good reading
prudentbear.com
...given
prudentbear.com
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The mainland Chinese banking system is an enigma, wrapped up in a riddle, surrounded by mystery. Estimates of the bad loans in the system range as high as 50%. Only in a totalitarian, neo-communist military dominated country could such a system exist, much less continue to "function"! They have, however, a "Virtuous" cycle which works. They have managed to get the rest of the world to permit them to manufacture, at what can only be described as near slave labor cost, enormous volumes of goods. This has not only resulted in trade surpluses with virtually every body else but orders of magnitude in such surpluses rarely seen. They are currently piling them up with the U.S. at better than $10 billion per month. Since they recycle them all back into Treasuries/GSE's (They had the brilliance to peg their artificial currency, the renmimbi or yuan to the dollar) the silly Westerners haven't objected. Some will remember when the U.S. nearly had a policy separation with Japan over a lower magnitude of trade disparity. Western capitalism (read greed) likes the situation so much that China has now surpassed the U.S., the former leader, in attracting Foreign Direct Investment at well over $50 billion in 2002 through the first three quarters. This number almost correlated with the recent Wall St. Journal article on how much the Chinese have spent buying state of the art Russian weaponry.
Not to worry, our leader has seen into the soul of Xiang Zemin (figuring out who Hu is he is currently leaving to Condoleeza) and knows he is "a good man". (No problem if you want to go to war with Iraq; just declare the Uighurs terrorists and let me get on with exterminating them!) Stand back for a moment and ask; "What is wrong with this picture?!"
The writer is reminded of the first advice ever received on Chinese banking in the 1950's from an "old China hand." Having spent 30+ years in various postings under various regimes and absorbed the multi-millennia culture and it's long range imperative, he advised a callow banking apprentice on the 4 D's of Chinese banking. The wisdom received was as follows: beware the 4 D's; they will defalcate, they will default, they will defraud and, finally, they will defecate upon you!
Bloomberg recently, as an addition to an article on the health of the domestic bond market, reported on the 3.2 trillion renmimbi bad debt problem. They state that the $400 billion resolution wont really hut! First of all, if history is any guide, a "reported" $400 billion problem usually means several orders of magnitude larger reality. Second, the resolution will be a problem if they use their surplus currently invested in U.S. Gov. and GSE issues to provide the resource! On balance, however, the insular Chinese banking system was never a significant off-taker of U.S. credit and, therefore, their parlous situation does not shrink availability. It only poses the afore-mentioned risk if they sell their surplus.
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Giant Allianz is admitting further bad news of major proportions. They even admit after the fact that the purchase of Dresdner was not the brightest idea in the irmament! The British banking system is credited with producing a residential real estate bubble second only to that underway in the U.S. The Europeans have one way out, which would result in instant crucifixion in the U.S. After they "fess up" to their less than brilliant disasters and take the write-downs, they hit the market with a big rights issue and recapitalize. We are of the minority position that this time around, contrary to the righteous methodology of the 1988/1992 era when they sucked it up, swallowed and wrote it off, that U.S. financial institutions this time around are not doing the "right thing"! The Conseco bankruptcy is only about a year late! How much other unresolved resides in the wonderful world of CDO's and securitization is to be seen but another indicator was the research showing that MBIA doesn't mark to market! But this isn't about U.S financials. The Europeans in 2002 have taken hits, which would indicate that they are still, until there is evidence to the contrary, biting the proverbial bullet and then using their unique rights game to get things back on a survival footing. They are able to force the rights into the market to some extent due to the crossholding and group dynamics of European financial enterprises. The same dynamics of group and/or crossholding share ownership may lead, however, to what we believe will be an unwillingness on the part of the groups/partners to go back into the Wall St driven credit creation machine for another dose of disaster. From a percentage standpoint, in the aggregate, the Europeans have been by far the greatest participants and off-takers in the CREDIT BUBBLE in the United States! It is a necessity that this order of magnitude of tankers be standing by to take the sulphurous crude which would otherwise overflow the Wall St. refining mechanism as it grinds out the necessary constantly growing volume of credit. If we are correct and they continue to draw back from the sluicing pipe of such credit; there is going to be a superfluity of such product. Obviously, for a while, the domestic off-takers can permit the effluent to flow into their own holds but capacity is clearly finite. The explosion in U.S. banking system credit in the last few months may be a manifestation of just such a trend. Given their OFHEO (their regulator) mandate for the GSE's to buy virtually any form of ordure as "liquidity", they are certainly grinding to accept as much of the overflow as possible.Nevertheless, without a re-entry of the only other GREAT financial players, the Europeans, there is a limit!
IF WE ARE CORRECT IN OUR PREMISE AFORE-DESCRIBED, THAT THE CREDIT CREATION MECHANISM ABSOLUTELY HAS TO RUN AT AN EVER FASTER RATE TO OUTRUN THE INCREASE IN BAD LOANS, THE FAILURE OF THIS VERY LARGE PORTION OF THE "OFF-TAKER" INSTITUTIONS TO RE-ENTER COULD RESULT IN A SLOWING, OR MORE LIKELY, DERAILING OF THE WALL ST. JUGGERNAUT!
With the ECB finally cutting rates as it becomes apparent the European economies are slowing, admittedly at varying rates, the domestic portfolios of Europe's financial institutions certainly are deteriorating; another reason to pull in the reins on foreign adventuring. Lastly, the population of the continent and it's financial players understands war in a way that the current ONLY SUPER POWER does not. Tony Blair may trot along at the heels of the Great Warrior Bush but the rest of the other side of the Atlantic are clearly not as sanguine. The uncertainty generated as THE SUPER POWER careens towards conflict is definitely not an inducement to expand exposure in the credit market of that power. All in all, we see European financial institutions continuing to retrench, recapitalize and utilize what firepower they have increasingly internally. If correct, such withdrawal, even if only to the extent of no further growth, is a problem for the overextended credit mechanism of the United States.
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