Over the past year, we have frequently warned that the biggest financial risk (if not social, which in the form of soaring worker unrest is a far greater threat to Chinese civilization) threatening China, is its runaway non-performing loans, which at anywhere between 10 and 20% of total bank assets, mean that China is one chaotic default away from collapsing into the post “Minsky Moment” singlarity where it can no longer rollover its bad debt, leading to a debt supernova and full financial collapse. And as China’s total leverage keeps rising, and according to at least one estimate is now a gargantuan 350% of GDP (incidentally the same as the US), the threat of a rollover “glitch” gets exponentially greater.
To be sure, in recent months the topic of China’s bad debt has gained increasingly more prominence among the mainstream, and notably none other than Kyle Bass has made the bursting of China’s credit cycle the basis for his short Yuan trade as noted here previously:
What I think the narrative will swing to by the end of this year if not sooner, is the real issue in China is not simply that profits have peaked. The real issue is the size of their banking system. Do you remember the reason the European countries ended up falling like dominoes during the European crisis was their banking systems became many multiples of their GDP and therefore many, many multiples of their central government revenue. In China, in dollar terms their banking system is almost $35 trillion against a GDP of $10 and their banking system has grown 400% in 8 years with non-performing loans being nonexistent. So what we are going to see next is a credit cycle, and in a credit cycle you see some losses, but if China’s banking system loses 10%, you are going to see them lose $3.5 trillion.
And judging by the surge in recent and increasingly louder calls for a Chinese devaluation, some advocating a major one-off currency debasement, Bass’ perspective is certainly prevalent among the trading community. Bank of America goes so far as to speculate that the “upcoming G20 meeting in Shanghai offers an opportunity for policy makers to seize the “expectations” initiative via a one-off China devaluation.” It does, however, also add that the “risk is markets need to panic first” before instead of piecemeal devaluation, China follows through with a Plaza Accord-type currency intervention.
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