Neck and Neck: Russian and Chinese Official Gold Reserves

Submitted by Ronan Manly, BullionStar.com

Official gold reserve updates from the Russian and Chinese central banks are probably one of the more closely watched metrics in the gold world. After the US, Germany, Italy and France, the sovereign gold holdings of China and Russia are the world’s 5th and 6th largest. And with the gold reserves ‘official figures’ of the US, Germany, Italy and France being essentially static, the only numbers worth watching are those of China and Russia.

The Russian Federation’s central bank, the Bank of Russia, releases data on its official gold holdings in the Bank’s monthly “International Reserves and Foreign Currency Liquidity” report which is published towards the end of the third week of each month, and which confirms gold reserve changes as of the previous month-end.

The Chinese State releases data on its official gold holdings via a monthly “Official Reserve Assets” report published by the State Administration of Foreign Reserves (SAFE) that is uploaded within the Forex Reserves pages of the SAFE website. This gold is classified as held by the Chinese central bank, the People’s Bank of China (PBoC). The SAFE report is published during the 2nd week of each month, reporting on the previous month-end.

In both reports, official gold reserves (i.e. monetary gold) are specified in both US Dollars and fine troy ounces. Monetary gold is gold that is held by a central bank or other monetary authority as a reserve asset on a central bank’s balance sheet.

Delta: 63 Tonnes

For the Bank of Russia, its latest report, published on 19 September 2017 addressing August month-end, shows the Bank holding 57.2 million fine troy ounces of gold (1779 tonnes). For the Chinese State, the latest SAFE release is reporting Chinese official gold reserves of 59.24 million ounces (1842 tonnes).

Russian gold reserves, as officially reported, now total 1779 tonnes, and are now just 63 tonnes shy of the ‘official’ gold reserves of the Chinese central bank. Given that the Bank of Russia is expected to add about another 36 tonnes of gold to its official reserves during the remainder of 2017,  then if the Chinese State does not reveal any increase in its ‘official’ gold reserves between now and the first quarter of 2018, Russia will most likely surpass China in terms of official gold reserves by April 2018.

While its possible and probable that the Chinese State / PBoC really holds more gold than it claims to hold, any upcoming scenario in which the Bank of Russia surpasses the People’s Bank of China in terms of gold holdings would at least be symbolic in terms of international monetary developments, and would be sure to generate some chatter in the financial press.

Although the official gold reserves of these two key nations are now nearly neck and neck, there are still some interesting contrasts between them, not least the way in which the Bank of Russia’s reported gold holdings have been steadily increasing month on month, while the reported gold holdings of the People’s Bank of China have remained totally unchanged for nearly a year now, since the end of October 2016.

Therefore the situation which is now emerging, i.e. the distinct possibility that Russian official gold reserves will surpass those of China something in early 2018, is a situation which is emerging precisely because the Russian Federation keeps adding to its gold reserves, while the Chinese State seemingly does not.

Differing Styles of Communication

The routes via which these two strategically important nations have amassed their official gold reserves are also quite different, at least at a public reporting level.

Bank of Russia Gold Reserves: 2006 – September 2017, Source:www.GoldChartsRUs.com

It wasn’t so long ago (2007) that the gold reserves of the Russian Federation were still in the region of 400 tonnes. However, beginning in about the third quarter of 2007, the Bank of Russia began a concerted campaign to rapidly expand its official gold holdings, a trend which never subsided and which has been ongoing now for exactly 10 years. By early 2011, official Russian gold reserves had exceeded 800 tonnes. By the end of 2014, the Bank of Russia was reporting holding more than 1200 tonnes of gold. And by the end of 2016, Russian official gold were more than 1600 tonnes. For full details on the Bank of Russia’s gold holdings, including gold storage, gold reserve management, gold purchases and Russian government views on gold, see “Bank of Russia, Central Bank Gold Policies” at BullionStar’s Gold University.

From the above chart, it can be seen that during 2014, 2015 and 2016, respectively, the Bank of Russia added 171 tonnes, 208 tonnes, and 199 tonnes to its gold reserves, or in total 578 tonnes over a 3 year period. In 2017, with the Bank of Russia having added another 164 tonnes of gold for the year to end of August, its official gold reserves now stand at 1779 tonnes.

The route to the Chinese State accumulating 1842 tonnes of gold is a different one to that of the Russians, again at least from a publicly reported angle. While the Bank of Russia has historically published changes to its gold reserves on a monthly basis, the Chinese central bank has chosen to remain very secretive, and between 2001 and mid 2015 had only issued four public updates addressing the size and growth of its gold reserves. These 4 updates were as follows:

• 4th Quarter 2001: From 394 to 500 tonnes: A 106 tonne increase


• 4th Quarter 2002: From 500 to 600 tonnes: A 100 tonne increase


• April 2009: From 600 to 1,054 tonnes: A 454 tonne increase


• July 2015: From 1,054 to 1,658 tonnes: A 604 tonne increase

Beginning in July 2015, however, the Chinese State started to report changes in its official gold reserves on a monthly basis, and by July 2016 was reporting 1823 tonnes of official gold holdings. The following graphic, taken from a BullionStar infographic on the Chinese gold market, illustrates the sporadic reporting of Chinese official gold reserves between the early 2000s and July 2015. Note that between July 2016 and October 2016, the Chinese State through SAFE reported that the PBoC had acquired another 19 tonnes of gold, taking its total reported gold reserves to 1942 tonnes as of the end of October 2016.

Chinese Official Gold Reserves, 2003 – 2016 Source: Chinese Gold Market Infographic, BullionStar

The sparse official reporting by the Chinese is also clear in the below chart from the GoldChartsRUS website, which shows cumulative holdings of monetary gold by the People’s Bank of China (PBoC) between 2000 and 2017. Looking at the top panel of the chart, it can be seen that between 2001 and 2015, there were only 4 distinct jumps in the quantity of gold held by the PBoC.

This was followed by a period of about 15 months from July 2015 during which SAFE reported small monthly accumulations in PBoC’s gold holdings, as can be seen from the gradual increases in the bars in the top panel from July 2015 to October 2016, and the corresponding presence of frequent activity in the monthly changes in the lower panel of the chart.

Official Gold Reserves of the Chinese central bank: Divulged Holdings 2000 – 2017. Source:www.GoldChartsRUs.com

By September 2016, Chinese State gold reserve holdings had reached 59.11 million ounces. In October 2016, the SAFE report announced that Chinese official gold holdings had reached 59.24 million ounces, a 0.13 million ounce increase from the previous month. However, then something unusual happened, at least in terms of monthly updates. Since October 2016, Chinese official gold reserves have not changed at all. The SAFE updates are still published each month, but the gold holdings figure has remained unchanged at 59.24 million ounces (1842 tonnes).

Therefore, for nearly a year now, the Chinese authorities are signalling that they have not acquired any new gold. At least that is what they want the public to believe. Hence the constantly recurring headlines from the financial media, such as this one from Reuters a couple of weeks ago, “China gold reserves steady at 59.24 mln ounces at end-September – central bank”.

But is it true that China only holds 1842 tonnes of gold and that it has not been active during the last year in continuing to accumulate monetary gold as part of its reserve assets? And for that matter, is it the case that the Bank of Russia and Russian Federation only hold 1779 tonnes of monetary gold?

While its difficult to know for sure, it is possible that the People’s Republic of China and the Russian Federation both hold additional gold that is not reported by their monetary authorities. This is so for multiple reasons, including the opaque ways in which these monetary gold reserves are accumulated, the traditional secrecy of both governments, and the fact that both countries have access to other investment pools that might hold gold that can be transferred at short notice into the respective central banks’ official gold holdings.

How Much Gold could the Chinese State really have?

The historical track record of the Chinese State in sporadically communicating the size of its monetary gold holdings shows that there has often been a large gulf between the true size of its gold reserves and what the Chinese claimed to have via its piecemeal and rare updates. For example, even based on its official numbers, the PBoC accumulated over 600 tonnes of gold between April 2009 and July 2015 but did not reveal this until July 2015.

The nearly year-long hiatus between October 2016 and the present, during which the Chinese authorities, via SAFE, claim that the PBoC’s gold holdings have remained at 1842 tonnes, could be true, but only in so far as the Chinese State does not wish to inform the world about its sovereign gold reserves. Beyond this, the true gold holdings of the Chinese central bank may be significantly higher than even official published figures suggest.

