A Chinese solar company has sealed its place in history as being China’s first onshore bond default after the government declined to bail out the company as was the norm in the past for fear of roiling the market. Although the default amounts to merely a nano particle in a $1.5 trillion corporate bond market, it pushes China to the brink of an epic financial implosion that could topple the global economy.
Shanghai Chaori Solar Energy Science & Technology said Friday it was only able to pay $654,000 of the $14.6 million in interest owed on a $163 million bond. The solar cells and panels producer almost defaulted on a loan in 2012 but a local government pressured its bank to restructure its debt.
“A $14 million to $15 million loss is infinitesimal in the Chinese economy, but the fact that the Chinese allowed this loss to happen is tremendous,” Harry Dent, economist and founder of Dent Research in Delray Beach, Fla., wrote in a client missive Friday. “It puts investors in the shadow banking system, all of those wealth-trust products sold by banks but not backed by banks, on notice that they could lose money.”
Shanghai Chaori is the first domino to fall in a lineup of debts and speculative investments longer than the Great Wall. Thanks to China’s massive shadow banking system, a term referring to any lending and borrowing outside of the regulated realm, China has more debt than tea. Local governments, real estate speculators, developers, corporations, and trusts alike borrowed massive amounts of money to build cities overnight to achieve double-digit economic growth targets.
“Private sector credit to GDP is now in excess of 180 percent of GDP or 18 percent above the 28-year trend and Bank for International Settlements/Basel Committee on Banking Supervision analysis has found that a positive deviation of 10 percent or more from trend raises the possibility of a banking crisis based on historical precedents,” Alexander Redman and Arun Sai, analysts at Credit Suisse wrote in the Global Emerging Market Equity Strategy report, released March 5. “Moreover, the ratio of delivery of new loans per RMB (renminbi) of GDP generated has risen to close to four times from an average of 1.4 times in the 18-years (leading) to 2008.”
A growing number of borrowers are taking on more debt just to pay the interest on their loans. Hordes of borrowers pay only their interest obligations and roll over the principle. Nonperforming loans have climbed for nine quarters straight, according to the Jerome Levy Forecasting Center in Mount Kisco, NY.
“Chinese policymakers appear to be using the threat of withholding liquidity to force banks to rein in lending,” Srinivas Thiruvadanthai, an economist with the Levy center wrote a report Feb. 24. “Yet the threat is itself destabilizing and the fulfillment of the threat would be even worse.”
China’s government has the means to take enormous losses to stabilize the financial system as it has done twice in the past 20 years. But given the massive growth in the shadow banking system and real estate speculation, a financial crisis may be beyond the government’s control, Thiruvadanthai believes.
Critics say China’s first bond default was a long time coming. Years of easy money policies fueled excessive development and real estate speculation to the point that it teeters on the brink of an epic economic implosion that rivals the 2008 financial crisis. Countless apartments in the outskirts stand empty while home prices in the major cities skyrocketed. Ordos, a city in the central region, was built for one million people but has only 70,000 residents. Home prices in major cities like Beijing and Shanghai are the most expensive in the world.
Slowing Economic Growth
U.S. export growth to China dropped from 27 percent in December to 10 percent in January year over year, Patrick Newport, US economist at Lexington, MA-based IHS Global Insight reported Friday citing data from the January International Trade release.
China’s 2014 work report showed the government aims to grow the economy by 7.5 percent this year, slightly above the 7.7 percent expansion in 2013. The country will likely surpass that goal by a small margin as the government carries out its reform plans, although risks in the financial sector and housing market persist, says Brian Jackson, a China economist at IHS Global Insight. But he’s optimistic that China’s economy can withstand some debt defaults.
“On the housing front, localized policies and low inflation provide ample room for loosening, if necessary, while 11 percent real growth in an already sizable public housing program will ensure stable baseline demand for the construction sector,” Jackson, wrote in a client note released Wednesday night. “Financial and debt risks will loom for some time, with an occasional default souring sentiments momentarily, although a systemic meltdown remains unlikely.”
Given that China is the world’s biggest commodities consumer, an economic slowdown will weaken demand. That in turn will dampen prices of commodities, the emerging market countries’ main exports. Income erosion will reduce their demand for Chinese goods, driving a vicious cycle, Dent contends.
“As the crisis unfolds, China and the emerging markets will be forced to reduce their foreign currency reserves,” Dent wrote in his Survive & Prosper newsletter March 4. “They’ll buy less U.S. Treasury bonds, and that will help drive up interest rates in addition to our new tapering policies.”
Rising interest rates will increase borrowing costs, which will shrink business and consumer spending. That will lead to more layoffs and another housing market slump, Dent reasons. The entire world should be concerned as China stands on the brink of an epic financial implosion in the wake of Shanghai Chaori’s bond default, the country’s first. A credit bubble burst will trigger the next Great Depression, says Dent.
By Quynh Ho
The Wall Street Journal China
The Wall Street Journal
The Jerome Levy Forecasting Center
Brian Jackson, China economist at IHS Global Insight
Harry Dent, economist and founder of Dent Research
Patrick Newport, U.S. economist at IHS Global Insight