It's long but worth reading:
China: Inside The Belly Of A Corrupt Banking System. Oil: Big Cash Hoard At Exxon. Market Tries To Regroup, Yet Again.
by Dr. Joe Duarte,
Dallas, TX, March 18, 2005 , 08:00 EST
Stocks once again will try to bounce. Another end of the day fading act, could be very bad for the action next week. Greenspan’s making another speech. And consumer sentiment will be out.
The pre-market stock index futures were higher on 3-18. The U.S. Dollar was steady. Asian markets closed higher . European markets were higher . U.S. Treasury bond yields were steady . The U.S. Ten Year note was trading with a yield of 4.48% in electronic trading. Crude oil was near $56. Gold was trading near $437
The economic calendar for March 18: 8:30a.m. February Import Prices. Consensus: +0.7%. Previous: +0.9%. 9:45a.m. March Preliminary Univ. of Michigan Consumer Sentiment Index. Consensus: 95.0. Previous: 94.1. 12p.m. Greenspan speaks at the National Community Reinvestment Coalition Annual Conference in Washington. Source: Wall Street Journal.com.
China: Inside The Belly Of A Corrupt System.
China’s banking system could be well on its way to failure. The “resignation” of Zhang Enzhao, chairman of China Construction Bank (CCB) on March 15, citing personal reasons, could well be a signal that there is more trouble already on the way than meets the eye.
According to Stratfor.com, the CCB situation suggests “China's attempts to prepare itself for competition with foreign banks are failing -- putting the country well on track for a major financial crisis.”
Behind The Scenes
According to Stratfor.com, there is a whole lot going on behind the scenes, in this matter: “The ["personal reasons"] behind Zhang's resignation – likely have something to do with rumors that he is under house arrest as part of ongoing investigations into corruption. Specifically, the government suspects Zhang of receiving kickbacks from information technology firms in exchange for cheap loans. Considering that China's economic system is predicated upon easy access to credit, and that the IT sector has been singled out for favored treatment, Zhang undoubtedly will soon face charges of embezzlement.”
Stratfor, echoing our sentiments, and our previous assertions here, added: “Corruption is endemic to the Chinese financial system, where banks are seen less as sources of loans than as sources of capital. The cost of credit is kept inordinately low in order to keep throughput at factories high and employment maximized. Such cheap loans allow Chinese firms to stay in business despite bad management, substandard products, insufficient demand and a host of other normal business killers.”
And there is more: “Simply put, Beijing has decided the best way to keep the disgruntled workers from causing political problems is to keep them in the factories -- no matter how pointless the factories. A hefty percentage of the loans that keep these monuments to government fear operating are not repaid on time, if at all; they are the ["bad loans"] occasionally reported in the media.
The real danger is lurking below the surface, though, as Stratfor points out: “Various estimates of the total amount of money from bad loans in the Chinese financial sector range upward of $800 billion, versus a total Chinese gross domestic product of only $1.6 trillion.”
Size Matters
Stratfor adds that the situation in much of Asia is similiar “but in China it goes a step further,” due to the “sheer size” of the country. Indeed, because China is so large, there is a multiplier effect, which “means there are literally thousands of local branches for each of the major banks - the CCB alone has more than 16,000. Local bank managers and officers, therefore, establish close, often personal, connections with myriad firms - making every handshake an opportunity for corruption.”
According to Stratfor, and other sources, bribery is business as usual in China, as “the China Banking Regulatory Commission says it is investigating 157 independent cases of regulation breaches -- code for the type of activities in which Zhang appears to have been involved.”
Why China Is Trying To Clean Up Its Banking System
On 3-17, in this space we wrote: [China’s central bank announced that it would be cutting the interest rate it pays banks on reserves. The move seems to have been aimed at giving Chinese banks more liquidity, by making it more attractive to lend money than to keep it on reserves. On Thursday, the Chinese government “ended preferential mortgage rates and began allowing banks in some cities to require bigger down payments.”]
