China's Debt Crisis

China may be forced to continue to increase its debt position. Their cash flow future looks grim.

China’s debt is largely held by corporations. The problem is a fair number of their small and large companies are poorly managed. Their inefficient equipment and systems results in high-cost, money-losing operating companies. This results in deficit cash flows which severely limits the capital available for the repayment of debt.

China is reportedly attempting to have lenders restructure weak loans into equity. The majority of the lenders are banks. Banks will be converting their loans into equity in a number of financially distressed companies which may negatively affect a bank’s financial condition.

Will the current tariff challenge affect corporate revenue and further increase operating losses?

As a consequence China may need to increase its debt to support companies incapable of repayment or restructuring.

Debt Articles:

Forbes

South China Morning Post

China Power

Bloomberg

Tariff Articles:

Bloomberg

Politico

-->

Recession?

Are we headed into a recession in 2016-2017?

The decline in the key drivers of economic growth say yes:

• Business fixed investment has declined by an annualized 4% over the past two quarters. Business equipment and software declined 5%. Non-residential structures dropped almost 8%.

• Employee layoffs. "U.S.-based companies announced 65,141 job cuts last month (April), up 35 percent from March.” Boeing plans to layoff  8,000 employees - 10% of its workforce. Intel plans job cuts of 12,000 - 11% of its total headcount.

• In 1980 there were 60 USA non-financial corporations rated AAA. Today there are just 2 with the recent surprise that ExxonMobil was downgraded to AA+. This will reduce capital investment and ultimately employment and GDP growth.

Business investment and employment are critical factors in economic growth.

As a result of these negatives:

• The Labor Force Participation rate dropped to 62.8% in April 2016. A 38 year low. Thus 94 million people are out of work. This is a decline over the recent several years from 66%-67%. New job creation is weak and will not improve the participation rate.

• GDP growth is in decline. It registered an anemic 0.5% increase (revised to 0.8% in May 2016) in the first quarter of 2016. In the third and fourth quarters of 2015 it was 2.0% and 1.4% respectively.

China’s struggles area concern. Its growth has consistently slowed. 2015 was its slowest year in 25years. This is a factor in the global decline in the demand for commodities and the 55% reduction in commodity prices since 2014 negatively affecting capital investment and employment. Unfortunately 2016 growth is difficult to accept as real as it has been stimulated by debt in an economy that is seriously overleveraged.

The USA’s growth prospects are muddled by an apparent decision by one of its major industries – automobiles. General Motors, Ford and Chrysler are reportedly not investing in flexible production systems as are its German and Japanese competitors. This is described as: “…technological change that stands to radically reshape the car business.”

Will this result in the Big Three’s costs being higher than its competitors? Probably. It will most likely lead to lower unit sales and lower overhead absorption resulting in lower operating profits, lower cash flows, less capital investment and lower employment.

Adding to the puzzle about General Motors’ viability is its $500 million investment in Lyft – a Uber competitor. Lyft is a business outside of GM’s vehicle manufacturing core. Is GM losing disciplined strategic focus?

Follow-up articles: 

Business Insider, May 26,2016, “Japan's prime minister is warning world leaders about a 'Lehman-scale crisis'” He interprets economic data as pointing to the reemergence of the global financial crisis of 2007-2008.

InvestmentWatch, May 26, 2016: Interview with former Federal Reserve Chairman Alan Greenspan: “Greenspan: Western World Headed for a State of Disaster”. “…have a very profound long-term problem of economic growth…(not) on the verge of a market…collapse…”

 

Henry Paulson's Book “Dealing with China”

Henry Paulson, Jr. has a new book titled “Dealing with China”. Is this a practical treatise on working with China?

Seventeen of the book’s twenty chapters are detailed descriptions of Mr. Paulson’s own personal history while working with Goldman Sachs, as US Treasury Secretary and with the Paulson Institute. It is an interesting personal story. However, the autobiographical review is not truly helpful for dealings with China.

A Wall Street Journal book review by Jeffrey Wasserstrom is quite accurate:
“…careful language that will not bother Chinese censors…Mr. Paulson is too soft on his “old friends,” including the man now in power, Xi Jinping.”

The Financial Times review by James Kynge is on target as well:
“…Paulson’s prescriptions all tend toward forging better relations with China by supporting what China wants…may win friends in Beijing but will be less popular among U.S. allies…such as Japan...the lessons…are…academic.”

These reactions are entirely understandable, leaving the reader to wonder what is clouding Mr. Paulson's vision. His assessment of China consistently glosses over reality. While addressing the needs of the Chinese people, Mr. Paulson curiously concludes: “…they have made good on their vows.” Throughout this book, Paulson is clearly advocating on China's behalf. He encourages a greater role for China internationally, including with the World Trade Organization. Paulson suggests: “We should… make concessions… to encourage China to take a more prominent role.”

In a Fox News’ interview with James Rosen discussing his book Mr. Paulson offered: “I would definitely not classify China as an enemy…they are a competitor.”

The FBI report in Matt Dean’s recent Fox News’ article raises doubt that China is simply a competitor: “China the most predominant economic espionage threat to US…the number of economic espionage investigations undertaken by the agency over the last year…a 53 percent increase…state-sanctioned corporate theft by China is at the core of the problem.”

Are China’s strategic ambitions hostile? Jingoistic?  Its territorial claims as reported by the BBC’s Carrie Gracie and in the Financial Times book review have raised concerns in Taiwan and Japan.

Mr. Paulson is a successful and serious man. He is certainly not naïve. But his glowing praise of China’s economic and social progress, including suggesting a leading international role, raises sincere questions about his impartiality. This book was unfortunately a disappointment for those seeking constructive analytical insight.