Aspire CPD

Big PictureEconomicsMacro TrendsSMSF Strategies

Time for a financial crash?

24 Sep 2021 7 month(s) ago

What is happening in China could be a trigger for the next global financial crisis. The markets are interconnected and flimsy, and we have seen this kind of thing before.

The next crash is never the same as the previous one. In 2008 it was arguably China’s stability that stopped the global banking system from imploding. This time around it may be China that triggers a crisis.

As analyst Greg Hunter comments:

“It looks like we are on track for yet another global financial meltdown.  This time it is coming out of China in the form of a failed property development company called Evergrande. 

“It’s five times bigger than Lehman Brothers, whose failure cratered the global economy in 2008.  Will central banks, including the Fed, just let it all fail or will they print massive amounts of money trying to stop the fall?   If history is a guide, we should get ready for the most money creation ever.”

What does this mean so far for investors in the global environment? In the GFC doing nothing was usually the best strategy, because to do something was to sell at the bottom. Those who held on to their shares instead of sellling, for example, saw share prices plummet but then got extremely good returns as the markets recovered.

The witty aphorism: 'Don't just do something, sit there,' proved to be highly applicable.

Financial writer John Rubino says there are some small signs of the markets being rational:

“Stocks are tanking, cryptos are tanking, currencies of the world are getting volatile, politics are volatile and gold is going up while all this is happening, which it is supposed to do.  Gold is supposed to be the safe haven where you hide out when nothing else seems trustworthy...

“That hasn’t been the case in prior bear markets.  When stocks tanked, they pulled down gold and silver... It’s a good sign when markets start to behave rationally again. 

“When high risk assets don’t seem worth it anymore, capital flows into real assets that hold their value no matter what the government is doing to the currency.  That’s the way it’s supposed to work, and that is the way it is working...”

Shares in the Australian market, which are on only half the valuations of US stocks and are underpinned by high dividend yields, are probably much more protected than in the US. But what matters is trust, which is what the financial system’s survival depends upon. If trust goes, everyone will be affected, as Rubino comments:

“Trust is probably the key word in this whole discussion.  Fiat only exists because we trust the people who are managing them to maintain their value.  You take the trust away and there is nothing there.  A fiat currency is not a real thing.  It doesn’t actually exist other than little pieces of paper that have no intrinsic value or computer code, which also has no intrinsic value. 

“So, you take away the trust that we had in the Fed, Treasury, Congress and the President to do the right thing, and be honest, when it comes to the financial markets, you take that away and there really isn’t anything there.  Nobody would want to hold a currency managed by people they can’t trust.  Pay attention to that because the less we trust the guys in charge, the less we trust the currency. 

“The less we trust the currency, the less we trust the financial markets and the less valuable these financial assets are.  So, it all ties together, and it all depends on that one word—Trust.”

What should be created is a trust index for different financial markets, which would probably be a good leading indicator. The loss of trust is what happened in the global financial crisis. The banks stopped trusting each other – they realised other banks were just as dodgy as they were – and so they stopped lending to each other in the interbank lending market. Such lending is the lifeblood of the system, like the blood supply in the body, and when the interbank lending rate rose the whole system froze and was only just bailed out.

The attack on trust this time is likely to come from China. The country's internal debt is a perilous 260% of GDP:

Analyst Antonio Graceffo describes how bad things are in that country, which, according to a lot of Western analysts, is on an inexorable rise.

“Over the past several years, China’s corporate debt to GDP ratio has been steadily increasing. In 2017, it hit a record 160 per cent, up from 101 per cent 10 years earlier. Chinese leader Xi Jinping has made it a priority to rein in the debt, particularly in China’s $10 trillion shadow banking sector.

“Local government financing vehicles (LGFV) have defaulted on many trust loans in the shadow banking system, but not on a public bond. So far this year, 915 million LGFV have defaulted. This so-called hidden debt of local governments has become so pervasive that Beijing has identified it as a national security issue.

“Investor confidence has been shaken, as both private and state-linked companies, once considered safe investments, have been in default. The danger is that investors, fearing contagion, might panic and begin selling off both good and bad debt, driving down the market.

“A complete collapse of Evergrande could cause widespread economic turmoil and even civil unrest. The future of Evergrande and the Chinese economy depends on whether the central authorities will allow Evergrande to go into default, leaving its creditors high and dry, or if the Chinese Communist Party will intervene in order to maintain stability.”

The aggregate picture is pretty bad, as Graceffo describes:

“China’s public debt already stands at 270 percent of GDP, and non-performing loans have hit $466.9 billion. In addition to existing economic challenges, real estate giant Evergrande Group has signaled that it may default on payments owed to creditors.

The company now owes total liabilities of $305 billion, making it the most indebted real estate developer in the world. It’s also the largest issuer of dollar junk bonds in Asia. Evergrande owes money to 128 banks and more than 121 non-banking institutions

“Evergrande accounts for 4 percent of total Chinese real estate high-yield debt. The company’s debt is of such significant size that it may pose a systemic risk to China’s banking system. Late or defaulted payments by Evergrande could cause a chain reaction of defaults across institutions. An Evergrande sell-off could drive down prices, crashing overleveraged developers. Authorities worry that this threatens to destabilize the entire real estate sector, which makes up about 30 percent of the Chinese economy.”

Expect the Chinese authorities to crack down even harder on their citizens as the CCP fear of a backlash intensifies. Foreign companies investing in China will do very badly; indeed that process has already started. And the flimsiness of the global system will be exposed once again.


Reader note: This is general reporting only and should not be considered in any way to be investment or tax advice. It does not take into consideration the investment objectives, financial situation or particular needs of any particular investor. For more information please read our disclosure statement.

Related Article(s)