Just How Indebted are Chinese Companies?

Despite the focus on Chinese banks and local governments, it is important to note just how stressed the entire corporate sector is in China.  Additionally, Chinese firms are turning to real tricks to keep from collapsing.  Let me give you a couple of examples.

Ever heard of a perpetual bond?  There are many ways to structure a perpetual bond, but it basically is a debt that is never repaid but receives a yearly interest payment.  Companies are interested in issuing perpetual bonds because it a hybrid with some of the characteristics of debt in that it requires a fixed yearly payment and some characteristics of equity, given certain structuring factors, such as a continual use of capital.  The primary reason companies are interested in issuing perpetual bonds is this: in international capital markets, perpetual bonds can in some cases be treated for financial purposes as equity.  One enterprising Chinese company has seen the opportunity to lower its debt to equity ratio by converting some of its outstanding bonds to perpetual bonds.  Given an average debt to equity ratio for non-financial Chinese companies above 100%, don’t be surprised if other Chinese companies start exploring the perpetual bond or unique ways to lower their debt burden.

Probably the best example of Chinese public-private financial gluttony is the steel industry.  Just how obscene is the credit orgy in steel?  According to this article citing the Beijing Economic Observer, steel companies made “2.2 billion yuan (US$356.7 million)” in profits but had “3 trillion yuan (US$486.4 billion) in total liabilities as of June”.  Let me put that in perspective.  If you borrowed the same amount of money and put the money in a savings account earning 2% annually, over the same amount of time you would have earned $4.9 billion or roughly $4.5 billion more than the entire steel industry of China.

Closing out our Chinese corporate hall of shame today is China Southern Airlines.  Incurring an operating loss of 114 million yuan was transformed by a 1.5 billion rmb currency bet into a net profit of 344 million rmb.  Needless to say, airlines that make their money as hedge fund managers quickly exit the airline industry to focus on currency trading.

The Quiet Crackdown

There is an ongoing officially sanctioned, crackdown on dissent in China.  It targets anyone who does not faithfully repeat party slogans or demands accountability and transparency.

The Beijing internet police are targeting opinion makers and passing regulations that “warn citizens not to harm the economy, the State, or individuals.”  This crack down stems directly from the top in Beijing and a memo referred to as Document No. 9 complaining that opponents of the Communist Party authoritarianism in Beijing have “stirred up trouble about disclosing officials’ assets, using the Internet to fight corruption, media controls and other sensitive topics, to provoke discontent with the party and government.”

What we are witnessing is nothing less than a crackdown trying to hide corruption and prevent any expansion of the limited freedom of speech enjoyed online in China.  Official channels have recently urged citizens to “be careful what information they convey….and use their right to expression responsibly.”

This has resulted in a variety of Chinese celebrities with massive online followings having their Weibo accounts or blogs deleted.

A popular blogger with 12 million follower in China, who is a naturalized American though ethnically Chinese, was detained supposedly for visiting a prostitute though his account has also been deleted.

Chinese human rights advocates are being arrested for seeking to peacefully assemble.

Professors in Hong Kong are being silenced for advocating democracy in Hong Kong.  It is worth emphasizing that this is not even a call for democracy in China but rather in Hong Kong.

A Peking University economics professor is facing a vote to be fired for signing Charter 08, among other affronts to Communist Party authoritarianism, which calls for Chinese democracy and guarantees of human rights.

A professor from the East China University of Political Science has been banned from teaching for calling for the Communist Party to operate within the Chinese constitution rather than be a law unto itself.

On Monday it was announced that a Briton and his Chinese wife were arrested for operating a company specializing in corporate security specifically background checks.  This is sensitive due to the information compiled by Bloomberg and the New York Times showing the family of current Chinese leader Xi Jinping had amassed a fortune of $376 million USD before even taking office.  Shortly thereafter, the New York Times released an investigative report showing quite conclusively that the family of outgoing leader Wen Jibao controlled at least $2.7 billion.

It is disheartening but not surprising that a Party seeking to maintain its crumbling grip on power would target citizens and professors willing to stand up to an oppressive and authoritarian state.  The official crack down on reports of corruption and calls for officials to list assets strike a nerve because Party sanctioned plunder of the government continues to this day.  In 2011, a report accidentally posted on the Peoples Bank of China website found that $125 billion had been stolen by 16,000 officials. That averages out to nearly $8 million per corrupt officials and it is worth noting that corruption prosecution has been declining in China. It is no wonder that the Communist Party is concerned about the Chinese citizenry knowing the sheer brazenness of their plunder.

