(By Darrel Whitten) The Eurozone debt/banking crisis really became the investor risk du jour from late 2009. As sovereign bond vigilantes began to heavily short selected Eurozone sovereigns through CDS (credit default swaps), Greece (Q1 2010), Ireland (Q3 2010), Portugal (Q1 2011), Cyprus (Q3 2011), Italy (Q4 2011), Slovenia (Q1 2012) and Spain (Q2 2012) saw their 10-year sovereign yields surge through 7%, a key sustainability level which forced many of these countries to seek bailouts. Once "risk free" sovereign debt held on Eurozone bank balance sheets became toxic, creating a significant number of "zombie" banks that were actually insolvent if holdings of public and private debt counted as assets were marked to market.
Already weak economic activity in mainly the Club Med Southern European countries was exacerbated by demands from the Troika (the European Central Bank, the European Commission and the IMF) for draconian austerity measures in return for bailout funds, and only worsened the dependency on these countries for bailout funds to keep their fiscal finances afloat.
A serious political rift between the Northern European creditors led by Germany and their Southern European debtors seriously impeded the meaningful comprise needed to implement effective countermeasures, and thus the crisis has continued to metastasize, to the point that it seriously threatened the global financial system as well as the global economic recovery.
Has Super Mario Discovered a Euro Crisis Game Changer?
Now, it appears that "super" Mario Draghi, president of the ECB, has made some meaningful headway in dividing and conquering German opposition to the ECB's acting as an urgently needed lender of last resort for the Eurozone. Germany, particularly the Bundesbank, continues to talk tough in resisting more bailouts without extracting another pound of flesh from its indebted Eurozone peers. The fact of the matter is, Germany is eye-deep in the crisis as well, and cannot afford a messy break-up of the Euro any more than their Club Med neighbors.
Germany already has billions of Euros invested in preserving the currency zone, money that so far appears to have disappeared down a black hole, and their exposure to losses from a break-up or exit of other countries is significant via the TARGET2 Eurozone paymenst system. Jens Boysen Hogrefe, an economist at the Kiel Institute for the World economy (IfW), estimates the potential cost fo Germany amounts to about €1.5 trillion, the greatest share of which lies with the Bundesbank. Within the framework of the TARGET2 payment system, the Bundesbank has accumulated claims amounting to about €700 billion, which are expected to grow to €1 trillion by end 2012, of which it could probably only recoup a small portion if the Euro fails, including the €100 billion in bailout funds promised to countries like Greece, Portugal and Spain.
Germany's withdrawal from the Euro would be a disaster for German banks. Thus when push comes to shove in terms of saving the currency union, Germany and the Bundesbank is just as likely to blink as are the Club Med countries now in depression and drowning in debt, as Germany increasingly has more to lose. More details will be forthcoming from a September meeting of the Eurozone minds. If Draghi's plan does work, investors could be facing a temporary melt-up in risk markets, as the worst-case scenarios for the Euro are taken off the table.
But a China Crisis Could Replace the Euro Crisis
While the Eurozone crisis has been front and center on investors minds for the past two years, the movement of Eurostoxx 50 index suggests that the Eurozone is lurching, through fits and starts, in the right direction, while the divergence between the Eurostoxx index and the Shanghai Composite has become glaring.
|Source: Big Charts.com|
As the one economy most responsible for expanding global demand for a range of commodities as well as finished goods such as automobiles and construction equipment, the shock of a marked slowdown in China or god forbid a financial blow-up along the lines of the Japan financial crisis could have even more serious economic consequences.
- China's economy grew at the slowest pace in three years in Q2 as Europe's debt crisis hurt exports and a government drive to cool consumer and property prices damped domestic demand. The slowdown in China is due to overall industrial overcapacity accumulated in recent years. Coal inventories at Qinhuangdao port rose to 9.33 million tonnes on June 17, the highest since 2008, and stories that China is literally awash with excess copper inventories have been making the rounds for over six months.
- Weiqiao Textile Co. says cotton consumption in China, the world's largest user, may shrink 11% this year as deteriorating demand causes a significant overshoot in commodities supply. China's export growth collapsed in July and industrial output fell short of projections, after data showed the second-largest economy grew 7.6% between April and June. The world's largest iron-ore producer flatly states that China's so-called golden years are gone as economic growth slows.
-China's shipping sector has been buffeted by weak global demand and an oversupply glut. An increasing number of Chinese shipbuilders are going under amid flagging demand for new vessels. Zhejiang Jingang Shipbuilding Co
. which had been providing European customers with tank vessels, filed for bankruptcy with a local court in June. Ningbo Hengfu Ship Industry Co.,
which attracted attention in 2007 when it received a $160 million order for four bulk carriers from a German customer. U.K.-based research firm Clarkson Plc says nearly 90% of China's shipyards have not received new orders since the start of 2012.
-Shipping sector woes of course are spilling over into China's shipbuilding indusry. China's Rongsheng Heavy Industries says that first half new orders were a mere $58m versus $725m in the second half of last year, resulting in an 82% plunge in net profit. Accounts receivable as of June surged 13-fold from the end of 2010 as the company allowed more time to settle their debts.
- The HSBC China Manufacturing PMI (which is more reflective of the private sector in China than the official PMI which is more heavily weighted toward state sponsored corps) was 47,8 in August at at a 9-month low. The index has trended under the 50 boom/bust line for 10 consecutive months. The survey shows falling export orders and rising inventories.
- Foreign investors are steeling for bad news from China's four biggest banks as they report first half 2012 earnings. Their interest is how fast these banks loans are turning sour. While the sharp selloff in the stocks of these companies makes their valuations on the surface look cheap, investors aren't buying as they suspect the banks are under-reporting NPLs (non-performing loans), as banks all over the world do when markets start to go bad. Both property loans and exporter loans are a worry. As with Japan's Heisei Malaise, bank analysts and even Bank of Japan officials are warning of major risk developing in the Chinese economy through the proliferation of the kind of "zombie companies" Japan made so famous in its 20-year malaise. Further, banks are reportedly throwing good money after bad to prop up zombie companies because the government is telling them to do so.
The plunge in stock prices of the big four China banks, now among the largest in the world in assets, has exceeded 20%, and China Construction Bank is approaching its 2009 lows. The problems facing China's banks are primarily domestic.
- Kiyohiko Nishimura, the Bank of Japan's deputy-governor and an expert on asset booms, is warning that the surge in Chinese home prices and loan growth over the past five years has surpassed extremes seen in Japan before the Nikkei bubble popped in 1990. Construction reached 12% of GDP in China last year; it peaked in Japan at 10%. Such bubbles turn "malign" once the working age of people to dependents rolls over, as it has long since done in Japan. China's ratio of working people to dependents will peak at around 2.7 over the next couple of years as the aging crunch arrives, and will then go into a sharp descent, compounded by the delayed effects of the government's one-child policy.
-A report earlier this year by the World Bank and China's Development Research Centre warned that the low-hanging fruit of state-driven industrialization is largely exhausted. They said a quarter of China's state companies lose money and warned that the country will remain stuck in the "middle-income trap" unless it ditches the top-down policies of Deng Xiaoping. This model relied on cheap labour and imported technology. It cannot carry China any further.
Thus China's problem may not be simply a question of again opening the stimulus spigot wide.