HONG KONG (MarketWatch) — While China’s first-quarter growth figures pleased some analysts enough to upgrade their forecasts, George Soros was not impressed. Doubling down on his earlier comments that a hard landing for China was inevitable, he now says China’s is facing a financial crisis similar to the U.S. in 2008.
While such warnings over debt-fueled growth have become increasingly regular — both S&P and Moody’s cut the sovereign credit outlook to negative in March — at the same time, China has proved remarkably adept at kicking the can down the road.
The voice of legendary investor Soros carries considerable weight — but are we really any nearer that crisis point?
The counter argument is that China is different due to its sheer size and the ability of a one-party government to exert unprecedented control over the economy. This would mean conventional analytical tools or assumptions have to be jettisoned. Hard landings, financial or currency crisis would never quite materialize as we expect.
Of course, similar “this time is different” arguments were expounded during the 2001 tech bubble and then again with the U.S. property market prior to the 2008 global financial crisis.
Perhaps once again it is not different, just the timing is out.
There certainly appears to be evidence of stress building, even if authorities continue to paper over any cracks.
One place to look would be interbank liquidity, given this was a key vulnerability during the global financial crisis. On the surface things are relatively benign, although this is in a large part due to huge central-bank intervention. This past week alone, the People’s Bank of China pumped 870 billion yuan into markets to ease a cash drain.
Another early reliable indicator is financial stress in bond markets. This column recently highlighted that China’s corporate bond market has looked like the new weakest link. After the year began with record domestic issuance, liquidity could now be drying up, with reports over 40 companies have canceled planned issuances since March.
Then there are sovereign bonds. Here, authorities will be hoping for a healthy appetite as a glut of bonds from local governments will be hitting the market this year.
The most obvious recent sign of building financial stress is in China’s currency markets.
China’s loosely pegged exchange rate USDCNH, +0.2461% has been under intense scrutiny as its foreign reserves shrink — now down $800 billion since the middle of 2014.
At the same time, China has been tinkering with moving to a more market-driven exchange rate and two mini-devaluations — one last August, and again at the beginning of this year — did not go well. Both lead to big selloffs in global markets and appeared to trigger further capital outflows.
This puts authorities in a bind as in order to defend its loose peg to the greenback, dollars have to be used up, draining liquidity from the domestic economy. And looser monetary policy can just lead to more capital exiting.
March appeared to see some stabilization in reserve depletion, yet there is still reason to be concerned the long-term trend is lower.
Indeed, some analysts argue that China is facing a steep depreciation in its currency, whether or not we get a financial crisis or economic hard landing due to continued imbalance in capital flows.
Last week investment house CLSA issued a report arguing China will have no choice but to let the yuan float freely by 2017. This epoch-like embrace of the market will lead to the yuan initially falling more than 25%, it predicts.
The pain point for China is its financial account, as surging capital outflows continue to dwarf the current account surplus.
There is no issue with China’s current account, which remains in surplus. For instance it posted a record $365.7 billion trade surplus with the U.S. last year.
CLSA says China’s current policy of a gradual depreciation or crawling peg cannot fix its financial account problem. In fact it can even make things worse, as it signals a one-way bet.
This backs Beijing into a corner. Faced with an inexorable depletion in foreign-exchange reserves, the only way to find balance is through a market-driven exchange rate. This would enable “price discovery,” based on anticipation of profit by buyers and sellers of the yuan.
The problem, however, is that this process can be brutal as the currency’s value is left to the market.
As usual, George Soros’s warning needs to be taken seriously. China’s size means it certainly is different. But this could also mean it faces a different, bigger credit unraveling or the next financial crisis.