This post The Greatest Financial Bubble in History appeared first on Daily Reckoning.
China is in the greatest financial bubble in history. Yet, calling China a bubble does not do justice to the situation. This story has been touched on periodically over the last year.
China has multiple bubbles, and they’re all getting ready to burst. If you make the right moves now, you could be well positioned even as Chinese credit and currency crash and burn.
The first and most obvious bubble is credit. The combined Chinese government and corporate debt-to-equity ratio is over 300-to-1 after hidden liabilities, such as provincial guarantees and shadow banking system liabilities, are taken into account.
Paying off that debt requires growth, but the growth itself is fueled by more debt. China is now at the point where enormous new debt is required to achieve only modest new growth. This is clearly non-sustainable.
The next bubble is in investment instruments called Wealth Management Products, or WMPs. You may remember hearing about in the Daily Reckoning and also covered in Bloomberg’s article China Is Playing a $9 Trillion Game of Chicken With Savers.
Picture this. You’re a middle-class Chinese saver and you walk into a bank. They offer you two investment options. The first is a bank deposit that pays about 2%. The other is a WMP that pays about 7%. Which do you choose?
In the past ten years, bank customers have chosen almost $12 trillion of WMPs. That might be fine if WMPs were like high-quality corporate or municipal bonds. They’re not. They’re more like the biggest Ponzi scheme in history.
Here’s how they work. Proceeds from sales of WMPs are loaned to speculative real estate developers and unprofitable state owned enterprises (SOEs) at attractive yields in the form of notes.
So, WMPs resemble collateralized debt obligations, CDOs, the same product that sank Lehman Brothers in the panic of 2008.
The problem is that the borrowers behind the WMPs can’t pay their debts. They’re relying on further bubbles in real estate or easy credit from the government to meet their interest obligations.
What happens when a WMP matures? Usually the bank customer is encouraged to rollover the investment into a new WMP. What happens if the customer wants her money back? The bank sells a new WMP to another customer, then uses those sales proceeds to redeem the first customer. The new customer now steps into the shoes of the first customer with the same pile of bad debt. That’s where the Ponzi dynamic comes in.
Simply put, most of the debts backing up the WMPs cannot be repaid, which means it’s just a matter of time before the WMP market goes into a full meltdown and triggers a banking panic.
Finally, there is an infrastructure bubble. As explained in more detail below, China has kept its growth engine humming mostly with investment instead of aggregate demand from consumers.
Investment is fine if it is directed at long-term growth projects that produce a positive expected return …read more
Source:: Daily Reckoning feed
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