There is very little transparency into how the Chinese authorities accumulate monetary gold. In July 2015, when SAFE announced the first update to its gold holdings since 2009, it stated that the “major channels of accumulation” of gold were from purchases in foreign markets, domestic gold production, domestic scrap sources, and other transacting in the domestic market. But beyond this, the Chinese authorities never comment on where they source gold from.

There is lots of evidence that the Chinese State purchases significant quantities of gold in the international market, including in the London Gold Market, and then monetises this gold (i.e. classifies it as monetary gold) , before transporting it back to Beijing. See “PBoC Gold Purchases: Secretive Accumulation on the International Market”, at BullionStar Gold University for further details.

The Chinese State is also a possible candidate for having purchased a tranche of the IMF’s gold during IMF gold sales in 2010. See BullionStar blog  “IMF Gold Sales – Where ‘Transparency’ means ‘Secrecy’” for further details.

There are also plenty of other State entities and state controlled entities in addition to the Chinese central bank that could conceivably be holding gold reserves that could in time be reclassified as PBoC gold, and brought into the sphere of reporting. See section “Gold Transfers from other Chinese State entities” in BullionStar Gold University article “Gold Policies of the People’s Bank of China” for further details.

There is also evidence to suggest the Chinese State is really buying about 500 tonnes of gold per year, and that it has a first step target of holding at least 4000 tonnes of gold. This evidence, which is from 3-5 years ago, comes from senior people in the China Gold Association (CGA). See section “How much gold might the PBoC be buying each year?” in article PBoC Gold Purchases.

A gold reserves-to-FX reserves ratio of 5% would currently put Chinese state gold holdings at nearly 4000 tonnes. A gold-to-GDP ratio of about 1.77%, which is the equivalent of the gold-to-GDP ratio of the US, would currently put Chinese state gold holdings at nearly 5000 tonnes of gold.

Russia: Golden Pipelines and Stockpiles

In its “Methodological Notes to International Reserves of the Russian Federation“, the  Bank of Russia defines “monetary gold”  as:

“standard gold bars and coins with a purity of at least 995/1,000 held by the Bank of Russia and the Government of the Russian Federation. It comprises gold in vault, en route and in allocated accounts, including that which is held abroad. The item monetary gold includes unallocated gold accounts with non-residents.”

The primary source of gold flowing to the Bank of Russia comes from Russian gold mining production, with the Russian Federation acquiring a large percentage of domestic gold mining production each year. In practice, a small group of state influenced Russian banks are authorised to intermediate between the gold mining companies and the State, acting as a gold pipeline between the mines and the Bank of Russia / Government. These banks finance the mining companies, purchase their gold output , have it refined into gold bars by Russian gold refineries, and then offer this gold to the Russian State.

Some of these banks include Sberbank, VTB, Gazprombank and Otkritie. For details see section “Russian Banks as bulk buyers of Russian Gold” in the Russian gold market article in BullionStar’s Gold University.

But its possible that some of this gold ends up not with the Bank of Russia, but with other Russian State entities, one of which is the “Gosfund” or “Precious Metals and Gems fund” operated by “The Gokhran”.

This Gosfund could be buying a portion of Russian gold mining output, stockpiling it, and intermittently releasing some of its stockpile to the Bank of Russia. When I asked the Gokhran last year could it reveal its gold holdings, the Gokhran replied to me that “it does not publish information about the amount of gold reserves in the Russian Gosfund nor any data about its precious metal operations.” See letter reply from Gokhran below (for those who can read Russian):

Gokhran reply January 2016 to query on whether it could publish its Gold Holdings.

Conclusion

Given the high degree of opacity with which both the Russian State and Chinese State accumulate monetary gold, and the fact that they both can probably tap additional gold stockpiles to boost their official gold reserves, it will be interesting to see whether China, through SAFE, announces any increase in the PBoC’s gold holdings between now and the end of Q1 2018.

Because if China does not do so, the Russian Federation will soon have the distinction of being the world’s 5th largest gold holder, pushing China into 6th place. Will China update its gold holdings before the end of 2017, or at least by early 2018? Nothing is certain, but with an ‘official’ difference of only 63 tonnes of gold between them, the race is on.

This article first appeared under the same title, "Neck and Neck: Russian and Chinese Official Gold Reserves" on the BullionStar.com website.

Overheating China PPI Sends 10Y Yields To 30 Month Highs As Banks Inject Another Quarter Trillion Dollars In Loans

Despite a disappointing US CPI report on Friday, which saw core inflation miss once again despite an expected spike due to the "hurricane effect", moments ago China reported that in September, its CPI printed at 1.6% Y/Y, in line with expectations, and down from, 1.8% in August largely due to high year-over-year base effects, but it was PPI to come in smoking hot, jumping from 6.3% last month to 6.9% Y/Y, slamming expectations of a 6.4% print and just shy of the highest forecast, driven by the recent surge in commodity costs and strong PMI surveys.

While there has been no reaction in the Yuan, either on shore or off, the stronger than expected PPI has pushed China"s 10Y yield to the highest in 30 months, or since April of 2015.

Adding fuel to the flame was PBOC head Zhou Xiaochuan who said earlier that China’s GDP would pick up from the 6.9%  figure recorded in the first six months of the year "thanks to a boost from household spending", according to a synopsis of his comments at the G30 International Banking Seminar posted to the People’s Bank of China website on Monday." The reason why his comments have impacted the long-end is that the reported, and completely fabricated number, is higher than the previous consensus forecast of a goalseeked Q3 Chinese GDP of 6.8%.

And while spiking Chinese yields wouldn"t be concerned if China was indeed deleveraging as the Communist Party and the PBOC claim it is doing, the reality is, of course, that China continues to add more and more debt as the latest weekend credit numbers out of the PBOC revealed. As Bloomberg reported earlier, China"s broadest credit aggregated, Total Social Financing, jumped to 1.82 trillion yuan, or over a quarter trillion dollars in September ($276BN to be precise), vs a Wall Street estimate of 1.57 trillion yuan and 1.48 trillion yuan the prior month. New yuan loans also beat expectations, at 1.27 trillion yuan, versus a projected 1.2 trillion yuan, while for the first time in months, the broader M2 money supply did not hit fresh fresh record lows, and instead beat expectations, rising to 9.2% from an all time low of 8.9%.

Just as notable, after China"s shadow banking credit appeared to have finally been tamed after several months of contraction, shadow banking finance saw a pick-up in Sept (trust loans, entrusted loans and undiscounted bills), which accounted for 22% of Sept TSF vs. 18% in August. This was due mostly to milder deleveraging pace post the completion of self-checking of CBRC regs.

Commenting on the latest burst of credit creation by China, Kenneth Courtis, chairman of Starfort Investment Holdings and a former Asia vice chairman for Goldman Sachs Group, said that "Momentum continues to be very strong. Loan demand of the private sector has finally turned up in recent months."

It also means that just two weeks after the PBOC cuts its RRR for most banks in an unexpected monetary easing on Sept 30, “there is little hope of further policy easing in the fourth quarter as the monetary policy is very accommodative," said Zhou Hao, an economist at Commerzbank AG in Singapore. "There could be even a tightening bias."

Of course, confirming what we have been saying for years, Christopher Balding who is an associated professor in Peking Univeristy in Shenzhen said that "deleveraging is not happening if we look at any measure of credit growth" and that "lending in 2017 has actually accelerated significantly from 2016." This is shown in the chart below, which confirms that to keep its GDP at 6.9% or some other goalseeked number, China has to inject more than double that amount in credit every single month, in this case 15%. The biggest question is what happens to China"s credit impulse after the 19th Party Congress which begins on Wednesday.

When looking at the boost in household spending noted above by Zhou Xiaochuan, all of this is the result of a surge in household lending: "Household short-term loans have increased too rapidly, with some funds being invested in stock and property markets," said Wen Bin, a researcher at China Minsheng Banking Corp. in Beijing. "Regulators have started to pay attention to the sector and required banks to strengthen credit review. I think the momentum will show signs of slowing in the fourth quarter."

Commenting on the recent burst in Chinese household leverage, where short-term household loans soared to 1.53 trillion yuan, versus 524.7 billion yuan this time one year ago, Deutsche Bank"s Hans Fan writes that "noticeably China households are levering up quickly. We welcome the personal loans driven by genuine consumption growth, but there may be a notable portion of short-term consumer loans that were used to finance property purchases, which in our view contains higher risks." 

