My latest touch-point this week concerns China’s risk to the world –which is not its economy but its financial markets.
In today’s China, it’s the financial tail that wags the economic dog.
China’s financial equivalent to Iraq’s WMDs (Weapons of Mass Destruction) is its WMPs (Wealth Management Products), aka Worrisome Mass Problems.
Hopefully, like Iraq’s WMDs, it turns out to be non-existent, but this excellent Bloomberg article today sheds light on the risks of China’s WMPs.
Financial, rather than economic risk, is not new. The USA’s Roaring 20s economic boom was skewered by the 1929 stock market crash that led to the Great Depression. The 2008 Global Financial Crisis (GFC) triggered a global economic slowdown, and the Asian financial crisis of 1997 was exactly that –a financial crisis that led to deep recession in much of Asia.
In all cases, it was a combination of
A. excess financial capital being poorly deployed
B. risks not accurately calculated
C. a mis-match in asset/debt maturities and money flows leading to liquidity-freezes
D. regulations not keeping up with financial engineering
E. mania-type conditions amongst the investment public (and financial services firms that fed on them) both when markets rose (“don’t worry, markets won’t fall, this time its different”) and when markets fell (“don’t worry, I will get out before everyone else does…but everyone else is saying this”).
It’s so obvious when explained with the benefit of hindsight, but even the best brains in the business* at a time of mania miss the warning signs. It’s not helped by celebrity perma-bears crying wolf so frequently in the years before the peak, that investors, by the time of peak-mania, are already tuned off to any more bears and their so-far-to-date-false warnings.
*best brains like Long-Term Credit Management, a giant US hedge fund that imploded following the Russian bond crisis of 1998. The team at LTCM included Nobel Prize winners in Economic Sciences.
The key insights on China’s WMPs are:
- There is $9 to $12 trillion invested in Chinese WMPs and other under-regulated investment products distributed by banks, asset management firms, trusts, brokerages and private funds. (The products are not in the bank balance sheets.)
- In comparison, the Chinese stock market is worth around $7t, Hong Kong’s market $4.5t, the US $26t and Australia $1.5t (all in USD).
- WMPs have grown in size from ~CNY5 trillion in 2011 to nearly CNY30 trillion in 2016. Six times larger in just 5 years.
- Investors in WMPs are Chinese ‘mum and dads’, and high-net-worth buyers who believe there is an implicit guarantee from the Chinese government (via State owned banks) that these WMPs will not collapse. The government is trying to say otherwise. This is the biggest worry-point.
- China’s WMP and other non-bank asset management sectors in China has been rife with frauds, Ponzi schemes, non-transparency and poor regulation (hence the term ‘shadow banking’).
- Regulators are working on cleaning up the sector –but see D above –even experienced regulators globally have trouble keeping up with the markets.
- WMPs invest 40% in bonds including corporate bonds with exposure to real estate and corporates, 10% in equities and mutual funds, and 17% in non-standard credit assets and 15% in the money market. Just 18% in the ‘safe’ cash and bank deposits. And China’s economy is slowing, especially in construction and real estate.
- Interestingly, Bloomberg reports that of the 181,000 products that matured in 2015, just 44 suffered a loss. Most of these 44 were sold by foreign banks. One could speculate that foreign banks have higher standards of corporate governance and are reporting more accurate returns than their less related non-bank Chinese counterparts. But if foreign issued WMPs are actually losing money, are locally issued WMPs also losing money but just not reporting it? The counter argument is that foreign banks are lousy at investing in China and the locals do a far better job.
In summary, WMPs in China are a big part of the nation’s financial markets, and represent a systemic risk.
To get real insights on the overall China market, it may be better to track what’s going on with Chinese WMPs rather than tracking economic commentary.
After-all, money talks louder than analyst chatter. Just look at today’s headlines about North Korea and their nuclear threats and imminent war. The South Korean stockmarket today is up!
Meanwhile, my lunch-seminar on high-net-worth SIV /Chinese in Australia on track for full capacity. Please register soon to ensure you get a seat at the table!