If there is an encouraging aspect of this crackdown it is this: this is the sign of a weak and crumbling control apparatus.  The Chinese people are waking up and want to make their own decisions.  They want to express themselves.   These actions are not being taken because Beijing feels confident that the populace supports its policies and government.  The Party is cracking down because of popular discontent over fraudulent economic data, corruption, and the basic inability to say what they want.

I can say that I have received threats from influential Chinese entities about some of my writings and I am almost waiting to be picked up.  I have however made a conscious decision not to live in fear.  Authoritarian states like China and Singapore seek to instill fear in their people and I will not live in fear for what they may do.  I will be strong and courageous, speaking the truth, and living in peace.  Do not fear or be dismayed.

The Audacity of Chinese Inflation Data

It is frequently difficult to grasp for many people just how invented most Chinese economic and financial data actually is.  In my paper, How Badly Flawed is Chinese Economic Data? The Opening Bid is $1 Trillion I present some of the many ways.  Let me give you one example in the bar graph below.

Each year represents the amount that food price inflation contributed to the overall consumer price index.  For example, in 2003 if we use the official weight for food prices, food price inflation would have been responsible for 100% of consumer price inflation.

In the 9 years presented, there are only two years where food price inflation represents less than 70% of total inflation.  If you add this up over the years, between 2003 and 2011, food price inflation was responsible for 99% of all inflation in China.  Another way to think about this is that the Chinese government is claiming that no other prices rose in China between 2003 and 2011!  In other words, prices in China except for food have not changed in a decade.

You be the judge.


The Enormity of the Fire Breathing Debt Dragon

There is some skepticism of just how large the approaching debt crisis is by China-Dragons.  The argument goes that just as China did a little over 10 years ago, Beijing will simply create a bad loan  management firm to take those assets of the banks balance sheets.  The simple problem is this: the sheer size of the financial stress dwarves what even the Beijing puppet master can muster.

The South China Morning Post who has probably the best China coverage in the world puts the sheer size of the debt dragon into perspective and the role Beijing played in creating it:

“While many small and medium-sized enterprises, hobbled by a slump in exports, cried foul at missing out on their share of stimulus cash, steel traders were among the biggest beneficiaries of the state-backed loans.  In 2009, Shao and other steel traders were approached by banks which were actively seeking to extend loans to the private entrepreneurs. “They simplified loan approval procedures, gave us discounts to interest rates and encouraged us to take advantage of regulatory loopholes to borrow the money,” Shao said. “We are strong believers in the saying that cash is the king; therefore, we were more than happy to take the money.”

In other words, the banks were chasing down favored industries and companies pleading with them to take more loans at discounted rates.  But wait, it gets better:

“Shao says loan assessment officers told him he could move the same batch of steel products he had already borrowed against to a different warehouse, and use it as collateral against another loan. “Steel products worth several million yuan could be collateralised several times to obtain credit that amounted to scores of millions,” said Shao. “Nobody cared about our repayment capabilities at that time.” Some of the money went back into the steel trading business, with newly bought products being used as collateral to secure yet more easy credit. A steel trader with a personal net worth of 100 million yuan could eventually have about 10 billion yuan of cash on hand via the aggressive borrowing, people with knowledge of the situation said.”

Read that again in case you missed it: by using the same product as collateral to obtain many different loans, you could turn 100 million into 10 billion!  Needless to say the cash from this borrowing orgy was not exactly well used:

“And the abundant cash, combined with the credit lockdown many SMEs were suffering, presented yet another opportunity for steel traders.  Billions of yuan flew into the underground banking system in Zhejiang province, heartland of the shadow banking industry, to chase the high interest returns offered by illegal lenders. “I didn’t even bother to ask them how they would use the money,” Shao said of people he lent cash to. “The borrowers promised to pay higher interest than the banks’ lending rates and I just agreed on the spur of the moment. Now I don’t even know where some of the cash has gone.”

Nor was this baiju fueled lending binge limited to steel traders.  The credit crisis is spreading to smaller cities throughout China with the predictable consequences of collapsing sales, bankruptcies, and falling real estate prices. According to this New York Times article of one mid-size Chinese town, apartment prices rose from $20,000 to $330,000 in a city where the average per capita GDP was $4,000.  That translates to a home price to income ratio of 80.  Considering the United States peaked in San Francisco around 11, this would imply one of the biggest housing price corrections in the history of mankind.

It should come as no surprise that steel traders cash and real estate prices went hand in hand.  Between the incentives to turn out low price steel for large apartment blocks and lending to fuel their purchase, this completes two sides of the same coin.

