The Ship of Fools

China made headlines last week with news of a sizeable surge in its exports and, by extension, the trade surplus it runs with its foreign counterparts.

These were indeed impressive enough, hitting a record-high $268 billion (up 21.1% yoy) and $75.4 billion, respectively and continue an acceleration which has been underway since the spring, as the country has staged a seemingly remarkable comeback from the sci-fi horror scenes broadcast around the world from Wuhan in the first quarter of the year.

In those eight months of renewed freedom, the trade surplus has amounted to a massive $447 billion, almost half as big again as the tally for the corresponding months of 2019 and just failing to top 2016’s all-time highs. It has been boosted in good part by the sale of vast quantities of medical devices (+57%), PPE and other textiles (+46%) also by the electronic nick-nacks and home office fittings (with gains from +20% to +32%) without which no Lockdown lounge-warrior can do while condemned to a life of endless Zoom meetings and ever-extended WFH house arrest.

Signally, on the other side of the ledger, crude and processed fuels were the biggest contributors to China’s surplus, with imports of natgas, coal and petroleum product taken together slumping 35% or by $75 billion.

Adding to the mercantilist’s dream, but not recorded in these numbers by definition, China has been in the habit of recycling some $200 billion a year of its monetary gains in the form of net outbound tourism and travel expenditures. In this manner, routinely more than two-fifths – and even close to three-fifths – of the dollars earned by selling smart phones and sneakers were being sold back to grateful coach drivers, hoteliers, and restauranteurs around the globe.

It should hardly be a matter of surprise to discover that COVID-19 has served drastically to reduce that outflow, shrinking it by 60%, or some $85-90 billion, during the same period that the goods trade balance has been swelling so markedly.

Short of dollars, China has not been, therefore – something which has provided a more fundamental underpinning to the renminbi’s ~10% advance from making a second attempt at setting a 12-year high versus the US dollar to instead regaining  a 2 ½-year low.

Backing this up, we have seen the Caixin PMI touch its highest level in a decade, the causative acceleration of corporate revenues which such measures generally portend also clearly showing up in the admittedly methodologically unsound industrial business data. These latter purport to show profits per firm up almost 20% – the best outcome in past two years – partly because the red ink at the average loss-making firm is now only half as deep as it was last year – a level of improvement last (briefly) seen in late 2012.

Anecdotal evidence corroborates the picture of at least a selective rebound. That old favourite, excavator sales – as evidenced by Caterpillar’s monthly reports – also shows that earth is again being moved on a substantial scale in the Middle Kingdom.

Boxing the Compass

Perhaps of wider consequence, container freight rates have been soaring, with the Platt’s index up by more than half since the start of November and by almost 150% from a year ago. Drewry’s spot index is even more dramatic, currently showing freight rates of almost $3,500 per FEU today versus a mid-year price of around $1,500 per box – a gain of 130% in under six months.

In part, that price rise is attributable to the lopsided nature of the partial recovery in global trade, a disturbance of normal patterns which has left too many boxes sitting empty at some ports and in too short supply in others. Nevertheless, the evidence is undeniable that goods are again flowing around the world.  

Whatever the specifics, it is clear that posted rates have suddenly attained levels not seen this past ten years or so. Even this might not tell the whole story since market insiders have been expressing strong suspicions that the Chinese authorities have leant on local shippers to slow their ascent so as to avoid political embarrassment in the destination nations.

Needless to say, such intervention seems to have been met with only token compliance since the published indices conveniently only record ‘standard’ terms and conditions whereas the extraordinary squeeze being experienced in many key locations means it is very easy to argue that one is instead offering a ‘premium’ service and so bump up the fees accordingly.

As Flexport’s Nerijus Poskus explained: “Some carriers are charging an additional $1,500 or even $2,000 just to guarantee the equipment. What’s the value of having a price of $3,800 or $4,000 if it doesn’t give you space on a ship?”

That lack of space – and with it the ability to hike charges – is clearly evident on some lines where a third or more of cargo is being ‘rolled-over’ – i.e., bumped off its contracted carrier due to lack of capacity on overbooked liners.

Port congestion everywhere is mounting as a result. This brings with it a host of associated problems such as demurrage charges for overstaying berths, diversions to secondary ports from whence further distribution has to be made, and the threat of schedule slippages leading to cancelled or ‘blank’ sailings – all of which help keep the dominoes tumbling.

As a case in point, one major French company – CMA CGM – has gone so far as to cancel all bookings inbound to Europe from Asia until the New Year in order to try and alleviate the backlog.