Some more details:

A breakdown by borrower suggests household and corporate sectors continued to lever up, making up 31%/41% of new system credit in Sept (35%/38% in Aug). For households, while mortgage growth had slowed, s/t retail loan growth accelerated to 17.6% yoy in Sept (vs. 15.8% in Aug or 7.3% in 1Q17) to make up c.10% of credit creation. We attribute this to both decent consumption growth with rising credit penetration and property-related lending. We estimate 1/3 of new consumption loans may be used to finance purchases of second homes. However, PBOC and local CBRC offices have started to crack down on property-related consumer loans in September and we expect consumer loan growth momentum to moderate in the coming months.

However, as so often happens in China, this surging leverage "sugar high" will not last, as "regulatory crackdown on property-related consumer loans together with monetary policy staying neutral lead us to expect slower credit growth in 4Q17." The implications for China"s economy and the global credit impulse will be adverse, and will lead to a global economic slowdown just as all central banks enter tightening moment together.

Finally, for those wondering what the biggest timebomb in the global financial system was, is and will be until such time as it finally blows up, here is a lovely up close schematic courtesy of Deutsche Bank.

"The Taps Are Gushing" Hong Kong ATM Withdrawals Surge As Facial Recognition Fears Spread

Amid a crackdown on unauthorized mainland currency outflows by forcing ATM users to undertake facial recognition before cash is dispensed in Macau, Hong Kong ATMs are reportedly being hit by a massive surge in withdrawals from China"s UnionPay bank cards.

As The South China Morning Post notes, the mainland has been strengthening regulations since last year when a decline in the ­value of the yuan led to widespread capital outflows.

Mainland people are allowed to withdraw up to 100,000 yuan (HK$117,000) in cash overseas and remit up to US$50,000 worth of foreign currency offshore ­annually, according to 2016 ­foreign ­exchange regulations.

Users of UnionPay cards can withdraw up to 10,000 yuan per day for each card they hold.

To skirt around the foreign ­exchange controls, some individuals have been using separate ATM cards to make cash withdrawals, prompting the regulators to crack down on the practice.

The most invasive of those crackdowns was the imposition of facial recognition technology in Macau ATMs.

Regulators in the world’s most lucrative gaming hub are deploying machines with “Minority Report”-style technology to keep tabs on capital outflows from China and watch for potential money laundering schemes. China UnionPay Co.’s network is the first to use the software, which will be installed in all the city’s 1,200 cash dispensers.

...

“This is aimed at illicit outflows of capital from China,” said Sean Norris, Asia Pacific managing director at Accuity in Singapore. “It’s aimed at people drawing out money in Macau, going to the casino, betting very little, getting forex from there and moving it.”

But now, as SCMP reports, one source explains...

"It seems quite clear that as the introduction of ATM facial recognition technology in Macau has put the squeeze on cash dispensing withdrawals in Macau, the pattern of withdrawals has ­followed the path of least resistance - and that is to Hong Kong."

Monetary chiefs in Hong Kong have declined to deny or confirm information obtained by the South China Morning Post that ATMs have seen a "staggering"" rise in withdrawals since the ­casino hub introduced the facial recognition technology in May as part of a bid to stem illegal capital flight from the mainland.

"The rise in ATM withdrawals in terms of volume and number has been staggering. The taps are gushing," a source with knowledge of the situation said.

The development follows a move by the Hong Kong Monetary Authority to instruct local banks to submit data on cash withdrawals by UnionPay cards throughout the ATM network as the regulator cracks down on ­unauthorised mainland outflows.

The Monetary Authority spokeswoman added:

"The HKMA endeavours to enhance the security level of banking ­systems.

"We have been studying the applications of different technologies, including the feasibility, soundness and cost efficiency of facial recognition and other types of biometric authentication technologies, having regard to the technologies used in other ­jurisdictions.

"However, we have no plans to require ATMs to install facial ­recognition technology."

Which leads to one simple question... If everything is so awesome over there, why are Chinese authorities cracking down so hard on what seems like utter panic to get cash out of the onshore market?

And do not be fooled by the "strengthening Yuan" narrative... once again China is continuing to devalue its currency against the world... while maintaining the "Shanghai Accord"-like illusion that it is strengthening again the USD...

"It Feels Like An Avalanche": China's Crackdown On Conglomerates Has Sent A "Shock Wave" Across Markets

The first to suffer Beijing"s crackdown against China"s private merger-crazy conglomerates, wave was the acquisitive "insurance" behemoth, Anbang, whose CEO Wu Xiaohui briefly disappeared as the Politburo made it clear that the "old way" of money laundering - via offshore deals - is no longer tolerated. Then, several weeks later and shortly after the stocks of the "famous four" Chinese conglomerates plunged after China officially launched a crackdown on foreign acquirers amid concerns of "systemic risk", it was HNA"s turn, which as we described last week, risks becoming a "reverse rollup from hell", as HNA"s stock tumbled, sending the LTV of billions in loans collateralized by the company"s shares soaring and in danger of unleashing an catastrophic margin call among the company"s lenders.

Then Beijing"s attention shifted to the biggest conglomerate of them all: billionaire Wang Jianlin’s Dalian Wanda Group, which as the WSJ and Bloomberg reported was being "punished" by Beijing, and would see its funding cutoff after China "concluded the conglomerate breached restrictions for overseas investments."

The scrutiny could rein in Wang’s ambitious attempt to create a global entertainment empire, including Hollywood production companies and a giant cinema chain he’s built up through acquisitions from the U.S. to the U.K. Six investments, such as the purchases of Nordic Cinema Group Holding AB and Carmike Cinemas Inc., were found to have violations, said the people, who asked not to be identified discussing a private matter. The retaliatory measures will include banning banks from providing Wanda with financial support linked to these projects and barring the company from selling those assets to any local companies, the people said.

The move is an unprecedented setback for the country’s second-richest man, who has announced more than $20 billion of deals since the beginning of 2016. By targeting one of the nation’s top businessmen, the government is escalating its broader crackdown on capital outflows and further chilling the prospects of overseas acquisitions during a politically sensitive year in China.

Summarizing the abrupt shift in sentiment in China was Castor Pang, head of research at Core-Pacific Yamaichi, who said that “to investors, political risk is now the biggest concern when investing in Chinese companies. Not only Wanda, every Chinese company won’t find it easy anymore to acquire assets overseas. Stabilizing the yuan is the top priority for Beijing now.”

While it is not exactly clear just why Beijing so quickly soured on foreign transactions - as we explained back in 2015, it was abundantly clear back then these were nothing more than a less than sophisticated way to launder money offshore - unless of course the capital flight out of China is far worse than what Beijing would disclose, what has become quite clear is that Wanda was among the conglomerates including Fosun International, HNA Group and Anbang Insurance whose loans are under government scrutiny after China’s banking regulator asked some lenders to provide information on overseas loans to the companies.

In other words, the foreign merger party is over. In fact, for some of the above listed 4 conglomerates, the party may be over, period.

And now as the WSJ reported over the weekend, it has become clear that China’s government reined in one of its brashest conglomerates with the explicit approval of President Xi Jinping, "according to people with knowledge of the action—a mark that the broader government clampdown on large private companies comes right from the top of China’s leadership."

The measures, with President Xi’s previously unreported approval last month, bar state-owned banks from making new loans to property giant Dalian Wanda Group to help fuel its foreign expansion.

The cutoff in bank financing for the company’s foreign investments highlights Beijing’s changing view of a series of Wanda’s recent overseas acquisitions as irrational and overpriced. In short, and as noted above, Yuan stability above all.

For the local market, the shift in Beijing"s strategy is nothing short of a seismic shift:

“It feels like an avalanche,” said Jingzhou Tao, a lawyer at Dechert LLP in Beijing, who does mergers and acquisitions work. “This is sending a shock wave through the business community.”

* * *

Regular readers are aware of what, until recently, was China"s unquenchable thirst for foreign money laundering transactions, something we first pointed out at the start of 2016, and which had - until recently - grown exponentially. Since 2015, the four companies completed a combined $55 billion in overseas acquisitions, 18% of Chinese companies’ total. In recent days, however, as reported here 2 weeks ago, Wanda’s billionaire founder Wang Jianlin has been shrinking his empire by selling off assets and paying back the company’s bank loans.

What is surprising about the sudden shift, is that Beijing had for years been encouraged Chinese companies to scour the globe for deals. Now, in a dramatic U-turn, it is reining in some of its highest-profile private entrepreneurs in what officials say is growing unease with their high leverage and growing influence. As the WSJ notes, "the measures serve as a stern warning for other big companies that loaded up on debt to buy overseas assets, officials and analysts say."