Think I’m exaggerating the magnitude of this and the coming correction of asset prices?  Watch this 60 Minutes piece touring cities built for hundreds of thousands where no one lives.

The coming correction to asset prices will be one of the largest and most painful we have ever seen.

The Ongoing Data Discrepancy in Chinese Inflation and GDP

A question I have answered frequently in recent history is why I decided to write my working paper How Badly Flawed is Chinese Economic Data? and the answer is simple.  I was astounded that smart people would so readily believe the economic propaganda being announced by Beijing.  Apparently, other people have been just as skeptical and and heartfelt thank you to CNBC for broadcasting this:

Now whether you agree with everything that I have said, how I calculated it, or the final conclusions I reached let me give you some new information.  According to new official data (as I stress about Chinese data: do not actually believe it) in 70 major cities the price of new homes rose 7.5%.  Nor was this increase limited to new homes as existing home prices jumped also.  According to Bloomberg: “Existing home prices rose 15 percent in Beijing last month from a year earlier and increased 11 percent in Shanghai and Guangzhou each, according to the data”

Now to put these numbers in perspective you must bear in mind that according to the same people that released these statistics, from 2000-2011 urban areas saw housing price inflation of 8% total.  It must be emphasized that the real estate asset price and the consumer price change are two very different things but they are also very related.  The real estate component of CPI is not going to increase in perfect correlation with the change in real estate prices, especially when there is a bubble.  However, nor are the housing CPI and real estate asset price independent and unrelated.  To think that real estate asset prices go up by 7.5% annually but the housing CPI goes up by only 8% in 12 years in ludicrous.

The reason this matters is that banks are enormously stressed and continuing to lend to developers to buy land, consumers to buy apartments, and related industries to stay in business.  Think the banks aren’t stressed?  Chinese interbank rates are already spiking in anticipation of the end of the month capital adequacy ratio tests and the market is pushing for additional PBOC liquidity.

There are a couple of problems here.  First, it should serve as a warning sign that every time there is a capital adequacy test, Chinese banks go into panic mode.  That is not a good sign.  Second, banks should not be this dependent on on the central for bank for ongoing liquidity.  This smacks of an ongoing quiet bailout.  In normal times, banks should be able to lend to each other with minimal central bank intervention to ensure smooth financial market operation.

Given the line of rights issues that have already started are continuing by banks, this sounds a lot like a government engineered bailout except under quasi-Communist Authoritarianism, you get try to dupe the private investors into putting up the capital.  (Am I the only one that finds it odd that the quasi-capitalist US does a public bailout while the quasi-Communists conduct a private bailout?).  Point being, the PBOC and string of new rights issues are telling you just how stressed Chinese banks are.

You definitely can’t believe the macroeconomic data any more than you can believe a set of public Chinese books.

China Ramblings of the Day

The world just might be waking up to what Chinese have known for a long time that government data is bogus and it has very real impacts.  The reality is that stress in the Chinese economy is continuing to increase to ever greater levels.

Short term rates are falling while long term rates are rising according to the Wall Street Journal.  This is interpreted as reining in inflation and keeping “economic reforms on  track” but this misses the point.  Chinese businesses are strapped for cash from the big banks on down so providing ample liquidity will prolong the inevitable, drive money growth, and push up real inflation but not official inflation.  SHIBOR wasn’t about 10 or 20 year lending but overnight money because Chinese banks have a mountain of undeclared bad loans they keep rolling over.  As long as the PBOC keeps rolling these over, it will continue to delay the inevitable.

Chinese corporate and governments have already become very reliant on short term funding.  In June 2008, less than 20% of bonds were less than 5 years in maturity.  Now more than 50% is under 5 years with only about 15% more than ten years.  Governments and corporate in China are heavily reliant on short term funding and use very little long term funding.  No wonder the government announces with great fanfare that short term liquidity will increase and long term rates will go up because it looks good but accomplishes nothing.  Constraints on new credit growth, not rolling over old bad loans, restrains fixed asset investment, which let’s face it is the driver of the Chinese economy.  And before you say it, no, there is no such thing as rebalancing.  That is a figment of The Party and investment banking analysts imagination.

As much as the blatant fraud in Chinese statistics, what should scare people just as much is that thought that no one really knows what is going on inside the Chinese economy….not even the Chinese statisticians.  That is why you have the government using pickle sales to track internal migration and despite a blistering summer in China there is real concern over the lack of brown outs indicating slack power and a slowing economy.  Though everyone (should) know that you can’t trust Beijing propaganda numbers, it should be as much concern that Beijing doesn’t even have numbers to hide.