Our analysis of the situation, on 3-17, concluded: “By making more money available to banks, but making it harder for them to lend it, Beijing seems to be trying to accomplish one thing above all, to shore up the balance sheets of its banking system. To be sure, there is probably an ulterior motive, since Beijing is trying to sell stock in its big banks to the international public. But, beyond that, it seems that above all things, they may be trying to keep the banking system afloat, realizing that at some point, money flows into the country may slow, possibly enough to cause trouble. If the banks have more money on their balance sheets, it could theoretically decrease risk to the Chinese economy, in the case that foreign money pulls out.”
Now it gets interesting. As Stratfor sees it: “Under China's accession agreement to the World Trade Organization, Beijing must give all foreign banks full rights to compete with its own state network of banks by the end of 2006. If that happened today, most Chinese depositors would flee the government banks for the foreign banks, where they could receive higher rates of interest for their deposits. Foreign banks, after all, do not subsidize their loans. The loss of depositors would kill the state banks and leave the government footing the entire bill for sustaining the country's industrial non-sector -- an obligation that likely would bankrupt the government within a year.”
So, Beijing is trying to be crafty, as we noted above. “To head off that dark -- and rapidly approaching -- future, Beijing is attempting to follow a dual track. First, it is trying to bring foreign investors into the Chinese banks as minority shareholders in order to get more cash to support the system and expertise to make it stronger. Second, Beijing wants the banks to launch initial public offerings (IPOs) on international stock markets to raise working capital to cushion later shocks and smooth current operations. The CCB hopes to raise $10 billion in its IPO.”
The Shell Game
In other words, the Chinese government fully understands its predicament. In a sense, it’s running a shell game, and taking foreign investors along for the ride.
After decades of Communism, China, as Russia and Eastern Europe, was essentially bankrupt, morally, ideologically, and certainly financially, at least in comparison to the United States.
Its steady moves toward a more capitalist system, was likely more out of survival instinct, than for having seen the light. This of course explains why China continues to talk and act like a dictatorship, and is attempting to bully Taiwan into a bloodless annexation, while at the same time is continuing to attract foreign money.
The problem, is that much of the foreign money is being funneled into the pockets of Chinese officials, and their bureaucratic nests of deceit and bribery.
Stratfor thinks that China’s chances of succeeding in its dual scheme of propping up its banking scheme by domestic measures, and foreign money flows will likely fail “not so much the because of the recent spate of bank corruption scandals (the most recent involving the embezzlement of $8 million from a CCB Jilin branch) as because the scandals have become so common they have faded into the background. The Zhang case, however, cannot be easily ignored. In light of such a development, foreigners will simply need a few more months to gauge the quality -- or lack thereof -- of the CCB's corporate governance.”
Stratfor gives the Chinese government some credit for trying to clean up its banking system, but notes that “the core problem is that none of these banks is really a bank, but a means of allowing the government to extend credit to its herd of white elephants, the state-owned companies. As recently as 2002 the government officially referred to the CCB as ["the dispersing agency for the Ministry of Finance."] The government can spit and polish all it wants, but the Zhang case demonstrates Beijing's failure to fundamentally reform these institutions. The government has made no meaningful change in lending policies -- and so no meaningful change in performance.”
Stratfor’s conclusion: “What has happened is an effort to clear out some of the worst of the personnel. Whether China is truly serious about that crackdown, however, will become apparent as soon as the authorities appoint Zhang's permanent replacement (CCB President Chang Zhenming is filling the former chairman's shoes temporarily). If the new chairman comes from private enterprise or -- even better -- from abroad, there might be a glimmer of hope. If the new president comes from somewhere within the Big Four system, however, business as usual will prevail -- until the crash arrives.”
We’ll add this. Billions of U.S. pension and mutual fund money, not to mention hedge funds, and other vehicles make their way to China on a weekly basis. This is hot money, which is going to Beijing searching for that 15% annual growth rate found in the Chinese real estate market, as of last year.
As we noted here on 3-17. There is now reportedly a rising number of empty flats that are still being flipped by investors. At some point, empty houses, and empty bank vaults are going to force investors to reassess their growth targets in China.
A nearly zero risk, U.S. 30 Year T-bond is now yielding nearly 5%.
If U.S. rates rise further, as they surely will, all that empty growth in China is likely to be exposed for what it truly is, the latest global pyramid scheme.
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