How does the president fit into all of this? According to the WSJ, "Xi acted after China’s cabinet set the government machinery in gear by directing financial regulators, the economic planning agency and other bureaucracies to take a hard look at foreign acquisitions, once seen as a means for China to showcase its economic might."

And, as previously reported, the crackdown started at Anbang and HNA, when Chinese banking regulators first ordered banks to scrutinize loans to Anbang in June, and other highfliers including airlines-and-hotels conglomerate HNA Group, which has pulled back on overseas investments. HNA said in a statement it continues to take a “disciplined approach” to identifying “strategic acquisitions across our core areas of focus.”

Discussing the government"s crackdown on conglomerates, officials at Fosun said the firm has “overseas funds and other stable financing channels,” including a fund of around U.S. $1 billion to invest, but emphasized it “fully respects the government regulations both in China and overseas markets.” Fosun has a listed unit in Hong Kong, and its strategy to invest in health care and technology “adheres to China’s global investment strategy,” said a spokesman, Chen Bo.

In any case, the most likely outcome is that in the future China’s private companies will have trouble getting capital, which would help shift financial clout further in favor of big state-owned enterprises, which may also explain President Xi"s change in opinion. Beijing’s sterner line comes as big private businesses and others have been amassing capital and influence that challenge the authoritarian Chinese leadership’s firm hold on the economy.

Its grip has been tested over a bumpy few years. After a 2015 stock market meltdown and a botched government rescue, a gush of money flowed out of the country looking for better returns. That in turn put pressure on China’s tightly controlled yuan and foreign-exchange reserves, both seen by Beijing as barometers of confidence in the economy. It has also led to a chilling effect on Chinese outbound investment which has crashed as shown in the chart below.

Putting the foreign merger spree in context, Chinese firms completed $187 billion in outbound deals last year, according to Dealogic, as private companies snapped up trophy properties, soccer clubs and hotels, while Chinese with means bought homes and pushed up real-estate prices from Texas to Sydney.

The private sector’s share of overseas spending shot up from barely above zero about a decade ago to nearly half of China’s total overseas investments in 2016, before slipping back to 36.9% in the first half of 2017, according to Derek Scissors, a China expert at the American Enterprise Institute.

But the most important factor, and among the main reasons for the current crackdown, is that amid the rush of investments, Beijing burned through nearly a trillion dollars in foreign-exchange reserves trying to steady the yuan. That ultimately led government regulators to clamp controls on money exiting the country and to scrutinize all proposed major offshore investments.

Just as we predicted over a year ago would happen, once the government finally realized that all that M&A is nothing more than capital flight.

As the WSJ puts it, "the latest scrutiny is a watershed moment in the Communist government’s relations with a private sector it has never been comfortable with. Though some senior leaders, particularly Premier Li Keqiang, are urging a new culture of startups and small businesses, Mr. Xi has promoted plans to make already-large state enterprises larger and strengthen their sway over the economy."

There are other reasons for the crackdown too: one is the still fresh memory of what happened in Japan when it did the exact same thing. China is acutely aware that as Japan rose to economic prominence in the 1980s, its companies splurged on American real estate and other trophy assets, resulting in losses that cascaded through Japan’s banking sector.

But mostly, it is about power and control:

Mr. Tao, the Beijing lawyer, says the government’s new aggressive posture is driven in large measure by a need for control. “State-owned assets, whether in China or abroad, are still state assets,” he said. “But when private entrepreneurs take their money out, it’s gone. It’s no longer something that China can benefit from or the Chinese government can get a handle on.”

And since in any power struggle between Chinese companies and Beijing in general, and Xi Jinping in particular, the latter will always win, the market"s reaction was to violently selloff any big Chinese conglomerate stocks. An early sign of government discomfort with overseas spending was Anbang’s unsuccessful $14 billion bid for Starwood Hotels & Resorts Worldwide Inc. in 2016. Authorities expressed displeasure with the bold move, believing that Anbang had offered too much, according to a person with knowledge of the situation.

Anbang, which had appeared unstoppable in 2014 when it struck a $2 billion deal to buy the U.S. Waldorf Astoria hotel, fell deeper in trouble. This past June, special government investigators looking into economic crimes detained Anbang’s chairman, Wu Xiaohui, who hasn’t appeared in public since.

Separately, in the case of Wanda, regulators acted in the belief the company overpaid in efforts to expand beyond shopping centers and hotels and into entertainment, according to the people with knowledge of the action.

Its largest such acquisition was of Legendary Entertainment, the Hollywood producer and financier behind films including “Jurassic World” and “The Dark Knight.” Wanda spent $3.5 billion to buy Legendary in 2016; In Hollywood, industry insiders widely believed the company paid too much. Legendary said this week that it is well-capitalized, operating normally and able to fund its film and television productions.

As for HNA, recall that it was the stealthy buyer of Anthony Scaramucci"s SkyBridge Capital, another deal which will soon fall under tremendous scrutiny, and which could be unwound in the coming weeks if concerns about conflicts of interest emerge again, only this time not between the US and Russia - especially once the "Russia collusion" story is finally over - but the White House and Beijing.

China's Richest Man Forced To Sell World's Largest Indoor Ski Resort 2 Weeks After It Opened

The man who declared war on Disneyland just opened the world’s largest indoor ski resort. And now he’s being forced to sell it.

As the South China Morning Post reports, Wanda City, the $6 billion resort development built by China’s wealthiest tycoon Wang Jianlin, opened for business two weeks ago. The resort, which, at 1.6 square kilometres, is the world’s largest indoor ski park.

Now, it’s being sold along with the company’s other theme-park related holdings as Wanda Group seeks to pay down some of its enormous debt burden, which has recently attracted the scrutiny of Chinese authorities. The push into theme parks, part of the conglomerates debt-fueled global shopping spree involving several entertainment businesses, was partly an issue of national pride for Wang. When Disneyland Shanghai opened last year, drawing enormous crowds, Wang angrily declared “the frenzy of Mickey Mouse and Donald Duck and blindly following them is over,” according to the New York Times, and vowed that his theme parks would be even more successful.

The announcement of the deal triggered a bizarre reaction when shares of Wanda Hotel Development (0169.HK) - which is mostly responsible for development of property projects outside of China -and  which inexplicably surged more than 150% after news of the deal... even though none of the hotels being sold are included under this entity.  As shown in the chart below, shares of Wanda Hotel Development exploded higher, the most since April 2013, after the news that its parent was selling hotel assets to Sunac, yet assets which were completely unrelated to 0169.HK.

Located in the city of Harbin - near the country’s northern border with Russia - the resort features Russian architecture, a movie theater and a grand piano-shaped indoor ski resort that allows 3,000 people to ski or snowboard on six runs, all in an area covering 1.6 square kilometres. Up to 30,000 people will be hired to work in the resort, Wang said around the time of the opening. Harbin is also known for having China’s harshest winters.

“Harbin is known as the city of ice, which also happens to be the main theme of this resort, so we will together provide winter sports throughout the year,” Wang said.

According to the SCMP, skiing is gaining popularity in China, as the country prepares to host the 2022 winter Olympics in Zhangjiakou near Beijing.

The indoor ski slope isn’t exactly exotic in Harbin, where the winter season can last as long as six months, with the lowest temperature plummeting to minus 36 degrees Celsius. The city’s main tourist attraction is its annual ice festival, featuring life-size sculptures carved out of ice.

“This is a brand-new community that includes not only a theme park, but also a school, a hospital, housing and hotels,” said Andrew Kam, vice president of Wanda Cultural Industry Group, whom Wang hired from Hong Kong Disneyland. “There is nothing like this before.”

Wang had pumped nearly 40 billion yuan ($6 billion) into the Harbin resort, since opening a similar-size Wanda City in Nanchang city in southeastern China’s Jiangxi province in May last year.

Tickets to Wanda’s Harbin resort start from 68 yuan for a 2-hour tour of a snow castle for an adult, and as much as 488 yuan for unlimited use of the ski slope. By comparison, an adult ticket at Shanghai Disneyland costs start from 370 yuan during the low season and goes up to 499 yuan during the peak season.

Wanda agreed to sell its theme-park business on Monday as part of a $9.3 billion deal involving 76 hotels and a major chunk of 13 tourism projects. Wang sold the portfolio to Sun Hongbin’s Sunac China in a deal worth 63 billion yuan (US$9.3 billion). All the proceeds from the sale will be used to repay bank loans, Chinese media Caixin reported.

