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A bailout bigger than TARP
By Craig Stephen
20 June 2011
One of the great puzzles of China’s economic growth in recent years is how its new wealth has sent prices of so many overseas assets soaring, yet its domestic stock markets remain lifeless.
Fine wine, overseas property, art, luxury goods have all been racing ahead on mainland Chinese buying, but China’s A-share markets — after being near the world’s worst-performing last year — are again languishing at an eight-month low.
One way of looking at this is surely great value is emerging in under-bought A-shares. The other is that we should be paying closer attention to the behaviour of China’s connected insiders in an economy where the state always leads. More so, after last week’s revelations of staggering embezzlement by party officials, following on from a mega-bailout for municipal governments. This puzzling dichotomy points to far bigger problems in China than a few mispriced assets.
Chinese officials smuggled an estimated $124 billion of ill-gotten gains out of China in the 15 years up to 2008, we heard last week. And not from some WikiLeaks hacker-come-activist, but from a report released by China’s central bank, although it is now no longer on its web site. Read more on Chinese embezzlement report.
The report spelled out in fascinating detail the long-held suspicion of corrupt money being funnelled through Macau casinos, overseas property (especially in Hong Kong), luxury-goods purchases, or simply carrying money abroad in suitcases. China’s capital controls limit official remittances in and out of the country to $50,000 a year.
The first observation is that this looks like not merely a few rotten apples, but systematic corruption, given the size of these numbers. You then have to ask: Why release the potentially inflammatory report now from back in 2008?
One answer is the problem is now a lot bigger. This disclosure comes only weeks after China’s central government said it planned to bail out bad debts at municipal government investment vehicles of up to $464 billion. The report also contained a warning that rampant corruption poses a threat to Communist Party rule.
It is hardly being overly cynical to presume a sizeable chunk of this money went the same way as that first $124 billion. The post-financial-crisis lending spree in China might well have seemed like a once-in-a-generational chance to acquire riches. Some also highlight that with government leadership changes due next year, many of those in connected positions have been in a particular hurry to acquire assets.
Perhaps financial markets have been pre-occupied by the Greek debt crisis, but it has been surprising how little attention the colossal Chinese bailout has received in recent weeks.
But it is tackled head on by the strategy team at SG, led by Albert Edwards and Dylan Gryce, who warned ominously in a recent note titled “China’s Great Suppression – suicidal monetary policy and systematic fragility.”
Take that bailout and adjust it for the size of China’s economy, and SG conclude you come up with something one-and-a-half-times the size of the U.S. TARP bailout.
The hope is this bailout will somehow magically sweep the problem under the table. But just like in the U.S., someone will have to pay – taxpayers or the wider population through inflation as more money is created and the natural cleansing of a correction through markets is avoided.
SG characterizes this type of action as further evidence of “industrialization by suppression” in China that removes the volatility of economic life. They warn numerous past experiences suggest such fixes only buy short-term stability at the expense of long-term fragility.
With government control over many state industries and banks, a currency that is pegged and capital controls in place, China is arguably in a unique position to control its economy. Perhaps China indeed does have a superior economic system and can keep this all going?
One problem, however, is with this degree of control it becomes hard to get a true picture, with so few assets accurately marked to market. According to SG, China is building up a system prone to instability and potential breakdown. They do not forecast when this will happen, but do say ‘the longer it goes on, the more emphatic the release will be.’
And taking its TARP analogy ones step further, SG concludes China has one-and-a-half-times the financial crises of 2008 ahead of it. Small wonder so many connected insiders look to be taking their wealth out of China.