China lending stats update -- The decline continues.

It has been over a year since I last highlighted the slow decline in official lending statistics out of China. Since then not much has happened regarding the direction of Chinese lending growth; a slow decline continues.

I point you to Steve Keen's debtwatch for why the rate of growth in lending is important.

The rate of lending growth peaked in October 2009 and has been declining ever since.  Compare this to the Chinese equity markets and you'll see how Chinese stocks haven't gone anywhere since October '09 either.

Unofficial lending is naturally harder to track but there are anecdotal signs of stress in this sector as well.    http://historysquared.com/ and http://www.alsosprachanalyst.com/ are two good sites to follow the 'underground' lending market.

Something to watch in the new year

The year is wrapping up and the US stock market continues to grind higher in a Christmas rally. While the US is in a much calmer state as compared to a year ago, not all is well across the pond in Europe.

The fiscal crisis in the PIIGS of Europe (Portugal, Ireland, Italy, Greece, Spain) has not been 'fixed' in my opinion and will most likely move up to the headlines in America very shortly.

Here you can see a chart of the PIIGS bond yields  (Bloomberg) and they are not going in the right direction. The spike and fall in May 2010 was due to Greek financial difficulties and the spike in November was from Ireland. Note how much faster the fall in yields after the Ireland event has been retraced as compared to the Greek event.

As this chart shows the absolute yields and not the relative 'risk' of the PIIGS regions looking at the combined CDS for the PIIGS (Bloomberg) provides a clearer view of perceived risk.  It too is almost at new highs and could very well exceed previous peaks before the new year.    I suggest you keep an eye on both of these indicators and if you see them shooting higher you will most likely see weakness in the equity markets as well.

The flogging will continue until morale improves

The Federal Reserve recently announced they will purchase another 600 Billion in US Treasury bonds (commonly called Quantitative Easing 2 or QE2)  I am working on a longer email regarding how our current financial situation is very different from previous recessions and recoveries but the Federal Reserve's QE 2 announcement deserved some commentary. 

The markets did not really respond until after reading Fed Chairman Ben Bernanke's article in the Washington Post on November 4:

For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.

In short Fed Chairman Ben Bernanke wants higher stock prices so you'll feel better about yourself and go buy more stuff.  
Will it work?  
I have my serious doubts (as I'll expand upon in later emails).   The banks already have so much unused money they deposit the excess at the Federal Reserve. (973 billion as of October 10)  How is another 600 billion going to change the situation? 

So why is the Fed printing? Because they can and they feel like they can't do anything else. It looks like an easy painless solution but in the long term it will not fix the problem of too much debt in America. 

The problem with QE2 is the money being created is not going where Mr. Bernanke would like it to, the real US economy.  If you look at the market's reaction before and after the announcement one sees the money shifting into commodities and emerging economies while simultaneously weakening the US dollar.   The Fed is taking the easy way out by attempting to prop up and paper over our structural problems.

Lest you think this is merely the ranting of a crazed financial advisor former Federal Reserve Chairman Paul Volcker stated the QE2 plan won't help much as well: (Yahoo, November 5, 2010)

Volcker told a business audience in Seoul that the Fed's bond plan is obviously an attempt to spur the U.S. economy but "is not the kind of action that's likely to change the general picture that I've described as slow and labored recovery over a period of time."

The Wall Street Journal (November 4, 2010) expresses caution as well:

The Fed is essentially lending enough money to the government to fund its operations for several months, something called "monetizing the debt."

In normal times, this is one of the great taboos of central banking because it is seen as a step toward spiraling inflation and because it risks encouraging reckless government spending.

Financial markets Thursday responded warmly to the Fed move, but outspoken critics of the policy issued full-throated critiques.

"It is doubtful the Fed decision will produce any results," Brazilian Finance Minister Guido Mantega told reporters following a cabinet meeting with Brazilian President Luiz Inacio Lula da Silva. Officials in Brazil, which averaged 850% annual inflation in the 1990s, have been critical of the Fed's easy-money policies because they are spurring price pressures abroad and could encourage new asset bubbles outside the U.S.

If all else fails, keep doing what you did before seems to be the rule at the Federal Reserve.  By his actions Ben Bernanke is attempting to artificially raise asset prices and reduce the value of the dollar.  We shall see if he is sucessful, but what happens when the crutch of QE money is removed? 

