The Breakdown - Beijing Bazooka: Why China Isn't Being More Aggressive As Economy Deteriorates

Episode Date: September 5, 2023

On a macro show, NLW explores how China's economic situation has been deteriorating; the highly targeted interventions from the Chinese government; and the discussion of why more aggressive tactics aren't being deployed to right the ship. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Tuesday, September 5th, and today we are talking about why China's growth engine may be falling apart. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link of the show notes or go to bit.ly slash breakdown pod. Hello friends, welcome back to the breakdown. I hope all of you who are celebrating the long holiday weekend had a great end of summer and are looking forward to what promises to be a, well, actually I don't know what fall promises

to be. We're in the hinterlands where I believe on the one hand, the worst of the bear market has ended. But on the other hand, it still feels like we're pretty far away from a bull market beginning. That's, of course, because no one knew is coming into the space right now, and that means it's all of us who have sort of stuck around here, just kind of circling around the drain. There was a great example of this this morning where Visa posted some news relating to Solana, and whereas during a bull market, that might send prices surging, Salana itself was basically flat from yesterday and is still down 3% on the week.

I think unfortunately that until new sets of money come in, we're effectively just sideways and down only. But given that lethargy, it's a good time to get away from thinking, about crypto asset prices and thinking about bigger topics and issues. In fact, today we are jumping entirely outside of crypto to talk macro and specifically China. Now, obviously, the China story is bigger than just China and even bigger than just general global economics are interconnected. China has been a deterministic actor in the global economy, especially since COVID. Their ongoing lockdowns kept supply chain screwed up and depressed global demand, and by extension,

their reopening was supposed to herald a return to normalcy and create some economic buoyancy. Alas, the country finds itself in the midst of a serious economic downturn. In the U.S., we see article titles like, from the New York Times on August 31st, Why is China in so much trouble? From Bloomberg yesterday, China slowdown means it may never overtake U.S. economy. From the economist August 24th, Xi's failing model, why he won't fix China's economy. So given that, let's get into what's actually happening. First of all, last quarter's GDP growth in China came in at 3.2%. That is a significant amount below the government's target of around 5%. Now, in addition to not meeting that 5% target, when that target was announced in March during

the National People's Conference, it was recognized as the lowest growth target in decades, and as such spoke to internal and external problems across the Chinese economy. In a note published last week, Bloomberg Economist wrote that, quote, China is downshifting onto a slower growth path sooner than we expected. The post-COVID rebound has run out of steam, reflecting a deepening property slump, and fading confidence in Beijing's management of the economy. weak confidence risks becoming entrenched, resulting in an enduring drag on growth potential. Now, depending on who you read, you will find a range of explanations for this slowdown.

To some, it's about a demographic collapse with a rapidly aging population. To others, it's about shifting trade policy and ongoing U.S. attempts to decouple from China that have led to a slowdown in international investment. Others point out that internally in China, there has been a shift of emphasis from growth at all costs to security and resilience as China prepares for increasing conflict with Western powers. Now, of course, over the shorter term, the explanations for the slowdown are more defined. The Chinese reopening failed to live up to the hype, and youth unemployment in particular, has soared. It was last recorded above 20% before reporting was suspended in July.

Now, the consequences of the economic slowdown have led to issues piling up in a myriad of places across the financial sector. There are now problems bubbling to the surface in housing, financial services, and even the currency. Beijing has begun intervening with assorted rescue packages, although they remain closely targeted at this stage. So far, the government has avoided direct fiscal stimulus of household spending, which might be used to bolster collapsing consumer demand and stave off outright deflation in retail prices. Now, many have questioned why the Chinese government is being so restrained with fiscal support during this downturn. This is because it's a little bit different than the strategy deployed before.