The sale comes after China’s banking regulator last month asked lenders to review loans made to big overseas deal makers, including Wanda, to assess whether their escalating debt posed a credit risk, the Wall Street Journal noted.

While no wrongdoing was indicated, the revelation sent the stock prices of Wanda-related companies falling, while the yield on its bonds shot up. Wanda was cited on June 22 by the China Banking Regulatory Commission for special attention, along with the country’s three other biggest overseas asset buyers Anbang Group, Fosun Group and the HNA Group. The four must pay the equivalent of $11.5 billion in debt service by the end of 2018.

Wanda said it’s disposing of assets to “fully exercise the competitive industrial advantage” with its buyer, but analysts, who already smell blood in the water, say the company may be buckling under the scrutiny of China’s banking regulator to pare back on debt.

“Wanda may be feeling the financial pressure, or it won’t need to sell off so many assets,” said Liu Feifan, a property analyst at Guotai Junan International. “Wanda may badly need funding to support its expansion, but can’t count on rental income.”

The company has confronted other failures earlier this year. Wanda had to abandon a $1 billion takeover of Dick Clark Production in March, after it failed to obtain regulatory approval to remit funds for the acquisition, incurring a $50 million breakup penalty. The company famously bought film-production studio Legendary Entertainment, which released the blockbuster “Jurassic Park III,” in early 2016, provoking fears among lawmakers that the company’s new Chinese owners would seek to influence how China is portrayed in US media.

The deal is the single largest property transaction in Chinese history. Sunac China, the seventh-largest Chinese developer, was founded by Shanxi tycoon Sun Hongbin, one of the country’s most acquisitive property developers. The deal also shows how quickly companies will respond to regulators’ concerns. It raises the question: Will this be China’s preferred strategy for deleveraging its corporate sector? An ad-hoc approach where regulators single out companies for criticism, then allow pressure from investors to work its magic?

"China Faces Its Comeuppance" - Kyle Bass Warns Of "Tectonic Shift" In US Relationship

Hayman Capital"s Kyle Bass ventured on to CNBC this morning to drop some painful truth bombs about Trump"s "drastically changed Chinese diplomacy" and China"s looming "come-uppance."

Bass began by highlighting what he calls a "tectonic shift" in US-China relations in the last few days, pointing to two crucial events...

1. Things changed drastically when US launched unilateral sanctions on China over North Korea...

"Xi is a control freak and he absolutely doesn"t appreciate the United States acting unilaterally"

2. Things escalated when Trump sold $1.4bn in weapons to Taiwan, angering Beijing more as Bass notes:

"Taiwan was the one area which Beijing has asked Trump to stay away from during his meeting at Mar-a-Lago."

"Since the death of Otto Warmbier, any chance of meetings with North Korea are now off.. and our diplomatic relationship with China took a major step for the worse yesterday."

Bass notes that "China is trying to make marginal changes in its balance of trade with US - buying beef once again and importing a lot more crude oil from the US."

But then Bass shifts to the potentially even more precarious situation under the hood of China"s economy. As Reuters reports, China"s leaders want the restructuring of their massive non-performing loans problem to address financial risks while avoiding big employee lay-offs, and have instigated "cure by committee"...

"The solution for zombie firms isn"t just bankruptcy," a Shandong-based banking official told Reuters. "The impact of bankruptcy is just too big. Just think about the thousands of workers. Social stability is key."

Stability is always uppermost in the minds of Chinese leaders, and even more so this year, ahead of the five-yearly party congress this autumn, when a new generation of senior leaders will be selected.

"China is avoiding the crisis of calling in loans that can"t be repaid anyway," said Paul Gillis, professor of accounting at Peking University"s Guanghua School of Management. "This buys time to do things in an orderly way."

But Bass makes the crucial point that there are over 12,800 credit committees in China right now - overseeing CNY 14.5 trillion in debt for equity swaps - which is 8% of China"s total non financial debt, and is over 3x the official NPL figure of 1.6%-1.9% of GDP.

His final blow to any hopes that this solution will work...

"This exceeds all the equity in the entire Chinese banking system."

However, Bass"s final warning of the endgame of this credit bubble is far more ominous, because all of the new-found economic confidence and military condidence is "based upon a massive credit expansion and they"re going to have a comeuppance..."

Stocks Of China's Serial Foreign Acquirors Crash Amid "Systemic Risk" Crackdown

Last February we described some of the "horror stories" of corporate leverage that emerged as a result of China"s unprecedented offshore M&A spree that emerged in 2015 and raged through most of 2016: after all, with over $100 billion in foreign acquisitions, the bulk of the funding would inevitably come from debt. These were some of the examples we highlighted:

• Take Zoomlion, a lossmaking Chinese machinery company that is partially state-owned: its total debt stands at 83 times its EBITDA. "Zoomlion’s bid is a desperate attempt to remain relevant,” said Mr Pillay.


• Or how about Fosun, a serial Chinese acquirer that spent $6.5bn on stakes in 18 overseas companies during a six-month period last year, had a a 55.7x total debt/EBITDA in June 2015. "Fosun has bought brand names such as Club Med and Cirque du Soleil as well as a host of other assets including the German private bank Hauck & Aufhaeser."


• Or maybe the highly publicized purchase of China Cosco Holdings of the Greek Piraeus Port Authority for €368.5m. Cosco has promised to invest €500m in the Greek port despite having total debt at 41.5x its EBITDA!


• Or Cofco Corporation, which recently reached an agreement with Noble Group under which its subsidiary, Cofco International, would acquire a stake in Noble Agri for $750m (in the process preventing the insolvency of the biggest Asian commodities trader), has total debt equivalent to 52 times its EBITDA!


• Or how about Bright Food, which bought the breakfast group Weetabix for $1.2bn last year, and has total debt at 24 times EBITDA!

The visual summary was far more stunning, and showed some Chinese foreign acquirers ompanies had levered up as much as 83x.

As we summarized, "what is going on in China"s massively overlevered corporate sector, is that virtually every company has become one massive "rollup" a la Valeant, hoping to deflect investors" and analysts attention from their deplorable credit metrics by engaging in a scramble of global M&A at any price, just to buy 1-2 more quarters of silence from skeptics, even as leverage continues to build at multiple turns of EBITDA every single quarter."

The offshore merger spree did not last long: following a recent crackdown by Beijing on offshore (debt-funded) M&A, China"s foreign acquisition spree came to a screeching halt earlier this year, when virtually no new Chinese deals have been announced.

And now comes the hangover, because overnight China"s regulator finally started a crackdown on the debt-funded mess that emerged in China as a result of this spree.

It started with a report in China"s Caixin, which said that the China Banking Regulatory Commission has expressed concerns about "systemic risks" at some big companies, which just happen to be China"s most prolific overseas acquirers, and has asked banks to report their exposures to the companies after last year’s unprecedented outbound takeover spree.

Warning companies can transmit risks to upstream and downstream industries and banks, the CBRC added that it will closely track risks when problems occur in big companies. More to the point, the CBRC ordered checks on HNA, Dalian Wanda, Fosun and other prominent foreign buyers and asked banks in mid-June to conduct risk analysis and check loans made to these companies.

As Bloomberg adds, the regulator asked some banks to provide information on overseas loans made to Dalian Wanda Group Co., Anbang Insurance Group Co., HNA Group Co., Fosun International Inc. and the owner of Italian soccer team AC Milan. "The inquiries, which come a week after reports of an investigation into Anbang’s chairman, are likely to put a further chill on China’s outbound takeovers after tighter capital controls cut deal activity this year by 56 percent from the same period in 2016. 

Why the crackdown now? By targeting some of the country’s most powerful tycoons, Xi Jinping’s government may be sending a signal of its commitment to cleaning up the financial system before a key Communist Party leadership reshuffle later this year, according to Bloomberg.

“We are now in an environment where preventing financial risks is lifted as the top priority, so I think the regulators are trying to gauge the total exposure,” said Wei Hou, a Hong Kong-based analyst at Sanford C. Bernstein. “Regulators must have seen some red flags.”

The market reaction was prompt, and led to the negative close of the Shanghai Composite noted earlier, despite the solid green start in Chinese trading: as news of the CBRC’s request spread through China’s financial markets on Thursday, shares of companies linked to Wanda and Fosun tumbled and the Shanghai Composite Index erased an early gain. The turbulence came less than 36 hours after MSCI Inc. said China’s domestic equities would join its benchmark indexes, a stark reminder for international money managers of the risks in a market where opaque regulatory decisions are commonplace.

