Getting right to it. . .

Two months ago – I wrote about the record-breaking onshore defaults that have plagued corporate China in 2018.

And – further – I hypothesized that this trend will continue over the next year.

(You can read that article here if you haven’t yet – I even disclosed how I was personally playing the wave of coming defaults).

Now – only a few months into 2019 – and things are looking dire in corporate China.

Let me explain. . .

Thus far – 2019’s shaping up as another record year for Chinese corporate defaults.

To give you some perspective – in just the first four months of this year – Chinese firms have defaulted on roughly 40 billion in yuan ($5.8 billion USD) worth of domestic bonds.

And – according to Bloomberg – that’s 350% more than during the same period last year.

Making matters worse – many of these defaults are large Chinese firms. And some are even going right into bankruptcy.

For instance – four huge private firms in Shandong (China’s third wealthiest province) have filed bankruptcy over the last few months.

Other firms haven’t out-right declared bankruptcy – but are already behind many billions in missed bond-payments.

For example – Neoglory Holding Group (a property investment conglomerate) has missed payments of seven-billion-yuan so far in 2019. (And this comes after they missed repaying interest and principle to bond holders in September 2018).

Another example – Citic Guoan Group Company (which has interests ranging from financial investments to the property markets) defaulted on three-billion-yuan worth of bonds last month. And has at least another 15-billion-yuan worth of onshore bonds outstanding that are maturing.

It’s clear that unless anything substantially changes – the trend’s set for another record-year of defaults throughout China.

But after the recent trade-deal breakdown – and increased tariffs – I think things will be much worse than the mainstream expects.

You see – China’s stuck between a rock-and-hard-place. . .

On the one side – Chinese firms are suffering softer sales and slowing growth. This is crippling their ability to repay maturing bonds.

And on the other side – Chinese firms are feeling the effects of the Federal Reserve’s tightening (and a stronger U.S. dollar).

They’re having difficulty refinancing and repaying dollar-debts (of which there’s $2.25 trillion that Chinese firms owe over the next 30 months).

Thus – the Chinese government has repeatedly pressed banks to extend credit to private domestic corporations (specifically small-and-medium sized firms).

But the problem here is – most debt is denominated in U.S. dollars

Meaning – Chinese firms need U.S. dollars to repay their loans.

But – like I wrote about a couple weeks ago – Chinese banks are suffering their own dollar-shortage.

Take a look at the combined dollar-liabilities of China’s four largest commercial banks. . .

First – it was Chinese firms that were short on dollars-assets compared to dollar-liabilities.

Now – major Chinese banks are short on dollar-assets compared to dollar-liabilities.

What’s next? Will we see Chinese banks begin to default?

I wouldn’t be surprised. . .

For instance – two weeks ago – China Minsheng Investment Group (a private equity investment firm) defaulted on dollar-debts worth $800 million – with $300 million of that debt guaranteed by China Construction Bank.

And so far – investors remain confident that the bank will honor that $300 million dollar-debt.

But – with Chinese banks already drained of dollar-assets – they can’t afford to be stuck paying all these corporate defaults.

And eventually – the market will begin to notice. . .

The current situation in China has a striking similarity to what Japan dealt with in the 1990’s – when overly-inflated asset bubbles (which were pumped up by years of cheap debt) began collapsing.

Unfortunately – like Japan learned – the further the asset side sinks, the more difficult the liabilities side becomes to deal with.

(Eventually – Japanese banks suffered credit rating downgrades and found it difficult to raise dollars from overseas to refinance massive loans which turned into non-performing assets).

So – in summary – I expect further stress in corporate China. Especially as the yuan weakens (making it difficult to repay dollar-debts).

This stress will effect the Chinese banking sector – which is reaching a ‘tipping-point’ – and make the system highly fragile.

Eventually – the grossly indebted Chinese economy will deflate – showing how horrible the malinvestment was over the years of cheap money.

According to Hyman Minsky’s Financial Instability Hypothesis (FIH) – the Chinese economy is in the ‘Ponzi Stage’.

This is the last stage in the bubble. When debtor cash-flows can’t cover interest payments or repay the principle due – and soon must liquidate assets – causing prices to collapse.

Maybe next time, more will understand that “the bigger the boom, the bigger the eventual bust.”



AS A DISCLOSURE: As previously disclosed at the bottom of my February 21, 2019 article – I am still short the $FXI (China large cap ETF) via long dated, out of the money put options.

Did You Like What You Read? Enter your email below and you'll receive my top contrarian insights right when I find them. (PS - I 'll never send you any hype or useless material). And make sure to check out Speculators Anonymous: Premium if you want to receive my top macro-plays and asymmetric (low risk – high reward) opportunities right when I find them plus more. . . We respect your privacy

Related