Wednesday, November 21, 2018

China Has $3 Trillion of Dollar Denominated Debt. That Is A Potential Disaster

One of the most dangerous situations in finance.*

From the South China Morning Post, November 16:

China is underestimating its US$3 trillion dollar debt and this could trigger a financial crisis, says economist
Property developers and other mainland companies and investors that have borrowed dollar-denominated debt at low US interest rates are now facing repayment problems due to Federal Reserve rate increases and stronger greenback
Massive domestic debt has long been a headache for Beijing, but it is China’s growing external US dollar leverage that is being underestimated and it could possibly trigger a major financial crisis, according to Kevin Lai, chief economist for Asia excluding Japan at Japanese investment bank and securities brokerage Daiwa Capital Markets.
China’s US$3 trillion dollar debt makes it especially vulnerable because of tightening US dollar liquidity, a weakening yuan and the ongoing US-China trade war, said Lai.
Global dollar debt outside America has risen to US$12 trillion today from US$9 trillion in 2013, according to Lai. Of that total, 25 per cent, or US$3 trillion, has been borrowed by China Inc and its subsidiaries in Hong Kong, Singapore and the Caribbean. China’s US dollar cross-border claims have risen faster than any other emerging economy’s despite its partially closed capital account.

In response to two financial market challenges – the “taper tantrum” in 2013, when the US Federal Reserve started tightening monetary policy; and an attempt by the People’s Bank of China to reform the exchange rate in August 2015 – China took on even more dollar debt, instead of paying it down and resolving fundamental issues with corporate efficiency and governance.

“Can this trade war push the world’s dollar debt further to US$13 trillion or US$14 trillion?” said Lai, adding that the size of dollar debt globally was probably peaking given US dollar tightening. This would lead to investors selling their assets to get back their dollars and paying back their dollar debt. “We will be talking about a major financial crisis – a dollar debt crisis.”

The amount of dollar debt raised by China in its offshore centres that has entered its banking system is worrying given the prospect of further depreciation pressure on the yuan’s exchange rate, said Lai.
Traders, investors and their clients have in the past taken advantage of a lucrative spread between US and Chinese interest rates to borrow cheap dollar debt and convert it into higher yielding yuan-denominated assets.

But in an effort to support lending and economic growth, the PBOC has raised its rates only slightly in response to interest increases implemented by the US Fed. This has caused the differential between US and Chinese rates to narrow rapidly, to the point where it no longer offsets the cost of paying back the external dollar debt in ever-more-expensive US dollars.

The yuan was changing hands at 6.9439 per US dollar on Thursday, after tumbling 11 per cent since March. For many investors, their comfort zone lies in the range between 6.20 per US dollar and 7.00 per US dollar, so any clean break below the 7.00 threshold could trigger a major bout of yuan selling, forcing its value down further, said Lai.

As a result, dollar loans will become even more unmanageable, leading to more selling of the yuan and a possible negative spiral as the US$3 trillion “carry trade” in dollar debt is unwound.
“We are talking about a huge dollar whammy. If the yuan continues to depreciate then you will see a dollar debt crisis,” said Lai....MORE
Previously on borrowing in a foreign currency:

Our Dec. 2014 post: Evans-Pritchard: "Dollar surge endangers global debt edifice, warns BIS":
Two quick points*:
1) This is the second BIS warning in under six months.
2) It is very dangerous to borrow in a currency other than the one in which you earn your income.

True at retail, true at wholesale....
Reprised in "'Russian ruble's fall: A classic 'currency collapse'" and Why It's Such a Big Deal".

Borrow In Dollars, Pay In Tears 
We've said ad nauseum*:...
"The Swiss franc appreciation and the sorry saga of FX lending"

Remember When the BIS Was Warning That A Strong Dollar Would Wreck Everything?

In Which Izabella Also Comments On Russia and Foreign Liabilities
We beat her to it, I think. Our post "Russian ruble's fall: A classic 'currency collapse'" and Why It's Such a Big Deal" was timestamped at 11:56 am PST while hers is 20:07 GMT. 11 minutes ahead.
Great minds and all that.

From FT Alphaville:

Russian foreign liabilities in perspective
Once upon a time there was a magical land called Ru, where the roads were paved with oil and the houses were built from kitsch gold blocks. Because its capital glistened with a red petroleum hue, it soon became known as the wonderful Crimson City of Ru.

There, all the residents rejoiced night and day safe in the knowledge their needs would forever be catered to. Why? Because the Wonderful Wizard of Ru, known by some as “Ru the great and the terrible”, would forever see to it that his kingdom would be defended from its greatest enemy: the Wicked Witch of the West.

Ru was the most wondrous place in the world.

Nevertheless, because the Wizard was keen to get rid of the Wicked Witch of the West once and for all, he went about making outlandish promises to all those who might be able to help him.

It was at this point that a scarecrow, a tin man, a lion, and even a little girl from another land took up the challenge, believing the Wizard’s claim that the Witch’s death would be in the best interests of all.

And so it was they killed the Witch! And all her quantitative winged monkeys that had blighted the land of Ru for far too long....MORE
Unfortunately pour moi she more than makes up the puny time differential with beaucoup style points.