Latest Chinese Lending Stats: Ignore these numbers!

An odd way to start a post but as mentioned in my previous entry it is hard to know how much lending is truly going on in China these days.  The official data shows a decline in the rate of growth in lending and the government appears to be reigning in credit growth by raising reserve ratios. 

This does not tell the entire story. There is a boatload of off balance sheet lending but there are no 'official' numbers for that.
The WSJ (Sept 28,2010 ) recently commented:

A report from Standard Chartered economist Stephen Green estimates that by the end of August between 2 trillion yuan and 3 trillion yuan worth of loans (the banks don’t formally disclose the amounts) were moved off balance sheets–and outside the PBOC’s formal loan data–in this way. Over the same period, PBOC data showed the banks lending out 5.6 trillion yuan, suggesting the banking system has already passed the central bank’s 2010 target for new credit creation. It also means that the tightening signaled by the loan quota never happened.

Standard Chartered is guessing an additional 50+% of unofficial lending this year. Not a small number.  If the bank regulators crack down on this unofficial lending the rate of true loan growth would fall dramatically.

China lending update. Is bank lending speeding up or slowing down?

It has been a while since I have updated you on the bank lending situation in China.   This is not due to me slacking off (I'll admit to a slower pace of posts recently, but I have some good excuses, really)  following this topic.  The data source, People's bank of China, has suddenly been a little more reticent in publishing this data in English and as my Chinese language skills are a bit lacking this data series has languished....

Data released recently shows a continuing trend of official slowing in the rate of loan growth.  I put official in italics because there appears to be some off balance tomfoolery going on. . .

From Caixin Online:

Despite regulatory directives aimed at preventing banks from removing loans off their balance sheets to dodge credit restrictions, China's banks did not slow down their pace in packaging loans as wealth management products.

Banks and trusts cooperated on wealth management products, effectively allowing them to shirk their responsibilities toward credit limits imposed nationwide under the central government's macroeconomic controls.
In the first half 2010, according to trust company reports, the value of wealth management products cooperatively offered by banks and trusts rose to 2.6 trillion yuan, topping the previous year's 1.77 trillion yuan.

This amount combined with the 4.58 trillion yuan in on-the-books, new credit issued by banks in the first half brought total lending in China through June 30 to near the 7.5 trillion yuan limit set by the government for all 2010.

[The 4.58 trillion yuan number matches my data.  Look at the 'wealth management products' value of 2.6 trillion.  Greater than 50%  of the 'on the books official' value of 4.58 trillion.  Continuing . . ]

By charging fees as well as commissions of up to 2 percent, banks earn more than trusts when they jointly market bank-trust products. Moreover, by cooperating with trusts, banks keep customers otherwise unavailable due to credit controls, since off-book business doesn't require bank capital and thus avoids CBRC capital constraints.

When companies start hiding assets off balance sheet it rarely ends well.

If you are wondering where all that money is going, this blog entry by staff at the World bank is stunning. Not only for the information presented but the absolute lack of surprise. (ht Mish)

In Chenggong, there are more than a hundred-thousand new apartments with no occupants, lush tree-lined streets with no cars, enormous office buildings with no workers, and billboards advertising cold medicine and real estate services – with no one to see them.

I went to China in 2003 and I can assure you I NEVER saw a single piece of urban pavement that was not completely full of cars, trucks, bikes, scooters, etc at all times.   I have mentioned empty Chinese cities before such as Ordos. How many more empty cities in China are there? Andy Xie has wrote about this before. Here is his latest article regarding the excess housing stock in China:

What distinguishes China’s property bubble from others is its unprecedented quantity dimension. China just doesn’t have any constraint limiting supply. The current debate about the quantity of empty flats is about the extent of quantity excess. The stock of empty flats measures the size of the quantity bubble. Taiwan experienced a price-cum-quantity bubble in late 1980s. At the time the market quantified the number of empty flats by obtaining data from the electricity supplier on flats without usage of electricity. The stock of empty flats measured this way was about 15% of the total households. Some analysts are trying the same tactic to quantify the volume of empty flats in China. The problem with this methodology is the complexity of China’s housing conditions.  . . . While the data are not accurate, we can confidently conclude that China doesn’t have absolute housing shortage and the per capita space is above Europe and Japan’s level. Indeed, if we adopt Japan’s standard, China already has sufficient urban housing space for everyone in the country, i.e., there is housing for every person in the countryside to move into city. . .  Four unique factors may explain China’s unique phenomenon.