Consequently, because internal fighting is kept quiet everyone is left to rely on leaks rather than being able to trust the data.  This produces surprises like Jiangsu province north of Shanghai announcing that its $126 billion bank debt is manageable after a Chinese newspaper leak.  It also results in stealth stimulus with more fixed asset investment by already burdened banks  that simply tries to delay the inevitable reforms by pumping credit and money.  Shanghai is receiving a $40 billion loan, worth more than 12% of its GDP, to build tourism facilities (read its share of the Disney joint venture) from Agricultural Bank of China.  This is all signaling that Beijing will do whatever it has to do to keep growth buzzing even if that means pumping credit out of stressed banks into fixed asset white elephant projects.

Nor are the credit problems limited strictly to public actors.  The stress is being felt acutely in the corporate sector.  According to this Reuters article, Chinese coal and aluminum companies have racked up $490 billion in debt and to make matters worse they are borrowing to pay down debt.  I guess no one has explained the concept of borrowing and debt.

All this stress, which is widely felt in business and society, has led to some rather sardonic humor.  The latest viral anti-government incident was when the Sichuan government found itself trying to explain itself after it urged residents to “not think so long term” after an uproar over it unilateral change of the 70 year land tenure to 40 years.  This prompted citizens to comment that the government was predicting its own demise.

None of this is emblematic of an economy and financial system that is healthy.  Maybe investors and Chinese residents would be wise to not think so long term.

Why Does Anyone Still Believe Chinese Data?

It baffles me with everything that we know about Chinese economic and financial data that people, and even smart people who should know better, continue to believe the Communist Party Propaganda press releases put out by Beijing.  The Reuters team writes:

“The slowdown in the rate of deflation was taken as further evidence of a possible stabilisation of the economy, with analysts looking to data later in the day on investment and industrial output for more signs of a bottoming out in activity.”

When you simply make economic data up, of course the numbers are always going to look good.  For about ten years, Chinese unemployment has bounced between 4.1-4.3%.  Now even accepting that Chinese unemployment has remained quite low throughout this entire time period, which in itself a dubious proposition, we expect more random variation than that.

Let’s take another example from my recent working paper How Badly Flawed is Chinese Economic Data? The Opening Bid is $1 Trillion, on how the National Bureau of Statistics in China (NBSC) calculates consumer price inflation and how they should calculate consumer price inflation (CPI).

CPI should be calculated based upon what the average consumer buys.  To take a simple example, if Honda sells a million cars a year in the United States and their prices go up by 2% annually, that should count a lot more than the 10,000 Bentley’s a year that go up in price by 5% annually.

Despite having the highest scoring high school math students in the world, it is apparent that none of these technically proficient students work for the NBSC.  Below is a table with the official raw data on price change in private housing with a break down by urban and rural residents where the previous year is equal to 100.  This pricing data is used to build the Chinese CPI.

Looking at the raw data from the NBSC, it is apparent there is some skewing of the total change to urban residents.  When you calculate the total price change with the implied weighting between the urban and rural population, the NBSC is significantly overweighting the urban population.  The NBSC between 2000 and 2011 gives an 80% weighting to the urban population with a 20% weighting to the rural population.  In 10 out of the 12 years, if utilize a straight 80/20 urban rural, the implied total number is within 1 one thousandth of a percent of the official number.

However, this 80/20 urban/rural weighting is not remotely representative of the Chinese population.  In 2000, China was nearly two-thirds rural and 2010 reached a fifty-fifty urban rural split.  In other words, the NBSC was mis-weighting the   rural population by nearly 50 percentage points.  This results in a not insignificant accumulated difference over time.  The already bogus data price data gets reduced even more in the price basket by overweighting the population with the lower price increase: urban private housing residents.  If we weight based upon the actual population weight rather than the Alice in Wonderland 80/20 urban/rural weighting, this raises the price of housing by approximately ½ of one percent annually of more than 5% cumulative difference.

While this total does not drastically alter the final Chinese CPI number, it definitely adds to it.  More importantly, it shows just how absolutely fraudulent the Chinese data is and how many layers the employ to manipulate the data.  It is not just manipulating the price data, which they do, but also how to weight that data and who it applies to.

Furthermore, you continue to add up all these little ways that the NBSC is fraudulently manipulating the data and you arrive at some pretty big numbers.  As the saying goes, a trillion here and a trillion there, and pretty soon, you are talking some serious money.

My New Working Paper on Bogus Chinese Economic Data

So after getting a bunch of questions about a blog post I did about bogus Chinese economic data, some challenging what I wrote and some just wanting to know more, I decided to give it a bit more formal treatment.  I put together a working paper entitled How Badly Flawed is Chinese Economic Data? The Opening Bid is $1 Trillion available here.

