Fear And Loathing At The PBOC: China’s Fragile Financial System Rules Policy

Earlier in the year, China was the primary topic of conversation as its economy teetered upon the precipice of the great unknown, growth less than the “minimum”, while corporate defaults suddenly became somewhat contagious. At the time, monetarists globally were unconcerned despite the outward projection of a high degree of disorder because they “knew” the PBOC was “in control”, going so far, so they claimed, as to rejigger the yuan-dollar balance.

Since then, China has somewhat disappeared. Some of that has to do with the nature of attention, and those whose little and short spans are hardwired as such, and that turmoil has ebbed and flowed its way elsewhere (in Asia, Japan took center stage and not in a “good” way).

This quiet in China has reinvigorated the “worst is behind us” narrative, bolstered, seemingly, by recent GDP and sentiment survey results. However, the similarities in China echo, eerily I might add, such quiet as was “engineered” in the US in the months after Bear Stearns. Then too, the US economy looked to be on the mend as a positive GDP report and more than a few rising indications and sentiment surveys hid the roiling decay from obvious sight. But it was still there, gaining critical mass and awaiting the final fracture.

With the benefit of time, we can begin to piece together what has come from the PBOC’s grand experiment. There is little doubt now, in my mind, that in “allowing” a few defaults earlier in the year and forbidding the continued shadow expansion (at the same time) the central planners in Beijing were trying to gauge how “markets” would respond to real consequences. With all that took place, it became clear just how easily conditions could spin out of control.

And that was, I think, the conclusions reached by policymakers. The monetarists were not controlling the market at all, certainly not for dollars, and it horrified them to have to widen the dollar-yuan band enough to devalue – to let dollars into their country that was both starving for and desperately needing them.

What has been less publicized is that the PBOC has regained its monetarist and “easing” impulses. So much for sending signals that this was a new era of reform, in April regulators allowed several builders to sell debt notes and even private placements of shares. The intended functions of such debt sales were not to bolster company finances, but simply to prevent further default events. Issuing debt to repay old debt more than smells of that Minsky-ism that came so thickly in the air during the “test phase.”

As the Wall Street Journal observed this weekend,

On Wednesday, construction company Huatong Road & Bridge Co. somehow found the funds to make a bond payment that it had earlier warned it would miss. With China’s second-ever corporate default averted, investors could for now set aside fears of a wave of bankruptcies. But any student of finance knows that postponing defaults will build up bigger problems in the future.

Again, the mainstream narrative is for PBOC omniscience in all monetary things, including debt and currency. And the recent moves in allowing these new financings to take place might seem to add weight to that sentiment, but I think it rather clearly shows, in the right contextual framing, that the PBOC is not in control of “markets” but deathly afraid of them. To change course so suddenly, after making such a spectacle about debt and finally controlling the out-of-control shadow markets, is more than highly suspicious.

Fragility is the pre-requisite condition for massive dislocation. Fragility itself is found symptomatically in asymmetry. The extremely small defaults of earlier in 2014 should not have, to use orthodox economics’ own terms against it, ceterus paribus, produced such massively negative struggles in Chinese debt markets, yuan funding markets and even dollar strain. The asymmetry of it all describes, not suggests, the key state of criticality.

That the PBOC would contradict itself, and its most recent political mandate, in search of “extend and pretend” estimates the level of decay and the dangers of its further revelation.

It is not just the PBOC, as all central banks have come to fear the imposition of market forces now even seven full years after the first rumbles of “unexpected” dis-containment. Janet Yellen openly claims that markets are the problem, but she never accounts, wilfully, for the use of such “markets” as a policy tool on the way up. When tracking the “right” course, markets are efficient and regular, but if they should reveal such artificiality that leads to fright and flight, then markets suddenly transform into deep pools of illogical irregularity. There is a deep inconsistency at the heart of not the marketplace, but in the dark recesses of monetarism’s greatest flaw.

The use of “markets” as a policy tool is the greatest economic problem of the 21st century, and it has only grown in size, scope and, unfortunately, potential since 2007. A central banker fears not really markets, but rather what he knows about himself but will never fully admit. That markets will, eventually as Herb Stein once wryly observed, reveal all his efforts as nothing more than a crafty illusion, not full of economic miracles but the criminal impoverishment of all those he meant to supersede.

The only way to justify heavy mismanagement of this type is to proclaim the markets insane when it is the creation of bubbles and nightmarish misallocation of resources that markets actually attempt to reveal.

“It used to be that the China bears mostly cited anecdotes and bulls mostly cited statistics,” Mr. Adams says. “Now a bear doesn’t need 100 photos of ghost cities—the outlook from the statistics has weakened.”

Again, fragility sneaks out in several ways heightening more the potential asymmetry of future events. China may have found itself out of the spotlight for now, but the cracks are still there, papered over in the glaze of no other options left consistent with preserving the monetarist paradigm. If it makes some investors feel better to think that central bankers have exercised full control throughout, they might be shocked to see that it is not control but utter and terrifying fear. The head of the PBOC said it best earlier this year:

Our choice has its own rational reasons behind it. But this choice also has its costs. For example, whether we can efficiently cope with asset bubbles and inflation is questionable.

Make no mistake, allowing debt to be used to temporarily rescind default is barely “coping with asset bubbles” and close to the direct opposite of “full control.”


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