1) Sustained negative real interest rate has led to declining demand for money and rising appetite for speculation. Greed and fear of inflation are working together to form unprecedented speculative demand for property.
2) The massive amount of gray income looks for a ‘safe’ haven. China’s gray income of various sorts could be around 10% of GDP. In an environment of rising inflation and depreciating dollar-the traditional safe haven, China’s rising property market is becoming the preferred place for this money.
3) China’s masses have no experience with property bubble. The property crash in the 1990s touched a small segment of the society. Foreigners and state-owned enterprises were involved. Geographically, it was restricted to Southern freewheeling zones like Hainan and Guangdong and Shanghai. Most people in China don’t know that the country had a property crash. Lack of fear is turbo-charging the greed.
4) Speculators believe that the government won’t let property price fall. They correctly surmise that local governments all depend on property for money and will try every effort to prop up its price. But, their faith in the government omnipotence is misplaced. In the end, market is bigger than government. Government behavior can delay, not abolish market force. Nevertheless, this faith in government is removing the fear over the downside. Hence, the speculative demand just grows with credit availability unchecked.

When this bubble goes pop you better have some popcorn and a good seat because the explosion will best any action film explosion sequence.

Is a steep yield curve leading us astray?

Does a steep yield curve guarantee future economic growth?  Usually but maybe not this time.

A recent article on BusinessInsider got me thinking about the yield curve and its power to predict when a recession is NOT likely. 

The article title and copy was interesting:  Unless 'This Time It's Different', There's Now Zero Chance Of A U.S. Double Dip

Substantial research suggests that the difference between interest rates for 10-year and 3-month U.S. treasuries is a reliable leading indicator for the U.S. economy, so much so that the New York Federal Reserve even creates charts using this metric, boldly titled "Probability of a U.S. Recession".
Let's hope the science holds, since according to the New York Fed's latest chart there's almost zero chance of a U.S. recession now. In April, the treasury-spread-based probability of recession collapsed to 0.04%.
We're not going to claim we're completely sold on this metric, but have to concede that historically it has worked and it's also hard to imagine why the U.S. would fall back into recession in the near-term given the rebound already in place. Things would have to start deteriorating first, and we haven't seen that yet. Should this time be different? That's not a rhetorical question. You can read the New York Fed's justification for this metric here and decide for yourself.

Here's the chart produced by the NY Fed as of June 21, 2010 which BusinessInsider refers to. As you can see it is saying there's effectively NO chance of a recession anytime soon. 

This relationship is considered so solid the yield curve is part of the leading economic indicators published by the Conference Board where the yield curve is 10% of the LEI index.

Even Krugman of the NYT has commented on how a steep curve implies positive future growth.

Now, this spread could be fairly small if people expected the economy to remain in the dumps for a long time; see Japan. What the large spread now tells us is that the US economy is in the dumps now, but that investors see a reasonably good chance of a strong recovery in the not-too-distant future. That’s good news, not bad news.

Both the Fed and Pimco have web sections devoted to discussing the yield curve and its predictive powers.

Substantial research from the Federal Reserve on the yield curve shows it is a good predictor of future economic growth.
From Federal Reserve: July/August 2006 - Current Issues:

Conceptual Considerations
The literature on the use of the yield curve to predict recessions has been predominantly empirical, documenting correlations rather than building theories to explain such correlations. This focus on the empirical may have created the unfortunate impression that no good explanation for the relationship exists—in other words, that the relationship is a fluke. In fact, there is no shortage of reasonable explanations, many of which date back to the early literature on this topic and have now been extended in various directions. For the most part, these explanations are mutually compatible and, viewed in their totality, suggest that the relationships between the yield curve and recessions are likely to be very robust indeed. We give two examples that emphasize monetary policy and investor expectations, respectively. . . .

Here's the important part . . .

A rise in short-term interest rates induced by monetary policy could be expected to lead to a future slowdown in real economic activity and demand for credit, putting downward pressure on future real interest rates.

