Markets Tumble On Chinese Growth Fears as Goldman Slashes Growth Forecast
Markets tumbled overnight on fears that China's slowdown will produce the much dreaded hard landing as economists at Goldman Sachs cut the growth forecasts for the emerging market economy. Chinese shares fell over 5 percent while copper tumbled to a new 2013 low on global growth fears.
China's economy has been slowing since the global financial crisis shook developed markets and limited China's export growth. A massive fiscal stimulus in 2009 helped to boost the economy back to high-growth levels through 2010 however increased credit levels in the economy have put a strain on any further fiscal boost while export growth continues to sag.
As Jonathon Laing wrote in this weekend's cover story for Barron's, "The primary fault line in the Chinese economy that worries many has been the explosion in the credit-to-GDP ratio since the onset of the 2008 global financial crisis and economic slowdown, as China sought to stimulate its economy in the face of a lag in its longtime growth engine, exports. This total societal debt load has followed a similar growth trajectory to that of the U.S. and British economies in the six years leading up to the 2008 crisis; Japan's credit orgy from 1985 to 1990, a prelude to two decades of stagnant growth punctuated by bouts of deflation, or Korea prior to the Asian financial crisis."
"According to a report from analysts at Fitch, China's recent credit bubble has topped them all with total debt rising from 130% of GDP in 2007 to 210% in the first quarter of this year. In Japan, by comparison, during the fateful six-year credit bubble, the jump in the ratio was just 45 percentage points, from about 150% to just over 195%."
Turning Off the Spigot
Rather than step in to ease monetary conditions and prevent a banking crisis, the People's Bank of China (PBOC) has actually been withdrawing liquidity from the interbank market. Two short-term note sales in early June withdrew much-needed capital from the interbank market after a national banking holiday had already seen a large outflow of deposits from banks. The timing also coincided with companies withdrawing money to pay taxes.
The PBOC did purchase some bills late last week in an effort to ease interbank strains. Overnight lending rates, measured by the overnight Shanghai Interbank Offered Rate (SHIBOR), have eased substantially following the sharp spike late last week. The overnight lending rate has declined to 6.489 percent after peaking well over 10 percent last week.
"The past five years has seen the explosion of China's shadow banking system that largely operates in a regulatory realm outside the direct control of Beijing, and yet last year was estimated to have accounted for more than 45% of China's credit creation," writes Laing. "This burgeoning nonbank channel comprises a crazy quilt of institutions and investing instruments that extends from off-balance-sheet offerings of wealth-management products from traditional banks to the credit wares of brokerage houses, pawn shops, and credit-guarantee loan paper. Even the fast-growing Chinese bond market can be chaotic, with four regulators, poor disclosure, and credit-rating inflation."
As if the extremely negative assessment in the ever-popular Barron's this weekend wasn't enough to affect markets, the economics team at Goldman Sachs lowered its growth forecasts for the Chinese economy over the weekend. Goldman is just the latest bank to cut forecasts for the Chinese economy.
Goldman now forecasts an annualized second quarter growth rate of 7.5 percent for China, down from the previous estimate of 7.8 percent. For the full year 2013, they expect growth of 7.4 percent vs. the prior estimate of 7.8 percent and also lowered 2014's growth forecast 7.7 percent from 8.4 percent.
However, Laing says that China has weapons left in its arsenal to avoid a collapse and keep the economy chugging along. "[The PBOC] could unleash some of the CNY19 trillion that its central bank holds as loan reserves, or deploy the $3.38 trillion (CNY20.7 trillion) in foreign-currency reserves, though much of that has already been committed."
"Beijing also could sell part of its interests in its state-owned enterprises, though Chu reasons that the central government would be reluctant to dump such assets at "fire-sale prices." As a last resort, China could also print money, adding to the rapid monetary growth of recent years."
Markets tumbled on the outlook cut and on general fears that China will not be able to avoid the much dreaded hard-landing in China. The Shanghai Composite Index fell 5.29 percent while the CSI Index of the 300 largest companies dropped a whopping 6.31 percent. Most major European indices traded down nearly 2 percent while S&P 500 futures fell 16.3 points to 1,567.80.
Industrial metals were crushed as copper fell to a new 3-year low. Copper futures fell 2.63 percent to $301.85 after posting a new low earlier. Meanwhile, the Australia dollar, a proxy for industrial commodity demand, fell 0.46 percent against the U.S. dollar and made a new multi-year low as well.
Materials and commodity-price sensitive stocks in the U.S. plunged pre-market on lower metals prices and weaker demand outlooks. U.S. Steel (NYSE: X) fell 2.69 percent pre-market while Freeport McMoRan-Copper and Gold (NYSE: FCX) shares fell 2.34 percent and Deere and Company (NYSE: DE) declined 2.55 percent. Overall, investors sold anything and everything that was sensitive to growth and commodity prices.
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