During the 2008 crisis in subsequent global economic shocks, there was no lack of willingness to deploy the quote Beijing Bazooka and engage in system-wide support and massive infrastructure spending. This time around, we're not seeing that kind of approach, which has puzzled many international commentators. And yet, of course, it's not like the Chinese government is doing nothing. As multiple problems have reached a crisis point over the past few weeks, the government has launched a round of targeted interventions, so let's look at a few of those. The first sign of major interventions came last Sunday when Beijing announced a package of measures aimed at boosting the stock market. A tax on stock trading was reduced for the first time

since 2008, and in addition, the top stakeholders in firms that were trading below their IPO price were restricted from selling shares. Deposit ratios for margin financing were also lowered. Alongside these overt policy decisions, Beijing also leaned on large institutions to support the market. During a seminar held the previous Thursday, the China Securities Regulatory Commission extracted a pledge from assembled pension funds, large banks, and insurers that they would help to stabilize the stock market and boost economic development. These combined actions caused a dramatic pop at last week's Monday open. Chinese markets began the day up 5.5%, but the euphoria was short-lived, wearing off in just 10 minutes of trading with the market collapsing back down. The primary Chinese

index closed that Monday up only 1.2%. By way of comparison, the last time China cut stock trading taxes in 2008, the move triggered a 9.3% rally the following day and kicked off a significant bull run into the following year. Now, the changes were widely anticipated after Beijing pledged last month to, quote, invigorate capital markets and boost investor confidence. The Chinese stock market has been a fairly horrendous place to invest in recent years. The major index is down 4% so far this year on the back of two consecutive years of annual losses. Chinese markets are underperforming a broader sample of Asian equities by about 6% this year and have been one of the worst performing markets in the world. Foreign investors have been fleeing the wreckage. The past few weeks saw over

13 consecutive days of net selling from international firms, which is the longest streak on record. Still, with a little over a week since that Monday intervention, there do appear to be some signs of success. The Shanghai-Shen Index, the major onshore market index, is now up 2% since last Monday's close. More importantly, the index has now seen two weeks of a positive trend. The main Chinese index is up 3.6% since this year's low, which was recorded the week prior to the interventions. Now, this recent surge in Chinese stock saw an extra boost from large housing developers during recent trading. The Hangsang Main Line Properties Index rose by over 8% on the back of good news for the troubled property sector. The biggest headline was generated by

Country Garden, which was previously the nation's largest developer. The Chinese property, Goliath, had missed 22.5 million in interest payments on $2-dominated bonds in early August. Concerns mounted throughout the month that this missed payment would lead to an official default and potentially bankruptcy, which was, of course, the path that rival developer Evergrand went down over the past two years. However, Country Grant has now caught up with delinquent interest payments on the two bonds within grace periods avoiding a default. The payment came after successful negotiations surrounding another tranche of bonds which were due to mature on Friday. The firm managed to negotiate with creditors to push the maturity date out until

2026, affecting 537 million in principal repayments. Still, Country Garden remains under pressure, with $2.9 billion in note obligations falling due throughout the rest of the year. Overall, the firm has $187 billion in total liabilities. What's more, the story is not much better across the broader housing industry. 34 of China's top 50 private sector developers are delinquent on offshore bond issuance. The remaining 16 creditworthy firms, which now includes Country Garden, have a combined $1.5 billion in bond payments falling due this month. That's the highest monthly amount since January. Xi Wei Fang, a senior analyst at Loomis Sales Investments, Asia said,

it's uncommon for close to 70 to 80% of the non-state-owned issuers in a major sector to run into default or distress within such a short period. More default is definitely expected by now. Bringing it back to Country Garden, although the securities have benefited from a bounce, they're still trading at deeply distressed levels between 9 and 14 cents on the dollar. A note from Bloomberg Intelligence on Monday said, Country Garden could struggle to avoid a downward spiral in its liquidity even after it dodged to default. The developers slump in contracted sales, down 72% in August, could persist to mid-faltering homebuyer confidence.