So an inverted yield curve chokes lending which then slows economic growth.  Conversly a steep yield curve induces lending which stimulates economic growth.  Lets look at some data provided by the Federal Reserve from 1974 onward comparing yield curves and recessions.  As you can see there is a strong relationship between the two. In all cases an inverted curve preceeded or coincided with recessions as shown by the gray recession bars. Furthermore no recessions occurred without a yield curve inversion (or nearly so) happening beforehand.  Also note how steep the yield curve is now as compared to recent history.  Rarely has the curve exceed 4%

It's no wonder the steep yield curve is considered such a reliable indicator.

Let's take it one step further and look at the relationship between a steep yield curve and economic activity through the mechanism of lending growth. This graphic adds bank loans and leases at commercial banks.  Looking at the graphs you can see in each case an inverted yield curve resulted in a recession and a slowdown in lending.  Once the yield curve returned to 'normal' with higher long term rates bank lending resumed growing and the country exited a recession  . . . except this time. Bank lending continues to decline which is exceptional.  (Before you get excited about what appears to be a sudden spike in the rate of lending you should know that is due to off balance sheet lending vehicles being brought back onto bank balance sheets.  Annaly's blog has the details.) 

Annaly's recent blog post on debt and GDP growth reinforces the previous picture.  Real credit market growth is strongly linked to real GDP growth. 

My contention is the steep yield curve is no longer an accurate predictor of future economic growth due to the lack of credit growth.

Has there been another time when a steep yield curve has led us astray?  Yes.  Robert Shiller provides some excellent long term historical data going back to the 19th century.  Let us examine some data from 1928 through World War II. While the data fields are not precisely similar they are close enough to provide analogs to modern data sets on this topic. 

Here the difference between 1year and 10 year rates is shown as compared to real earnings on the Standard and Poors equity index. 

While this does not show lending activity it does show what one would hope results from increased lending namely earnings growth.

Some interesting relationships can be observed:

The yield curve was very inverted in 1929 and returned to a 'normal' curve in 1930. Earnings did rebound from their lows but did not exceed their 1929 peak until after World War II.

More importantly a serious fall in earnings in 1937 coincided with a non-inverted yield curve.

The rarely mentioned mechanism (credit growth) between a steep yield curve and economic growth is not working.  It is my contention until credit growth at least stops falling the steep yield curve rule of thumb should be ignored and one should be concerned with very tepid (if at all) real GDP growth.

If my thesis is correct and this rule is broken it could come to quite a shock to those who consider it dogma. Considering the yield curve is part of the Leading Economic Indicators from the Conference Board it may well be used by many in portfolio allocation decisions.   If you hear in the future how the steep yield curve is showing how we can't go into a recession remember the yield curve alone does not create economic growth but creates the opportunity for increased credit growth which then causes economic growth.

This Time It's Different.

Sources:

Federal Reserve FRED data
Federal Reserve section on steep yield curve

Robert Shiller

edit 01/28/11: As has been pointed out to me in other conversations Japan has had a few recessions over the last 15-20 years while their yield curve has not been inverted.

Fast Money needs to do their homework -- High lumber prices are due to a temporary supply shortage not demand

I was watching Fast Money on CNBC tonight and their Prop Desk blurb on lumber and by implication Plum Creek (PCL) caught my attention.  The Fast Money speaker posited lumber prices had risen dramatically and this was a sign of a lumber and housing recovery.




I recently listened to the Plum Creek earnings report and management specifically commented upon weather conditions in the southeast US creating supply problems.  To quote from a SeekingAlpha article:

A lot of this lumber is filling inventories; it is concern over wet weather. As we mentioned, lot of these mills especially in the southern United States are very short inventory, and therefore there is not a lot of lumber inventory in the system.


I was down in Mississippi, Louisiana, and Arkansas last week, and what my guess is that half the forests are inoperable, and I don’t what it was like two months ago. I know they got some 9 inches of rain in one day. It’s a severe problem, and most areas you can’t operate in today. They need two or three or four weeks of dry weather so that we can get into a lot of these areas. That’s why inventories are so tight in that region. So it’s a huge issue.

