China Banking Crisis Coming?

Bloomberg.com is reporting that China May Face ‘Massive’ Bank Bailouts After Stimulus Program.

One year ago the L. A. Times reported on a raft of empty, "see-through" office buildings in Beijing, built for political reasons. This article suggests that just as the academic and Big Finance economists who warned that the U. S. housing market had levitated into a bubble were proven correct, foreigners who have no first-hand knowledge of what's going on in China are wise to be cautious about its real prospects. From the article:

China may be forced to bail out banks that made loans for local-government projects under the unprecedented stimulus program unleashed in 2008, according to Citigroup Inc. and Northwestern University’s Victor Shih.

In a “worst-case scenario,” the non-performing loans of local-government investment vehicles could climb to 2.4 trillion yuan ($350 billion) by 2011, Shen Minggao, Citigroup’s Hong Kong-based chief economist for greater China, said yesterday.

“The most likely case is that the Chinese government will engineer a massive financial bailout of the financial sector,” said Shih, a professor who spent months researching borrowing by about 8,000 local government entities. . .

Shih was more pessimistic than Shen in an interview on Bloomberg Television in Hong Kong yesterday. He said that if the central government stops lending to the entities now, the cost of a bailout may already be “in the neighborhood” of 3 trillion yuan. . .

The article more briefly presents some other viewpoints and is worth reading by many investors, given China's role in the commodities market. If China cools off, all commodities price will tend to follow. If China actually experiences a bursting bubble, it's a look-out-below scenario at least for a while for a great many markets with the possible exception of gold, which one of these days may stop tracking the stock market.

The larger context of the above issues is that it is a fact that China went on a credit binge in the aftermath of the fall 2008 global financial crisis. The U. S. government has done the same with the collaboration of the Washington-based Federal Reserve Board (which for all practical purposes is a public-private entity with the emphasis on public and thus is currently best thought of as an arm of the Federal government and the privately-owned New York Federal Reserve Bank). Certainly Britain has moved almost in policy lockstep with America. The countries with better banking regulations such as Canada and Australia actually may have their own housing bubbles or at least significant booms. Japan has continued to print money.

In other words, major governments all over the world have responded to a crisis caused by too much debt by socializing the losses at the cost of new government borrowings. This means that the return of corporate profits is largely due to money-printing rather than corporate brilliance, the sudden implementation of major cost-saving measures (other than such examples as IBM slashing R&D expense), or organic growth.

Gallup.com's near-real time polling data show that hiring/not hiring remains mired where it was 16 months ago. The same % of people think the economy is poor as thought so 20 months ago.

The stock market has bounced and hiring has lagged, just as predicted by Reinhard and Rogoff's research into banking crises ("This Time Is Different" is their ironically-titled book on the subject).

Almost every economist, investor and day trader "knows" that we are in a sweet spot of the investing cycle, with the economy due to turn up while the Fed remains easy, valuations are (allegedly) cheap to reasonable, and that happy days will be here again so that there will be gullible investors to sell overpriced stock to. Even hard-headed Andrew Smithers has sounded a softer tone, despite his own research showing that historically, this is a miserable time to be in the general stock market.

While Bloomberg is reporting that only now has American investor optimism replaced pessimism, my own review of Value Line's stock charts shows no bargains. Whether or not they have been optimistic, stock prices are "too high" or at least too high for current profits, asset value and dividends in my view for most individual issues, with the "junk" the worst buys.

MCD is my current favorite of the quality stuff, based on various chart patterns, recent operational news, and other criteria. Of greatest importance is that while it has not quite traded above its all-time high of mid-2008, its 50-day and 200-day moving averages are both at all-time highs. So this recent move to $65 and above is well-supported. This thinking worked out well for gold last summer. Even if MCD doesn't go up in price, its yield beats cash and is close to that of a 10-year Treasury and is likely to rise steadiliy in the future.

A few working days ago, I spoke favorably of long Treasuries for a trade (TLT). I closed that trade out with a small profit Friday. TLT went up a little more after I sold it. Any government as powerful as the U. S. government can keep supplying enough bonds to the market to overwhelm the possibility of meaningful price appreciation. It appears as though this administration, with the support of Congress, means to do just that. Perhaps by November, China will be seen to have a bursting bubble, a Perot-like zeal to shrink our Federal deficit will have gained real power in the elections, and Treasuries can surge up in price (down in yield) as David Rosenberg has been forecasting for some time.

Thus a core holding in Treasuries is reasonable, but it should be in direct ownership of bonds, not in a perpetual fund that in theory could provide zero nominal return indefinitely. The Japan scenario remains a realistic possibility for the U. S., which would surprise almost everyone, perhaps even the Japanese.

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