Links, July 28

2nd-half slowdown update. Calculated Risk.

the China story:

China and bust? Ed Harrison via naked capitalism.

Just how risky are China's housing markets? Yongheng Deng, Joseph Gyourko, Jing Wu; voxeu.

Our look at the available data strongly suggests that prices are quite risky at current levels, and that it would take little more than a modest decline in expected appreciation to engender sharp drops in prices.... [despite strong income growth in urban China] Price-to-rent ratios have increased by at least 30% over the past 3 or so years in each of these cities.... real, constant quality land values increased by over 750% since 2003 in the Chinese capital... to be very difficult to explain fundamentally... owners must be expecting very high rates of price appreciation for these price-to-rent ratios to be sustainable... this sort of backward looking expectation formation is a classic element of bubble psychology... Reinhart and Rogoff’s recent study of financial crises often finds the genesis in the country’s property markets. Recent data indicate there is reason to suspect a similar predicament in China’s housing sector. Whether it leads to a full blown crisis is another matter, of course, that depends upon the amount of leverage in the system and the safety and soundness of the regulatory environment, among other factors.

China Banks Said to See Risks in 23% of $1.1 Trillion Infrastructure Loans. Bloomberg.

Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator....

Only 27 percent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded, the person said....

The China Banking Regulatory Commission has told banks to write off non-performing project loans by the end of this year.

Chinese Banks At Risk, Part 1. Patrick Chovanec, An American Perspective from China.

Ratings Understate `Dangerous' Chinese Local Government Risks, Dagong Says. Bloomberg.

The PBoC can't easily raise interest rates. Michael Pettis, China Financial Markets.

re the above stories about the Chinese banking system:

I would suggest, based on my pretty extensive experience in emerging markets, that we should assume the real problem is worse than the initial evaluation. It almost always is....

I agree that these loans won’t pose a risk to the banking system, but that doesn’t mean that there won’t be huge losses. It just means that the losses will be covered by the household sector. For years I have been arguing that without liberalizing interest rates and pushing through governance reform, there won’t be meaningful reform in the domestic financial system. It isn’t even conceivable to me that a combination of rapid credit growth, socialized credit risk, severely repressed interest rates, and serious lack of transparency could ever have led to anything other than large-scale capital misallocation and rising debts.

So of course there are problems in the banking system, and of course there is a lot of debt piling up in all sorts of unexpected places, and of course bit-by-bit we will get more information, like this leaked CBRC report....

One of the problems with a severely repressed financial system, especially one with rapid credit expansion, is that there tends to be a huge amount of capital misallocation supported by borrowing, and in an increasing number of cases it is only the artificially-reduced borrowing costs that allow these investments to remain viable. I worry that even if the PBoC wanted to raise rates, it would not be able to do so without exposing how dependent borrowers are on artificially cheap capital....

of course it is not just the PBoC that has this addiction to repressed interest rates. Many years of very low cost borrowing has created a huge dependency on low interest rates among SOEs, local governments, and other creditors of the bond markets and the banks (not to mention the banks themselves), all of whom are directly or indirectly funded by long-suffering households....

All this might sound like I am effectively recommending that the PBoC continue to repress interest rates, but of course repressed interest rates are what caused the problem in the first place. To continue to do so simply makes the underlying problem worse, by piling on even more non-viable debt. Rather than suggest that the PBoC must keep rates low, what I am really arguing, I guess, is that this is a very difficult trap from which to escape.

What can the authorities do? If Beijing raises interest rates quickly, debt and bankruptcy will surge and growth will collapse – although the eventual rebalancing of the economy might happen much more quickly.

If they don’t raise interest rates, they can keep growth high for a while longer, but the amount of reserves and misallocated capital will continue rising, making the eventual cost of raising interest rates even higher. The risk is a Japanese-style stalemate in which for many years the authorities are forced to keep rates too low because they simply cannot countenance the alternative, and during this time consumption growth continues to struggle.

Finally, if they raise interest rates slowly, they will slow growth while still suffering many more years of worsening imbalances, until rates are finally high enough to begin reversing the imbalances. But for this strategy to work, they would need a very, very accommodative external sector – China’s domestic imbalances require high trade surpluses until they are finally reversed.

So there’s the dilemma: they’re damned if they do and damned if they don’t.

Now let us stress-test the central banks. Terrence Keeley, FT.

Consider Asian central banks, with their total of $5,000bn in foreign reserves. These assets are often mistakenly seen as a sign of strength. As the vast bulk of liabilities against these reserves are denominated in local currencies, a prolonged period of US dollar and/or euro weakness would generate unprecedented marked-to-market losses. A 20 per cent appreciation of the renmimbi versus the People’s Bank of China’s owned foreign assets would thus result in a hit to Chinese federal finances of some 10 per cent of domestic GDP

oil spill link of the day:

Of Course Clean Up Workers Can't Find the Oil ... BP Used Dispersants to Temporarily Hide It, So Now It Will Plague the Gulf For Years. Washington's Blog.

other fare:
Slowed food revolution. Heather Rogers, The American Prospect.

Who killed the climate bill. Foreign Policy.