Furthermore quite a few directors and officers of Plum Creek sold some of their holdings a few days after the earnings report:

CROWE BARBARA L 591

JIRSA ROBERT J 224

TUCKER DANIEL L 251

HOLLEY RICK R 4,376

BROWN DAVID A. 611

HOBBS JOHN B 178

LINDQUIST THOMAS M 2,097

RICKLEFS HENRY K 582

Wilson Nancy L 254

KRAFT JAMES A 604

LAMBERT DAVID W 1,076

KILBERG JAMES A 1,275

NEILSON LARRY D 776

REED THOMAS M 655

FITZMAURICE JOAN K 624

For a total of 14,174 shares.  No one purchased shares, all were sales. (Source)

I'm not disparaging Plum Creek or their officers / managers for selling off a small portion of their shares, but doesn't the comment about a short term weather phenomenon spiking lumber prices and quite a few officers unanimously selling their shares cause you to reconsider the short term valuation of the company?

I have followed Plum Creek on and off for several years and right now have a very small (just one contract) short call spread position on the company.  It is a company I may very well own in the future if the price is right.  Right now I do not foresee a strong housing rebound and my position is due to valuation issues. The price of both lumber and PCL have already had their run in my opinion.

My beef is with Fast Money.  Do your homework.  PCL may continue upwards for a little longer but it is riding high on a short term phenomenon.  The price rise is due to weather and a short term supply disruption. Once the forests dry out they are going to cut cut cut and the relatively high prices of lumber will come crashing down.

p. s. I would not call lumber futures a 'secret sauce' unconventional indicator. It is a publicly traded futures contract available on stockcharts.com and everywhere else.  The implication you are revealing your sekrets is vaguely insulting.

Betting markets are predicting a win for Brown in Massachusetts -- What does this mean?

The betting site intrade.com shows Scott Brown leading in the special election for the vacant Senate seat in Massachusetts.  (The image is a static picture and does not show the current odds, click on the link above to get a current number)

While there has been much talk regarding this being the '60th Senate vote that will stop health care' I believe more attention should be paid to the House.  Health care passed by the slimmist of margins in the House and Mr. Brown's strong showing in a very Blue State most likely has quite a number of  Democratic House members quaking in fear. 

It does not matter if Brown wins now, even a close defeat may be enough to scare some House members into not voting for the health care bill.

Politics is not my strong suite and I'll try to avoid discussing it as much as possible.  This event just struck me as interesting due to the predictions markets opinion and the ramifications of one Senate vote.  Please no hate mail regarding one party being better than another.   I prefer neither party and hold my nose when I vote.

The smell of lending bubbles in China. Do you like butter on your popcorn?

One item which is becoming a pet peeve of mine is the practice of writing articles making predictions with no underlying factual data to buttress their conclusions.  If you are going to predict something, at least tell me why! 

A current hot topic is China and whether it is in a bubble.  And if in a bubble, what kind?  Well, here's some juicy data and anecdotal evidence for you to chew on.

If you notice, lending in China skyrocketed last year.  As of November 30, 2009, total loans outstanding are up nearly 35% year over year.  That is a huge increase in the rate of growth.  

I would put to you that all that money sloshing around did not just end up in solidly performing loans made with proper underwriting standards with the full expectation they will be paid back. 

Sharp eyed readers may notice the decline in lending growth from October 07 to the nadir of November 08 coincides with the dramatic decline in the Chinese equity markets almost perfectly.  Once the lending spigots were turned back on the Chinese markets reversed course and charged back up again. 

I have previously mentioned my suspicions that some of that lending deluge has also made its way into the commodity markets as pure speculation, but I'll leave that to a later entry.

The hedge fund manager Jim Chanos has also noticed this excess credit creation.  Around time point 4:15 he starts to discuss China and their excessive lending.


When will this bubble pop? Can't tell you that. Keeping the pace of lending up at 35+% yoy may be a challenge for the Chinese government this year as the banks are running out of spare capital. There's already a lot of talk and some action trying to tamp down the speculative fires in property prices.  Where and when this all goes poof  is subject to speculation.  If it ends in 2010 it will punch a serious hole in the current world-recovery-buy-commodities-and-all-risky-assets theme. Its a dangerous game to play right now as prices can go parabolic before they go splat but I'm watching and waiting. 

Sit back and get your popcorn. The show will be very interesting to watch in 2010.