Props to Karl Denninger for bringing this to our attention: Bloomberg has run an article that casts serious doubt on the health of the Chinese economy. It appears the central government “plans to nullify all guarantees local governments have provided for loans taken by their financing vehicles.”
Here’s my Cliff Notes understanding of how it worked: Chinese banks made large loans for real estate development. Many of these loans were guaranteed by local governments. Quite a few of these developments stand largely or entirely devoid of human habitation. A friend who went on a business trip to several large Chinese industrial cities a few years ago noted all of the blocks of flats which appeared to be empty, and were offering at prices he couldn’t see producing many sales. You can find plenty of reports of entire cities that have been built and never occupied (it’s even on Youtube).
Now, you don’t need to be an MBA to see how this might end. Developers working with municipal loan guarantees aren’t likely to be overly concerned about taking some serious risks. Several analysts have been calling the Chinese economy a wreck waiting to happen for some time now. Others dismiss the concern. I wouldn’t be so sanguine. This situation bears watching. If you have exposure to China in your portfolio, at a minimum, keep a careful eye on it.
A full on China crash may be a low probability event, but it would have high impact. Global markets in risk assets would not react well. If the probability of a larger crisis grows, I will reduce stock holdings, and increase “safe haven” assets like US Dollar and Treasury bonds. Better safe than sorry, and we can always re-allocate once things settle down. Rule #1: don’t take large losses.