandi of parceling out quotas for national credit growth from the top, and then water-falling them down a vast chain of command to the counties, townships and villages. There have never been any legitimate financial prices in Chinaall interest rates and FX rates have been pegged and regulated to the decimal point; nor has there
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ever been any honest accounting either-loans have been perpetual options to extend and pretend. And, needless to say, there is no system of financial discipline based on contract law. Chinas GDP has grown by $10 trillion dollars during this century alonethat is, there has been a boom across the land that makes the California gold rush appear pastoral by comparison. Yet in all that frenzied prospecting there have been almost no mistakes, busted camps, empty pans or even personal bankruptcies. When something has occasionally gone wrong with an investment the prospectors have gathered in noisy crowds on the streets and pounded their pans for relief-a courtesy that the regime has invariably granted. So in two short decades, China has erected a monumental Ponzi economy that is economically rotten to the core. It has 1.5 billion tons of steel capacity, but sell-through demand of less than half that amount that is, on-going demand for sheet steel to go into cars and appliances and rebar into replacement construction once the current pyramid building binge finally expires. The same is true for its cement industry, ship-building, solar and aluminum industriesto say nothing of 70 million empty luxury apartments and vast stretches of over-built highways, fast rail, airports, shopping mails and new cities. In short, the flip-side of the Chinas giant credit bubble is the most massive malinvesment of real economic resources-labor, raw materials and capital goodsever known. Effectively, the country-side pig sties have been piled high with copper inventories and the urban neighborhoods with glass, cement and rebar erections that cant possibly earn an economic return, but all of which has become collateral for even more loans under the Chinese Ponzi. China has been on a wild tear heading straight for the economic edge of the planet-that is, monetary Terra Incognito based on the circular principle of borrowing, building and borrowing. In essence, it is a giant re-hypothecation scheme where every mans debt become the next mans asset. Thus, local governments have meager incomes, but vastly bloated debts based on stupendously over-valued inventories of land. Coal mine entrepreneurs face collapsing prices and revenues, but soaring double digit interest rates on shadow banking loans collateralized by over-valued coal reserves. Shipyards have empty order books, but vast debts collateralized by soon to be idle construction bays. Speculators have collateralized massive stock piles of copper and iron ore at prices that are already becoming ancient history. So China is on the cusp of the greatest margin call in history. Once asset values starting falling, its pyramids of debt will stand exposed to withering performance failures and melt-downs. Undoubtedly the regime will struggle to keep its printing press prosperity alive for another month or quarter, but the fractures are now gathering everywhere because the credit rampage has been too extreme and hideous. Maybe Zhejiang Xingrun Real Estate which went belly up last week is the final catalyst, but if not there are thousands more to come. Like Maos gun barrel, the printing press has a sell by date, too Of the more than US$562 million (RMB3.5 billion) that it owed to debtors, US$112 million was borrowed from 98 private parties with annual interest rates of up to 36%, according to recent revelations from Chinese media [http://www.eeo.com.cn/2014/0321/257947.shtml] . Under that kind of pressure, the only surprise is that the default didnt happen sooner. The company struggled to find capital for years; the chairman is suspected of borrowing up to
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US$38.6 million with fake mortgages. But before Xingrun gets branded as Chinas worst small, private homebuilder, its important to understand how it ended up in the mess in the first place, and what specific factors brought the operation down, or at least to the brink of collapse (local government officials insist it hasnt officially defaulted yet [http://www.bloomberg.com/news/2014-0321/zhejiang-xingrun-hasn-t-declared-bankruptcy-local-official-says.html] ). Xingruns business in Fenghua, a county-level city that is part of Ningbo in a manufacturing belt on Chinas east coast, ran into trouble through a renovation project starting in 2007, Chinese media pointed out [http://finance.chinanews.com/house/2014/0324/5984459.shtml] . The company attempted, after securing government support and taking over for another distressed local property company, to build high-rise apartment blocks in a village called Changting. The project required the company to build homes for the original residents before the existing village could be torn down and the new buildings built. Construction was slated to start in the first half of 2012. Xingrun projected that it could pay off its debts within three years. The project never got to the construction phase. In fact, the small village homes are still standing. Xingrun built the replacement homes for the villagers but theres no sign of its main housing product, high-rises. Nothing has happened because the residents of the village have tangled the project and the company in a lawsuit that has stretched for years. That explains why Xingrun was unable to pay back its loans. But why has it come so close to keeling over now? Its troubles with the Changting project persisted for years but the company simply rolled over loans and borrowed at high rates from private lenders. One problem for capital-strapped developers in the Ningbo area is that private lenders no longer want to lend to highly risky companies. In fact, they are calling in their loans. This is just one of the problems afflicting Xingrun. The value of property in some areas of Fenghua is decreasing and that trend has lowered confidence in developers ability to pay dizzyingly high interest rates. Banks arent hot on lending to this kind of developer either. In the past, a developer such as Xingrun could ask the local branch of a commercial bank for more credit. The local branch would take that risk because loan officers there knew that, somewhere much higher up the chain, officials promoted the lending. That support exists no longer. Now, when small developers beg local banks for credit, they will likely be turned away. Local bank managers are reportedly being told that they may lend to risky borrowers if they wish, but they will be held accountable. High risk is something no one seems willing to stomach these days in stark contrast to just a year ago.

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Fenghua is a small town, and Xingruns reach beyond that area is limited. Analysts have come out strong in saying that such a default has little systemic risk. The bigger picture in the region, however, cant be ignored. Xingruns woes are still the woes of the local authorities. The default will add US$305 million (RMB1.9 billion) to Fenghua provinces nonperforming loan portfolio, pushing up the rate of toxic assets to 5.27% and making it Zhejiang provinces most indebted government, according to calculations by The Economic Observer [http://www.eeo.com.cn/2014/0321/257947.shtml] newspaper. Add Fenghuas problems to those of the greater Ningbo region. The area reportedly has at least six years of housing stock either sitting empty or under construction. The massive buildout will put small developers under great pressure to pay back loans, especially if private debtors are calling in high-interest loans. A slowdown in property prices wont help either. Without a rescue from provincial-level banks, Fenghua wont be the last local government stuck in a jam. Reprinted with permission from David Stockman [http://davidstockmanscontracorner.com/] .

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Former Congressman David A. Stockman was Reagan's OMB director, which he wrote about in his best-selling book, The Triumph of Politics. His latest book is The Great Deformation: The Corruption of Capitalism in America. He's the editor and publisher of the new David Stockman's Contra Corner. He was an original partner in the Blackstone Group, and reads LRC the first thing every morning. Copyright 2014 David Stockman Previous article by David Stockman: Let Them Eat iPads

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