Getting straight to the point – last October I wrote an article covering the record onshore bond defaults happening in corporate China (read here if you haven’t).

I wrote… “So after including the 11 defaults between Jan – July, this brings the total to 19 new defaults in only the first 10 months of 2018. . . This is a record year for both new defaults and the amount of bonds defaulted on. . . Soon, instead of focusing on ‘positive GDP growth’. And ‘increasing middle class wealth’, investors will fixate on short-term dollar debts owed by Chinese companies. And their potential risk of default. They always do. . .”

And just so you’re aware – the rest of 2018 (October – December) wasn’t any better.

There was an additional 30 billion of yuan in missed bond payments – which totaled 120 billion for the year (that’s up 400% more than 2017). . .

And I believe this trend’s set to continue in 2019. There’s already more than 10 billion of yuan worth in defaults so far this year.

Adding to this grim outlook – two massive Chinese firms recently missed bond payments.

The First – China Minsheng Investment Group Corp; a private investment group involved in renewable energies and real estate – hasn’t repaid their bondholders from what they pledged to repay earlier this month.

And the Second – Wintime Energy Co.; a firm that works in the coal industry – didn’t repay part of their restructured debt repayment plan. (This is the second time Wintime defaulted – the last being in October 2018).

This default news is very important because as Bloomberg noted, both companies were large borrowers.

To put this in perspective – if China Menshing Investment Group Corp ends up in a complete default, it will rank as one of China’s largest failures with 232 billion yuan of debt (as of June 30).

That’s almost double the amount defaulted on over the entire last year in China.

And if they’re having trouble finding access to credit – this suggests other firms are also. And there’s still more than 5 trillion yuan (over $700 billion in USD worth of onshore bonds) maturing throughout 2019.

This means the Chinese governments ‘vow’ to support the teetering $11 trillion Chinese bond market isn’t really working. And increasingly looking very expensive.

It’s clear bond investors are rapidly losing faith. Just look at the spread between China’s top-rated bonds and junk bonds – it’s at its largest in seven years.

Here’s a little background about why this is happening. . .

The larger deficits by the U.S. Treasury and liquidity crunch from a strengthening U.S. dollar in 2018 (thanks to the Federal Reserve’s hiking and Quantitative Tightening program) kicked off a global dollar shortage. (More on this here).

The higher U.S. rates gave investors higher yields on the safest debt in the world (U.S. bills and bonds). Which sucked dollars out of the Emerging Markets (why invest there when you can safely in the U.S.?). This has made it much more expensive for foreign entities to borrow dollars. Which is worrisome as there’s a wall of Chinese corporations facing debt maturities this year in 2019 that they need to roll over (refinance).

This all helped trigger China’s record onshore bond defaults in 2018 (and with much more on the way). They are having trouble raising capital to repay old debtors – let alone make enough cash flow from business operations to even pay the minimum interest due.

For instance – as CNBC wrote, “Twenty-six companies that defaulted this year (2018) face further maturities on 63 bonds worth a total of 53.3 billion yuan in 2019, and have issued 5.4 billion yuan worth of bonds with put options that can be exercised next year..”

Combine this with the slower economic growth coming out of China, an unresolved trade-war with the U.S. – and you have a potential crisis.

Don’t let the recent seasonal boost in Chinese data fool you – things are looking truly ugly.

And like Hyman Minsky – one of my favorite economists – taught us with his Financial Instability Hypothesis (FIH). Once debtors must borrow new debt to simply repay interest on maturing older debt (aka ‘the ponzi stage’) – a banking crisis is around the corner.

China’s latest massive credit injection shows their leaders are desperate to keep the ‘we have this under control’ perception alive. But that will only kick the ball down the field as now there’s even more debt.

So – to summarize – China’s economy and credit market are both extremely fragile. And I’m now officially short corporate China. . .

AS A DISCLOSURE: Because of the asymmetry (low risk – huge upside) of buying long dated out of money options. I personally purchased the $FXI Aug16’19 $33 Puts @ 0.18 for my own portfolio.

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