I plan on covering some of the major findings periodically over the next couple of weeks but Chinese is so fraudulently manipulated as to be Alice in Wonderland absurd.  Let me give you one simple example below in this table.

According to the official National Bureau of Statistics China (NBSC), the price of private housing in urban areas between 2000 and 2011 rose by a grand total of 6% with rural area prices grew slightly faster registering a 20% increase.  It needs to be emphasized that these are not annual numbers but rather the total increase in China in 12 years.  To anyone who is alive and has heard of China, these numbers are not simply questionable but downright comical and fraudulent.

It is also worth noting that according to the NBSC, approximately 70% of Chinese households are considered “private housing” occupants.  This means that the NBSC is saying about 70% of Chinese households have faced housing price inflation of between 6-20%.  More about this break down in a future post which is very interesting in itself.

The primary point of the paper is not simply to reveal more discrepancies in the Chinese economic data, which it does, but also to measure the impact of these fraudulent statistics on real economic activity.

If you don’t want to read the paper or hit the highlights, don’t worry I will be posting the greatest hits here over the next couple of weeks.

Enjoy and cross your fingers.

Invitation to a Cup of Coffee

As a responsible and humble academic, I would like to extend an olive branch the dear leader of Singapore, Prime Minister Lee Hsien Loong.   Despite my best efforts to avoid it, I will be transiting through one of the best airports in the world Changi International Airport paid for and built by the great people of Singapore.  Prime Minister Lee, I would be honored if you would join me for a cup of coffee in the transit area in the Singapore Airlines lounge.

Though I am aware that you are an extremely busy with pressing matters to attend to, I believe that an open and honest discussion about the public finances of Singapore would benefit us both.  I would ask you to put aside the grave matter of arranging dishwashing for hawkers, to meet with me about irregularities in Temasek Holdings.  Though I am a big fan of South East Asian street food, it is my strong belief that the people you have entrusted to manage Temasek have hidden key financial information from about their performance.

Though I am aware that congratulating the Will and Kate on the birth of their beloved new baby boy is a time consuming endeavor, I hope it concerns you that SMRT has recently announced its business model is unsustainable.  Despite large subsidies and declining quality, this has a significant impact on national reserves which will impact Singaporean public finances.  This is a matter of importance to the finances of the state and the people of Singapore, especially given the plan to rapidly expand the population base.

Though I am aware that reminding Lim Boon Heng, the incoming chairman at Temasek, of the need for unfailing loyalty to following commands will take significant time given his proven ability to do so previously, I believe it is important that you better understand the problems of Singaporean public finances.  Despite near continual surpluses since your father ruled Singapore in the early 1970’s, Singapore has become one of the most indebted countries in the world.  Furthermore, even after factoring currency and cost of capital changes, Singapore assets are barely more than the total combined borrowing and surpluses.

Given the resolution of the Leslie Chew case and a better understanding of Singaporean law restricting the ability to criticize government officials, I may even be willing to apologize for own political cartoon.  As Singapore is ranked 149th and 13 spots behind Zimbabwe and one ahead of Iraq in the freedom of the press ranking, I now realize that my attempt at humor may have caused people to laugh at something they believe to be true and which strong evidence supports.  Your refusal to allow a free press or political cartoons, I am sure prevents Singapore from descending into the type of anarchy befalling Zimbabwe and Iraq.

I will not be leaving the transit area during my time flying the wonderful Singapore Airlines but I sincerely hope that we can arrange a time to meet.  My children are looking forward to movies and the wonderful amenities at Changi Airport paid for by the people of Singapore.

I sincerely hope you a great leader, can find time in your hectic schedule to meet with a humble academic.

Links for Tuesday

Chinese government copying Singapore, sets up official website to refute online rumors. First rumor of national importance that needs refuting?  Qingdao woman orders Australian milk powder receives a kangaroo.  Good thing the Communists in Beijing are hard at work on this one.

Singapore school girls shave their hair to show solidarity with cancer patients, kept away from school for not having hair.  Apparently the school doesn’t allow punk looks.  I’m sure the cancer look will be the next hot fashion.

Chinese lawmakers (cough…yes men) question the governments statistics.  Wonder if the Party reads Baldingsworld?

Vietnam is writing an online media standards law too?

Photographic evidence that a lot of that Chinese credit expansion was wasted.  Paris in China anyone?

I am working on some major updates to my work on my paper on the Temasek portfolio and I am almost done with a paper on the impact the bogus Chinese inflation numbers have had on real Chinese GDP growth.  Good stuff all around.