The market impact was swift as shares of billionaire Guo Guangchang’s Fosun and various related companies tumbled in Hong Kong, in line with the plunge of Wanda shares. Fosun fell as much as 9.6%, while Fosun Pharmaceutical Group dropped as much as 7.8%.

The sudden drop dragged down the entire Chinese market.

When asked by Bloomberg to comment on their sharp stock price declines all the named companies denied they had any idea what was going on: Fosun spokesman Chen Bo said “all is normal” at the company, representatives at Anbang and Wanda declined to comment, while HNA didn’t immediately comment. A representative for AC Milan’s owner didn’t return calls seeking comment.

The regulator, however, provided some additional details: Zhiqing Liu, a deputy director at the CBRC, said "we are generally concerned with systemic risks posed by big firms."

The CBRC required banks to provide information on loans related to the five companies’ overseas investments, especially in property, cinemas, hotels, entertainment businesses and sports clubs, people familiar with the matter said. Banks need to submit their assessment of potential risks for such investments and any measures they have in place to deal with risks, the people said.

We have previously profiled the extensive acquisitions undertaken by Chinese companies, but here as a reminder, is the case study of HNA, an "acquisition airline group" as the FT puts it.

HNA has announced more than $30 billion of asset purchases since last year, according to data compiled by Bloomberg, ranging from from stakes in hotel operator Hilton Worldwide Holdings Inc. to asset manager SkyBridge Capital and Deutsche Bank AG.

Wanda has spent more than $10 billion, including the purchase of Hollywood film producer Legendary Entertainment, since 2016.

Fosun, which owns stakes in Club Med and Cirque du Soleil Inc., has also been pursuing billions of dollars of assets overseas.

Anbang’s international holdings include New York’s Waldorf Astoria hotel.

Among the more notable acquisitions by these Chinese companies were AC Milan, Club Med, the Wolverhampton Wanderers Football club, Cirque du Soleil, and real estate in NYC, London, and Sydney, but that period of wanton foreign purchases, many of which led to what was dubbed the "Chinese M&A premium", is now over.

To be sure, as a result of last year"s crackdown on capital outflows, today"s move was largely expected: as Bloomberg points out, "Chinese policy makers have already made it more difficult for acquirers to move money overseas as the government tries to stem capital outflows and prop up the yuan. The curbs have contributed to a spate of canceled deals, including the $1 billion purchase of Dick Clark Productions Inc. by billionaire Wang Jianlin’s Wanda. This year’s drop in announced deals is the biggest for a comparable period since the depths of the global financial crisis in 2009, according to data compiled by Bloomberg."

Meanwhile, the focus on banks’ exposures to foreign acquisitions comes against a backdrop of tightening financial conditions in China and a regulatory crackdown on risky behavior by banks, shadow-lending institutions and insurers, as well as the detention of the chairman of one of China"s most aggressive foreign acquirors: Anbang.

As reported last week, Anbang’s Chairman Wu Xiaohui was detained as part of a probe that includes looking into the sources of funding for Anbang’s overseas acquisitions, possible market manipulation, and “economic crimes." Anbang said last week that Wu was unable to perform his duties for personal reasons.

* * *

Meanwhile, going back to the Chinese stock market which just two days ago was added to the MSCI EM index, the Beijing intervention showed just why anyone rushing to invest in China may want to think twice. “I don’t think it’s the right time to invest or buy into these companies,” said Alex Wong, director at Ample Capital in Hong Kong. “Sometimes this kind of event can accelerate very quickly.”

And while the latest Chinese crackdown is bad news for local stocks, it is good news for US equities where the Chinese potential "merger premium" can now be eliminated, resulting in a fractionally more rational market. As for how far Beijing"s attempt to "normalize" its corporate sector will reach, and whether it will lead to even more deflationary outflows from the mainland, jury selection has only just started.

Carson Block Says "Laws Of Economics" Dictate China Will Face "Day Of Reckoning"

Muddy Waters Research founder Carson Block believes that China’s overleveraged economy will eventually face a “day of reckoning.” He just can’t say when.

During an interview with Bloomberg’s Erik Schatzker, Block, who made his name betting against shady Chinese companies trading in the US, explains how the Chinese government’s massive stimulus has led to a potentially destabilizing explosion of corporate-debt growth in the world’s second-largest economy – and why the Communist Party won’t be able to contain the fallout once its twin bubbles -asset and credit - finally burst.

“I’ve felt for many years that it’s a giant asset and credit bubble. Under the old orthodoxy, that couldn’t be sustained for long, but if you look around the world, the ECB and the Fed are helping to sustain frothy asset values. Japan hasn’t made sense for a while.”

“Ultimately there will be a day of reckoning, I know that. I just can’t say if it’ll be two months, two years or 20 years.”

But even though traders who bet against the Chinese yuan last year made a tidy profit, Block believes betting against the Hang Seng Index isn"t the best option for shorting China because the impact of PBOC intervention is too unpredictable on a macro scale. Betting against the Chinese stock market in aggregate could end up being a “widow maker” play like shorting Japanese government bonds was for several years. 

Instead, investors should bet against individual firms or sectors – a less-risky option, in Block’s view.

“If you start with the macro thesis and say there are a lot of credit problems in China then start looking at industries that might be canaries in the coal mine or companies that might be canaries in the coal mine, then you might get it right.”

However, speculators should be mindful of a trait common among Chinese companies: There are many that somehow manage to keep going even though the financials suggest that they’re doomed. Understanding which companies have the guanxi – a Chinese term meaning business and political connections – to enable them to continue operating, and which companies don’t, is the most challenging aspect of betting against Chinese firms, Block asserts.

But what about the bull case for China? The argument that the Chinese government will be able to pull off a “soft landing” while successfully transitioning from a manufacturing powered to a services-powered economy is predicated on the view that Xi Jinping and the Communist Party exercise absolute control over the economy, and have near-unlimited resources to help them thwart an economic collapse.

Block says this assumption, common among westerners, is an example of “cognitive dissonance” often applied to the PBOC. Even though many westerners believe it to be true, China’s central bank isn’t some all-powerful monolith, Block contends.

“These guys are no more capable than our policy makers in the US have been. The US government has the most power in the world to avert a major economic catastrophe.”

Speaking of the crash of 2008…

“If [the Fed and Congress] weren’t able to prevent it, it’s because the laws of economics, the physics of economics eventually catch up.”

“I’m willing to bet that these guys can’t escape the laws of economics in perpetuity.”

The PBOC’s April decision to deleverage unleashed turmoil in the country’s financial markets, causing Chinese stock and bond markets to erase hundreds of billions of dollars in value.

Beijing announced Friday morning that it has moved the goal posts once again and introduced a new “counter-cyclical factor” to its mechanism for managing the yuan’s exchange rate with the dollar - an effort to curb volatility. The move sent the yuan to three-month highs, but traders are still unclear about how this new mechanism works and what exactly was changed.

The Chinese yield curve experienced a “double inversion” this week when three year yields eclipsed five year yields and seven year yields eclipsed 10-year yields. At the same time, rising base funding costs and interbank credit risk concerns have pushed banks" cost of borrowing beyond the rate they charge customers for loans for the first time in history. The one-year Shanghai Interbank Offered Rate has exceeded the Loan Prime Rate, the first time this has happened since the latter was introduced in 2013.X

Meanwhile, China"s total debt-to-GDP has reached all-time highs.

Moody’s Investors Service sent offshore yuan tumbling earlier this week after it downgraded China’s credit rating to A1 from Aa3, saying that the outlook for the country’s financial strength will worsen, with debt rising and economic growth slowing. This leaves the world"s hoped-for reflation engine rated below Estonia, Qatar, and South Korea and on par with Slovakia and Japan.

China Resorts To “Old School” Tactics To Support Inflows

Submitted by Gordon Johnson of Axiom

Is the PBoC “Tweaking” the FX Reserve Data to Improperly Show Foreign Inflows?

Over the past 30 months when the PBoC sold/brought dollars (evidenced by a m/m decline in PBoC funds outstanding for FX), 66.7% of the time reported FX reserves fell/rose.

