The world financial system stands on the brink of a second credit crisis as interbank lending shows increasing risk
The world economy stands on the brink of a second credit crisis as the vital transmission systems for lending between banks begin to seize up and the debt markets fall over. The latest round of quantitative easing from the European Central Bank will buy some time but it looks like too little too late.
It was the collapse of US house prices back in 2007 that resulted in the seizure of the credit markets and banking crisis of 2008. And it would be easy to lay the blame for the 2008 financial crisis at the doorstep of American home owners, easy but wrong. The collapse of the US housing market was not the cause of the crisis, it was merely a symptom of the more insidious ills of cheap credit, low risk and the promise of another bailout round the corner.
The Keynesian pump priming that has taken place on a colossal scale across the world is failing. The Chinese economy was growing at 12pc in 2010, but that slowed to 7.7pc in 2013 and 7.4pc last year — its weakest in 24 years. Economists expect Chinese growth to slow to 7pc this year. It is the once booming property sector that has turned into a bust, and is now dragging down the wider economy as the bubble deflates.
The second global credit crisis is now already unfolding in China some 6,800 miles away from the epicentre of the first in the US. The bonds of Chinese real estate companies are now falling like dominoes. Kaisa, a Shenzhen-based, Hong Kong-listed developer that raised $2.5bn on international markets had to be bailed out by rival group Sunac last week after it defaulted onits debts. The bonds of other Chinese real estate groups such as Glorious Property and Fantasia have also sold off heavily as the contagion spreads.
Chinese authorities have responded to try and contain the situation. The People’s Bank of China introduced a surprise 50-point cut in the Reserve Requirement Ratio (RRR) from 20pc to 19.5pc. But this misses the point, the credit system in China is completely unsustainable unless new money is printed every year to refinance the old, simply tinkering to ease liquidity won’t cut it.
The strain in its banking system is highlighted by the elevated levels of the Shanghai Interbank Offered Rate (SHIBOR), which shows Chinese banks are worried about lending to each other.
There is no schadenfreude in watching China unravel. The idea that this is an isolated incident is laughable, remember the very same was said of US subprime. The problem is that banks such as Standard Chartered and HSBC have both rapidly increased their lending operations in Asia since 2008.
Loans are very easy to make, it is getting the money back that is tricky. If loans go bad in Asia they will ultimately have to be recognised on the very same group balance sheet from which finance is extended here in the UK. So, the contagion can quickly spread from the Chinese property market to a poorly funded UK bank that has never set foot in Asia. That is because UK banks borrow billions in short term funding from each other. Loan losses in China can very quickly become a UK problem.
The London Interbank Offered Rate (LIBOR), a guide to how worried UK banks are about lending to each other, has been steadily rising during the past nine months. Part of this process is all a healthy return to normal pricing of risk after six years of extraordinary monetary stimulus. However, as the essential transmission systems of lending between banks begin to take the strain it is quite possible that six years of reliance on central banks for funds has left the credit system unable to cope.
It seems nothing has been learned. The response to the underlying causes of the first global financial collapse, namely cheap debt, low risk and bailouts, has simply been a heroic effort to create cheaper credit, lower risk and even larger bailouts. It hasn’t worked.
A new study reveals the staggering scale of the problem as global debt has ballooned by $57 trillion since 2007 to reach about $200 trillion, according to McKinsey & Co. The main culprits of monetary expansion has been China, which launched a 4 trillion yuan (£386bn) stimulus package, the US Federal Reserve has launched three rounds of QE adding $3.7 trillion worth of assets to its holdings, the Bank of England has spent about £375bn and Japan has increased its asset buying programme to 80 trillion yen (£454bn) a year, up from the previous rate of 60-70 trillion yen.
The money has flowed the path of least resistance into the assets that provide the greatest return. Equities have soared and the stock markets in the UK and US are just shy off record highs. Taking a look across the companies who’s shares have benefited it is the new technology stocks that have risen the fastest and sit on the highest valuations.
Like every stock market mania, the most overpriced assets are the ones furthest divorced from any sound valuation. Eye watering prices are paid for companies with less than 50 employees using a “this time it’s different” formula based on clicks, eyes, views, or active members to persuade investors to part with their savings.
Some truly bizarre asset classes have sprung up like mushrooms in the fetid ground of quantitative easing. The crypto-currency of Bitcoin is perhaps the greatest example. Bitcoin has no central bank and only exists online as a virtual currency. It is seen as a rival to traditional state controlled money and payment systems, but in reality they are two sides of the same coin. Bitcoin flourished as quantitative easing was expanded, soaring in value by more than 700pc in 2013. Now quantitative easing has ended Bitcoin has collapsed.
US Money printing has boosted all markets to record highs
The fledgling crypto-currency hasn’t been alone in retracing its central bank funded gains. All asset classes are now crumbling. The oil price has collapsed from $115 per barrel in June last year to about $52 at the end of last week, iron ore has slumped from $140 per tonne in January last year to $62 per tonne at the end of last week.
It is not only asset classes that that are wavering, the key indicators of international economic activity are also flashing red. The Baltic Dry Index which is seen as a leading indicator for world economic growth tumbled to a 29-year low at 559 points last week.
The second credit crisis is already unfolding in China and the latest round of European money will struggle to halt the contagion in credit markets.
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