About 92% of its land bank is in low-tier and weaker tier two cities, where the latest policy stimulus is likely to deliver a little boost to home sales. And indeed, if the Chinese economy is headed for crisis, the housing market will likely be ground zero. By some counts, the housing sector and related industries make up around 20% of China's GDP. In addition, housing is used as a primary investment vehicle by many families, given low transparency in the domestic stock market. This reliance on housing has made support of the property market a key focus of recent interventions. Beijing has massively loosened lending standards for mortgages over the past week, A joint statement issued by the People's Bank of China and the National Administration of Financial

Regulation reduced minimum down payments to between 20 and 30% for first-time homebuyers nationwide. Previous lending standards required a down payment of 30 to 40% in Tier 1 cities like Beijing and Shanghai. A prime mortgage rate for new borrowers was also slashed by 40 basis points. In addition, policymakers have instructed banks to renegotiate loan terms for existing first-time borrowers later this month. This policy will lower repayment costs across some $3.5 trillion worth of outstanding household debt. Now, beyond just arresting the two-year slide in Chinese home prices, policymakers are hoping this change will have broader implications as well. The statement from the PBOC said,

The drop in the interest rates of existing housing loans can save interest expenses for borrowers, which is conductive to expanding consumption and investment. John Lamb, head of China and Hong Kong property at UBS Investment Bank, research said, this is a key part of the additional policy easing we have been expecting. We view this policy easing as more positive and different compared to the previous ones, as a nationwide policy like this helps strengthen homebuyers' confidence on property price outlook. Now, the weekend did see a rebound in home sales as the new policies kicked in. 1800 new homes were sold in Beijing on Saturday alone, which was more than half of the sales volume across the entire last month. Second home sales were also robust doubling compared to the

previous weekend. Still, there is a lot of commentary that these interventions are just not big enough to deal with the scale of the problem. Derek Tay, the head of investments at Camet Capital Partners said, Chinese property is a well-known hotspot, and we don't pick up pennies in front of steamrollers. The structural issues plaguing the Chinese real estate sector need more than relaxation measures. Now, another big unsolved problem in the Chinese economy is the potential failure of shadow banking giant, Zhang Rong International Trust. The firm is one of the 10 largest trust companies in China and manages over $137 billion. Earlier this month, Zhang Rong began defaulting on scheduled payments on dozens of wealth management

products. The defaulted payments amounted to around $20 million, but the concern is that missed payments could be just the beginning of a Lehman moment in China. Last week, Beijing asked two of the nation's largest financial firms to investigate the books at Zhang Rong, which some insiders view as a prelude to a bailout of the firm. To understand a little bit about how this functions, the $400 billion Chinese trust industry acts as an alternative funding source for weaker borrowers unable to get bank loans. The industry intermediates credit primarily from wealthy lenders to real estate developers

and local government financing vehicles. According to Goldman Sachs, the sector could be facing a 10% asset impairment across the board. Trying to sum up where we are, early last week, Ting Liu, the chief China economist at Nomura Holdings, said that the measure so far, quote, fall short in halting the downward trend and their impact will be short-lived, unless accompanied by support for the actual economy. The critique of Beijing policymaker so far has been that they are too reluctant to commit to full-blown stimulus efforts to rescue the flailing economy. Specifically, Beijing has been hesitant to deliver support to households.

Official explanations have warned of the, quote, trap of welfareism and expressed a preference for tax cuts to businesses rather than transfer payments. Yet some analysts believe that the restriction on stimulus is more economic in nature. The Chinese exchange rate has recently fallen to 7.3 yuan per dollar, which is the lowest level since 2008. Multiple interventions over the past month have failed to drive a rebound in the currency. Many analysts believe that the floor is being heavily defended and that Beijing is working behind the scenes to avoid a devaluation. The latest round of currency interventions occurred on Friday when the PBOC cut the amount of foreign reserves commercial banks must hold on foreign exchange deposits from 6% to 4%.

Becky Liu, the head of China macro strategy at Standard Chartered, said that the move was largely symbolic but that it, quote, reaffirmed the PBOC's defensive stance to defend the currency. Now, there is a lot more that we could get into. Tensions with China around access to AI chips continues to grow, with the U.S. recently forcing NVIDIA and AMD to stop selling to certain Middle Eastern countries, for fear that those chips will get then routed to China. And there is the constant buzz of policymakers in Washington saying that the administration should be even tougher when it comes to Chinese economic policy.

For now, it remains one of the most important economic narratives in the world, and so is something we will keep watching closely. However, that is going to do it for today's episode. I appreciate you listening as always, and until next time, be safe and take care of each other. Peace.