Yet, in each of the past three months this year when data is available (Jan./Feb./Mar.), this trend has not held up. In fact, in Feb., despite the PBoC selling $6.26bn worth of dollars, which implies FX reserves should have fallen by a similar amount, reported FX reserves by the PBoC actually gained $6.92bn; and in Mar., despite $15.85bn in dollars sold, the PBoC reported FX reserves gained $3.97bn (thus, painting a “rosy” picture of foreign capital flowing into the country).

So how is this possible?

Well, the likely explanation centers on the PBoC likely rolling (i.e., selling) a number of dated long-term US treasury bills that were comfortably in the money, allowing for profits which were subsequently used to “pad” the FX reserve balance figure.

Why would the PBoC do this? In short, it makes it look as if money is actually flowing back into China, potentially encouraging those thinking of offshoring capital to keep the money inside China.

China 'Shadow Banks' Crushed As Liquidity Costs Hit Record High

During the so-called Chinese Banking Liquidity Crisis of 2013, the relative cost of funds for non-bank institutions spiked to 100bps. So, the fact that the "shadow banking" liquidity premium has exploded to almost 250 points - by far a record - in the last few days should indicate just how stressed Chinese money markets are.

While interbank borrowing rates have climbed across the board, the surge has been unusually steep for non-bank institutions, including securities companies and investment firms. They’re now paying what amounts to a record premium for short-term funds relative to large Chinese banks, according to data compiled by Bloomberg.

The premium is reflected in the gap between China’s seven-day repurchase rate fixing and the weighted average rate, which, by Bloomberg notes, widened to as much as 2.47 percentage points on Wednesday after some small lenders were said to miss payments in the interbank market. Non-bank borrowers tend to have a greater influence on the fixing, while large banks have more sway over the weighted average.

"It’s more expensive and difficult for non-bank financial institutions to get funding in the market," said Becky Liu, Hong Kong-based head of China macro strategy at Standard Chartered Plc. “Bigger lenders who have access to regulatory funding are not lending much of the money out.”

Without access to deposits or central bank liquidity facilities, many of China’s non-bank institutions must rely on volatile money markets. As Bloomberg points out, The People’s Bank of China has been guiding those rates higher in recent months to encourage a reduction of leverage, while also stepping in at times to prevent a liquidity crunch.

The PBOC responded to this week’s jump in borrowing costs by making an unscheduled injection of hundreds of billions of yuan on Tuesday, and it followed that with another addition of cash through daily open-market operations on Wednesday.

"The PBOC is allowing smaller lenders to miss payments in order to force financial institutions to de-leverage," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore.

"But it will keep a fine balance. It doesn’t want the pressures to become out of control. There’s a possibility that the PBOC will directly inject funds in smaller banks, if the cash shortage continues.”

As Goldman noted, the rate surge reflects a combination of:

• A tightening bias by the PBOC. The central bank has shifted policy stance since autumn last year, but the clearer interbank rate rise in recent days suggests that the hawkish bias has stepped up further.


• Diminished clarity of the role of interbank rates in the PBOC’s policy framework. Since mid-2015, interbank rates had been kept largely steady, partly reflecting the PBOC’s efforts to build up a policy rate framework centering on interbank rates. The PBOC has also introduced SLF (standing lending facility), which is understood as a tool to keep volatility in interbank funding conditions low. However, in a signal that deviates from these previous efforts, the PBOC last Thursday tried to dissociate interbank rates from “policy rates”, which the PBOC said should mean benchmark bank lending and deposits rates. The comment appeared to open up a bigger scope for the PBOC to allow interbank rates to move higher (with the possible intention to avoid conflict with its official “stable and neutral” policy stance or potential pushback from other policy authorities).


• The SLF mechanism appears to have not functioned effectively in recent days. There have been occasional breaches of the general 7-day repo rate above the SLF rate (3.35% per PBOC’s official communication, although it was reportedly raised to 3.45% last week). This suggests that SLF has not effectively fulfilled its supposed function of imposing a ceiling to interbank rates. One possible reason is that SLF is accessible only by banks, and much of the spikes of the general 7-day repo rate have been a result of liquidity scramble by NBFIs (which have no SLF access), while banks" interbank funding cost (as measured by DR007; Exhibit 1) has remained more moderate and still below the SLF rate (note that the 7-day repo fixing rate is partly based on funding cost of NBFIs as well). Nevertheless, the apparent lack of effectiveness of SLF in suppressing interbank rate volatility might have weakened the anchoring of the market’s rate expectations in the near term, and such uncertainty could have compounded the liquidity squeeze.


• Continued high interbank repo borrowing by funds. The wide gap of R007-DR007 reflects continued stress imposed by NBFIs, likely particularly funds, on the funding market. Indeed, as of end-Feb, interbank repo borrowing by funds remained high at over 30% of the interbank repo borrowing (Exhibit 2) despite the increased pressure on the commercial viability of repo trades (borrowing via interbank repo to finance long-dated bond holdings).


• Regulatory impact. The PBOC has tightened the prudential requirements (particularly on the growth of banks" balance sheet) under its MPA examination, which is to be conducted at quarter-end. This has likely further contributed to, and amplified the impact of, a tightening in the interbank market.

In total, the interbank rate volatility may remain quite high in the coming days, especially in light of the near-term consideration of MPA examination at quarter-end and the PBOC"s apparent deviation from the previous monetary policy framework. Alternatively, today"s plunge in the dollar may have had a secondary purpose of easing Chinese financial conditions, where the ongoing dollar rally has pushed the local financial sector to the brink of illiquid collapse.

China Central Bank Admits It Has A Debt Problem, Warns No Easy Solution

It"s a well-known risk, perhaps the biggest to the global financial system: China"s debt is too high, with estimates ranging from 250% to 300% of GDP per the IIF:

And while China has largely ignored, or avoided, discussing the troubling implications of its unprecedented debt load, this changed today when the head of China"s central bank, Zhou Xiachuan finally admitted that it has a debt "problem" saying that corporate debt levels are too high and that "it will take time to bring them down to more manageable levels", underlining what has become the defining battle to put the world"s second-largest economy on a more sustainable footing: keeping GDP growing at 6.5% (or above) while injecting trillions in new debt.

"Non-financial corporate leverage is too high," PBOC Governor Zhou Xiaochuan told reporters at a news conference on the sidelines of the annual parliament session.

Quoted by Reuters, he said that efforts will be made to contain debt levels, including restructuring of firms with heavy debt burdens, alongside a push to reduce excess industrial capacity.  Furthermore, banks will withdraw support for financially unviable firms, he added, repeating pledges by other officials last year to drive such "zombie" firms out of the market.

"I personally think this process is relatively medium-term. It won"t have very obvious results in the short-term because the existing stock (of debt) is very large," he said.

Zhou Xiaochuan, Governor of the People"s Bank of China, attends a news
conference in Beijing China March 10, 2017. REUTERS/Jason Lee

Zhou also said that measures by local governments to cool rising house prices will slow mortgage growth to some degree, but housing loans will continue to grow at a relatively rapid pace. We profiled China"s mortgage debt problem last October when we showed that over 70% of all new loans went to fund mortgages, which in turn now account for a fifth of total Chinese outstanding loans.

According to official data, China"s debt-to-GDP has risen to 277%, up nearly 25% since the end of 2016 when it was 254%, with an increasing share of new credit being used to pay debt servicing costs, UBS analysts said in a note. In other words, China now finds itself in the "ponzi financing" stage of its debt lifecycle, with a "Minsky Moment" approaching fast. 

China"s credit growth has been "very fast" by global standards, and without a comprehensive strategy to tackle the overhang, there is a growing risk it will have a banking crisis or sharply slower growth or both, the IMF warned late last year.

While China"s leaders have pledged to contain debt and housing risks in 2017 after years of credit-fueled expansion, which has been propelled by the need to meet official economic growth targets, this has proven to be problematic with expectations that China will have to issue over $3 trillion in debt in the coming year, and as a result most analysts remain doubtful over the government"s commitment to follow through on potentially painful reforms, especially if growth falters.

Despite his dour admission, according to Reuters Zhou, who took control of the PBOC in 2002 and is the under the radar architect of China"s financial reforms, was seeimingly in a very good mood, smiling and engaging with the deputy governors beside him as well as news journalists throughout  the news conference. 

China"s corporate debt has soared to 169 percent of gross domestic product (GDP), according to figures from the Bank for International Settlements. China needs to first stabilize its overall debt levels before gradually reducing them, deputy central bank governor Yi Gang said at the same briefing.

