Doug Noland: State-Directed Credit Splurge

New data released Friday confirm ongoing historic Chinese Credit excess.

Total Aggregate Financing increased (a ridiculous) $524 billion during August to $40.5 TN, doubling July’s growth and exceeding estimates by almost 40%. It was the strongest monthly gain since March’s record $759 billion. This pushed y-t-d (8-month) growth to $3.828 TN, up 45% from comparable 2019 ($2.650 TN) and 67% ahead of comparable 2018 ($2.297 TN) growth. It’s worth noting Aggregate Financing surged an incredible $2.960 TN over the past six months, 62% ahead of comparable 2019 ($1.823 TN). At 13.3%, year-over-year growth was the strongest in several years.

With 2020 GDP estimates in the 2.0 to 3.0% range, the divergence between Chinese Credit and economic output is unprecedented. That Credit growth has accelerated in the face of rapidly deteriorating economic prospects portends major troubles ahead. China’s “Terminal Phase” excess – including rapid acceleration of late-cycle loans of deteriorating quality – is unparalleled in terms of both degree and duration. Stoking a stock market mania while prolonging a historic apartment Bubble only exacerbates systemic fragility.

August New Bank Loans increased an above forecast $187 billion. This boosted y-t-d loan growth to $2.102 TN, 20% ahead of comparable 2019. Six-month growth ($1.481 TN) was 29% above comparable 2019. Bank Loans were up 13.0% over the past year, 27% in two years, and 84% over five years.

Consumer Loans rose $123 billion during August. Year-to-date growth of $755 billion was 4.7% ahead of comparable 2019. However, six-month Consumer Loan growth of $722 billion was 23% ahead of comparable 2019. Consumer Loans were up 14.5% year-over-year, 33% over two years, 58% in three and 135% over five years.

Corporate Bonds expanded $53 billion. This pushed year-to-date growth to $580 billion, up 80% from 2019 and 133% from comparable 2018 growth.

But the August winner of the Chinese Credit Sweepstakes goes to government finance. Government Bonds jumped $202 billion during the month to $6.362 TN, the largest monthly increase in a data series going back to 2017. At $837 billion, year-to-date growth was 59% ahead of comparable 2019. Government Bonds increased 18.7% over the past year, 38% in two and 66% over three years (5-yr data not available).

China’s M2 “money” supply expanded $166 billion in August, following July’s $139 billion contraction. This put year-to-date M2 growth at $2.200 TN, 38% ahead of comparable 2019 ($1.592 TN). M2 surged $2.947 TN, or 10.4%, over the past year. M2 rose 20% over two years, 30% in three, and 58% over five years – in one of history’s most spectacular monetary inflations.

The narrative surrounding Chinese economic recovery has turned decidedly positive. This week’s data confirmed a rapid recovery in Chinese exports and vehicle sales. Apartment sales have also rebounded. It would be impressive if not for the State-Directed Credit Splurge. I have no doubt that Beijing can orchestrate economic growth through a massive expansion of “money” and Credit. But this comes with increasing costs to system stability. I would argue late-cycle “Terminal Phase” excess inflicts especially heavy damage.

Over time, a prominent geopolitical element to the global Bubble developed – a dynamic that has turned acute late in this historic cycle. In this intensifying U.S./China cold war clash over global supremacy, a bursting Bubble would put one of these adversaries at serious disadvantage. It’s not clear this plays a role in Federal Reserve policymaking. It surely does in Beijing.

I have for years fretted China might resort to military conflict to divert attention from failing in its management of domestic economic and financial systems. Even if domestic issues don’t create impetus to confront nefarious foreign adversaries, a faltering global Bubble backdrop nonetheless ensures myriad grievances and frictions. Moreover, the longer the Chinese and global Bubbles inflate, the greater the risk that China’s economic, financial and military ascendancy gives rise to U.S./China hostilities. Taiwan has always seemed a logical flash point.

