China is heading into an economic perfect storm
One of the funny things about debt is that, according to some economists, there's in theory a good reason why, if you're big or rich enough, you won't have to pay it back. Certainly, in times of low inflation, low interest rates and high levels of liquidity, entities with lots of assets and desirable businesses can repeatedly refinance.
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At the focal point of concern for foreign bond investors, and which is leading to considerable wringing of hands, is distressed debt manager China Huarong Asset Management collateralising the bad debt it has purchased as good debt, backed by its Hong Kong subsidiary.
China's debt markets are maturing, with tighter regulations, an expectation that risk assessment improves, and perhaps more of a "buyer beware" attitude, with investors increasingly cognisant that the state cannot be expected to rescue everyone. But the sea of debt is getting choppy.
The jump in prices of commodities, exacerbated by speculators, is now filtering through into a multitude of manufacturing components and finished products. This suggests a return of inflation in the near term as the trend is starting to look prolonged, which will certainly be bad for consumption and business globally, and at the same time may contribute to a further increase in loan defaults.
The actual mix of China's foreign reserves is a state secret, so we will not get a clear idea of how many US dollars remain in the coffers. But it is safe to say that its dollar reserves have likely been depleting. US dollars are important, as most commodities are priced and generally paid for in the currency.
Overall, China's forex reserves in March fell further than economists expected, to US$3.17 trillion. Still, the balance is an enormous amount of money, which peaked at nearly US$4 trillion in 2014, and yes, it ticked up in April to US$3.19 trillion. But the question is: is it now back in a downward trend, having fallen from US$3.21 trillion last December? The value of China's gold reserves also fell, with no apparent increase in the quantity of bullion held. It makes sense to be frugal for the moment.
As a large importer of ore, concentrates, crude oil and non-ferrous metals, particularly copper, China's demand for some of these raw materials may already have peaked. And as the government clamps down on speculation even as property development hits a speed bump, prices of hot commodities are likely to reverse soon. Easy credit has also been a driver of commodity prices, so if the peak in easy credit has been reached, then we should expect prices to correct soon - copper premiums are already starting to fade as demand at these higher prices wanes.
For that reason, I expect there to be growing pressure, and with it more opportunities, for Hong Kong to look towards the Greater Bay Area, with a view to speed up integration by moving businesses and housing that way to harvest Hong Kong's money and invest it there rather than, for example, concreting my backyard in Lantau. At least, that is my hope, because if China needs to ride through one hell of a storm and needs to keep the Greater Bay Area moving ahead at the pace expected domestically and internationally, I would guess the branch offices will be expected to man the pumps.
Neil Newman is a thematic portfolio strategist focused on pan-Asian equity markets
This article originally appeared on the South China Morning Post (SCMP).
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