* * *

Perhaps more troubling to China"s liquidity addicts, Zhou said that the central bank"s tilting towards a neutral stance would help with China"s supply-side reforms, reiterating that it would be "prudent" while reminding markets that the central bank has many policy tools at its disposal. In recent months, the PBOC has cautiously moved to a modest tightening bias in a bid to cool explosive growth in debt and discourage speculative activity, though it is treading cautiously to avoid hurting economic growth. It surprised financial markets by raising short-term interest rates in January and February by marginal amounts, and is expected to bump them higher in coming months, though an increase in its benchmark policy lending rate is seen as unlikely this year.

Over the weekend, Beijing set a more modest economic growth target of "around 6.5%" this year, easing from last year"s 6.5-7 percent range, ostensibly to give policymakers more room to focus on financial risks. The economy ultimately expanded 6.7 percent last year, but much of the growth came from record lending by state banks and higher government spending on infrastructure, which has helped revived the long ailing and heavily indebted industrial sector.

Still, despite promises of deleveraging, Beijing"s trajectory remains much of the same: bank lending in January was the highest on record and it did not slow as much as expected in February.

"If there is too much money in the economy, in fact it is very harmful to the economy as it might lead to problems such as higher inflation and asset price bubbles," Zhou said.

While admission of the problem is a key first step, few have any faith that China will take the necessary, and very painful, next steps to remove the debt froth that has kept not only China, but the global growth dynamo turning, especially now that the global credit impulse, as UBS demonstrated two weeks ago, has tumbled and is on the verge of turning negative.

Our global credit impulse (covering 77% of global GDP) has suddenly collapsed: as the chart below shows the "global" credit impulse over the last 18 months is essentially mainly China (the green shaded bit), which even now is still creating new credit at an annualized rate of around 30pp of (Chinese) GDP. But the credit impulse is the "change in the change" in credit and even the Chinese banks could not sustain the recent extraordinary pace of credit acceleration. As a result: whereas back in Jan "16 the global credit impulse was positive to the tune of 3.8% of global GDP (of which China comprised 3.5% of global GDP) it has now fallen back to -0.1% of global GDP (China"s contribution is -0.3% of global GDP).

Should the impulse turn negative outright, the transition would have dire implications for the global growth, and reflation, cycle.

China Just Created A Record $540 Billion In Debt In One Month

One week ago, Deutsche Bank analysts warned that the global economic boom is about to end for one reason that has nothing to do with Trump, and everything to do with China"s relentless debt injections. As DB"s Oliver Harvey said, "attention has focused on President Trump, but developments on the other side of the world may prove more important. At the beginning of 2016, China embarked on its latest fiscal stimulus funded from local government land sales and a booming property market. The Chinese business cycle troughed shortly thereafter and has accelerated rapidly since."

DB then showed a chart of leading indicators according to which following a blistering surge in credit creation by Beijing, the economy was on the verge of another slowdown: "That makes last week’s softer-than-expected official and Caixin PMIs a concern. Land sales, which have led ‘live’ indicators of Chinese growth such as railway freight volumes by around 6 months, have already tailed off significantly. " 

As DB concluded, "If China starts to slow again, the current risk-friendly environment has a short sell-by-date, particularly given rising oil prices and our view that any Trump stimulus will take at least a few quarters to work its way into US growth."

Yes... but not yet, because as China reported overnight, in January Beijing injected the greatest amount of aggregate monthly credit, between bank and shadow loans, i.e., Total Social Financing, on record, amounting to an all time high $540 billion.

While China injected Rmb 2,030 billion in new loans, slighlty below consensus estimates of 2,440bn - still the second highest number on record - it was the surge in TSF that stunned China watchers: in total, China added a record Rmb3,740 bn in aggregative financing last month, far greater than consensus expectations of Rmb3,000 bn, and more than double the December total of  Rmb1,626 bn. The implied month-on-month growth was 15.1% SA ann mom, up from 12.8% in December. (There was no issuance of local government bonds in January compared with Rmb102.3 bn of issuance in December according to WIND data.) According to the PBOC, TSF stock growth (not adjusting for local government bond issuance) was 12.8% yoy in January.

With loans coming below expectations, and total aggregate credit trouncing consensus, this means that in January, contrary to stated intentions to tighten and delever its shadow banking system, China unleashed the biggest shadow debt expansion on record, driven mostly by undiscounted bankers acceptances, as well as growth in both Trust and Entrusted Loans.

Some observations: although new loans at the beginning of the year tend to be seasonally high, in this January, the PBOC had been aggressive in keeping new RMB loans under check, on the back of inflationary pressures, rising leverage and solid activity growth. PBOC adopted a combination of measures including administrative intervention and market approaches such as raising the Open Market Operations rate. New RMB loans in January were, as a result, lower than market expectation, and its growth rate moderated slightly on sequential basis.

On the other hand, Total social financing surprised drastically on the, mainly due to the following reasons:

1. substitution effect - because there was no local government bond net issuance and new RMB loan extensions were strictly monitored by the PBOC, commercial banks shifted to alternative credit channels such as bank acceptance bills (+Rmb613 bn in January vs. +Rmb159 bn in December last year) and trust loans (Rmb318bn in January vs. Rmb164 bn in December);


2. lower real interest rates and better corporate profitability in 2016 compared with 2015, which raised credit demand.

More importantly, this surge in credit has also resulted in a major credit impulse not only in China, but also around the globe, resulting in the latest inflationary push higher, and also leading to better than expected economic data as the impact of China"s credit generosity entered the global economy. It also means that the inflection point envisioned by DB may not be here just yet.

In other monetary aggregate data, China reported that broad money growth accelerated slightly from December on a sequential basis. The drag from fiscal deposit change mostly dissipated (fiscal deposits increased by Rmb412.4 bn, lower than the increase in January 2016 and 2015). FX outflows have probably remained large in January, which would dampen M2 growth.

As Goldman notes, "January money and credit data highlights the difficulties facing the PBOC. It is increasingly difficult to control broad liquidity supply to the economy amid an increasingly sophisticated financial market."

Curiously, according to Goldman this latest record credit push may be the last hurrah:

"we see rising pressures for the monetary authorities to raise funding costs, even though we expect the central bank will be likely to continue with its stringent window guidance. Stronger sequential broad credit (adjusted TSF stock) growth tends to be supportive of short-term activity growth. We see rising upside risks to our forecast of meaningfully weaker sequential growth in 1Q, although qualitatively speaking, 1Q sequential activity growth is still likely to be weaker than it was in late 2016."

Finally, the latest confirmation that Deutsche Bank may indeed be right following the record January credit expansion, comes from Moodys, which wrote that "a combination of tighter liquidity and stricter regulatory scrutiny on commercial lenders’ off-balance sheet activities will dampen fast-growing shadow banking activity in China, Broad shadow banking assets, including entrusted loans, financing through trust companies, undiscounted bankers’ acceptances, and wealth management products (WMPs) reached 58 trillion yuan ($8.42 trillion) in the first half of 2016, equivalent to 82% of gross domestic product, according to Moody"s. As Caixin redundantly adds, "the shadow banking business is still growing." The Industrial and Commercial Bank of China (ICBC), the world’s largest bank by total assets, plans to issue additional WMPs worth 250 billion yuan in the first quarter of 2017, said employees of the state-owned lender. At the start of this year, ICBC managed 1.68 trillion yuan through WMPs.

While big banks are net fund suppliers in the interbank market, small and midsize banks, securities firms, and other financial institutions are net borrowers, the Moody’s report said. It pointed out that smaller banks rely heavily on wholesale funding, including aggressive issuance of certificates of deposit, and the purchase of WMPs in the interbank market as a way to boost profits amid declining net interest margins.

“Small and midsize banks are active investors in shadow banking products, including other banks’ WMPs, the trus and asset management plans of non-bank financial institutions,” the Moody’s report said. A growing reliance on wholesale funding exposes smaller banks to possible liquidity shocks caused by the withdrawal of funds by other financial institutions, especially when demand for cash increases at the end of the year or if default scandals occur, which in turn prompts the smaller banks to call back their own funds.

The growth of shadow banking may slow as regulation becomes more stringent, which mainly targets off-balance sheet WMPs, said Xu Jing, an assistant analyst with Moody’s Investor Service. In December, China’s central bank confirmed that it would include banks’ off-balance sheet WMP business in the Macro Prudential Assessment framework, a system to monitor commercial lenders’ credit exposure.

Following the record January expansion, China will have no choice but to take action if it hopes to have its "tightening" actions be taken seriously by the market and the global financial community.