September 9 – Reuters (David Brunnstrom, Humeyra Pamuk and Ryan Woo): “Taiwan denounced China… over large-scale air and naval drills off its southwestern coast which it called a serious provocation and a threat to international air traffic. Yeh Kuo-hui, from Taiwan’s defence ministry’s operations and planning department, told a hastily-arranged news conference that China’s intentions could not be predicted. ‘We must make all preparations for war readiness,’ Yeh said…”

A China move to reclaim Taiwan territory – entangling Washington in a confrontation with Beijing – should no longer be considered wackoism. A Thursday afternoon Zerohedge headline asked a pertinent question: “What Possible Disruption Is Coming That Requires China To Start Massive Stockpiling Of All Possible Commodities?”

The Shanghai Composite dropped 2.8% this week, trading to the lows since July. China’s growth-oriented ChiNext Index sank 7.2%, trading Friday at two-month lows. The CSI Small & Midcap 700 dropped 4.7%. It appears Chinese stocks have reversed course – the downside following July’s speculative melt-up.

Oddly, European stocks were this week’s outperformers. On Brexit concerns currency weakness (pound down 3.6%), the UK’s FTSE Index surged 4.0%. Germany’s DAX jumped 2.8%, Italy’s MIB 2.2%, and France’s CAC40 1.4%.

Here in the U.S., technology stocks faced heavy selling pressure. The Nasdaq100 (NDX) sank 4.6%, with the Semiconductors down 3.5%. The S&P500 declined 2.5%. Curiously, Bank stocks fell 3.6%, with the Broker/Dealers sinking 4.1%.

At this point, corporate Credit remains resilient. Investment-grade corporate bond prices traded somewhat higher on the week, with junk bonds little changed. High-yield Credit default swap (CDS) prices actually declined this week. Investment-grade CDS increased a few basis points to one-month highs. Despite equity market weakness, the VIX traded down almost four to 26.87. NDX volatility (VXN) dropped to 35.27 from last Friday’s 41.74 close.

Markets are traditionally a reflection of the social mood. These days, they’re more a representation of the mood of central bankers. If our monetary authorities are nervous, markets are prone to exuberance. When a somber social mood strikes fear in the central bank community, markets can turn downright manic.

The disparity between ebullient markets and disheartened social mood grows by the week. It was a tough week for the social mood of Americans living on the West Coast – Oregonians in particular. In only four days, Oregon lost over a million acres to forest fires. There was terrible loss of life and property. Pristine nature up in flames.

Long before Portland protests and mayhem, Oregonians were known for their cordiality and tolerance. It was in my adult life, residing in numerous states, when I better appreciated that folks from Oregon were generally happy and nice people. I’ve thought a lot about why this might be the case. The state generally doesn’t suffer from huge wealth disparities. You can live a good life on an average worker’s wages.

For many of us, we’re more than content watching our beloved Oregon Ducks play football, strolling on the beach, and partaking in myriad recreational activities in the mountains. First, Covid-19 eradicated our football season. The Ducks and Ohio State Buckeyes were to go head-to-head at Autzen Stadium tomorrow. We’ve been managing through the despair, but at least we still have all our nature pursuits. Until Monday night.

I’ve been in love with the McKenzie River since I was a kid. When we decided to move our young son to Oregon, I initially thought of looking for property “up the McKenzie”. The hiking, biking, camping, fishing, rafting – the pristine river, spectacular waterfalls and awesome mountains. The Simple Things in Life. Peace and Tranquility. In our nightly family prayer, we thank God for “the beautiful lakes, rivers and waterfalls.”

Since Monday night, the “Holiday Farm Fire” has consumed almost 200,000 acres. The community is absolutely heartbroken. We lost something precious. Please know that climate change is real – and it is leaving increasingly deep scars on the environment and humanity.

Original Post 12 September 2020


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Categories: Doug Noland, Perspectives