Then there are the ‘reefers’ or refrigerated containers, widely used for shipping food, flowers, and pharmaceuticals. Chinese inspection procedures have recently been tightened, bringing in their wake prolonged turnaround times and so denying the dockside electrical ‘plugs’ needed to run the units to all new arrivals. Several ports there – among them the mighty Tianjin – have therefore announced they will no longer accept such shipments until further notice.

Incidentally, estimates are that perhaps 60,000 of these specialist boxes will find themselves being requisitioned to deliver and store the more finicky COVID vaccines, something that can only add to these layers of complication in the coming months.

Ships in a Bottle(neck)

Meanwhile, on the other sides of the wide Pacific, exports to the US have become so lucrative (uphaul rates were up to ten times the westbound backhaul in late November) that destination ports have a strong incentive to move empty containers back to Asia without waiting for them to be loaded far inland with, e.g., agricultural products. This, in turn, has  prompted those that do get to the grain elevator to come with a hefty intermodal surcharge all of their own.

Another source of cost and delay is the added pressure on trucking firms being felt due to the COVID-related explosion in e-commerce (not forgetting the so-called ‘reverse logistics’ of customer returns running at around 30% of all goods ordered).

Warehouse space, too, is becoming critical and this is a problem many companies are seeking to overcome by – wait for it – holding onto the delivery container and treating it as an additional temporary storage facility, thus exacerbating the shortfall at the shippers.  

Nor will it just be Santa’s Little Helpers who suffer from this, for by no means all the goods being delayed are those destined to end up wrapped in shiny paper and nestled under the Christmas tree.

Producers, too, are beginning to complain of critical parts shortages.

Right back at the beginning of this year’s largely self-imposed productive chaos, we argued strongly that the idea that a complex, interconnected global economy could be effortlessly powered up and down throughout a serious of rolling, knee-jerk lockdowns and other restrictions, merely at the wave of a bureaucrat’s hand, was so ignorant and so wildly at odds with reality that only a politician could entertain it.

We further argued that the implied loss of demand due to business failure, revenue contraction, job loss, and so forth which the perennial deflationists were stridently forecasting could easily be surpassed by curtailments to supply and -given the unprecedented effusions of money being doled out by panicky governments and their captive central banks- could more than offset the downward pull.

Take this comment from the most recent ISM manufacturing report as an instance of this: “Cost of goods sold is much higher than normal due to labour and production inefficiencies.”

In microcosm – and long before we get to the looming madness of imposing Soviet-style Five Year Plans of ‘decarbonisation’ with all that entails for both the existing capital stock and the future efficiency and reliability of their replacement technologies – this tangle of logistical difficulties should demonstrate the feasibility of the case we made that ‘deflation’ is still the least likely outcome of this year’s excesses of zeal.

One way or another, all of this is adding price pressures and temporal delays across the chain. Some of this will be swallowed further down that chain – where it will inevitably reduce the funds available for expansion and improvement, while simultaneously adding to the financial bill. This will all tend to limit future supply prospects. Much, however, will be passed on to end-users in the here and now.

Since there has been much greater progress in boosting the supply of money than in ensuring there are more goods and services on which to spend its presently idling augmentation, there can surely be only one outcome to all of this.

Giving it the Ol’ Yuan, Two

But, back to China.

Much to the chagrin of those of us suffering from our own leaders’ continuing fixation on last winter’s zombie-horror images from Wuhan, things are again humming along – at least if we overlook partly anecdotal stories of 2-300 million migrant workers having returned in workless despair to their home provinces (and thus having dropped off the urban unemployment registers); if we ignore estimates that 10 million new college graduates will not have suitable jobs to go to in the cities; and if we disregard falling business registrations in several previous centres of commercial vibrancy.

But how has such growth been achieved?

Well, we need look no further than the efforts of the authorities to funnel copious amounts of cash into the system, in time-honoured fashion. Unlike its Western counterparts, this has required little overt action on the part of the central bank. Contrary to our experience, this has not been achieved by means of any vast expansion of the PBOC’s own balance sheet but rather through the usual loosening of the reins by which it guides the rest of the banking system and together with the accompanying brief, but insistent cry of, “Giddy-up!”

As a result, real money supply has accelerated at its fastest pace in five years to record an increase of 9.1% 3mma YOY – itself the most rapid since spring 2018. Falling ‘velocity’ not being ever much of a Chinese phenomenon, this has imparted the usual fillip to certain sensitive prices as well as to more general activity, along the way.

But, of course, there can be no new money without new loans. In the nine months since the imperative to kick-start the economy was first felt, CNY14.6 trillion of those have been issued to the ‘real economy’, an increment which is some 27% greater than that effected in the like-period of 2019.

On top of that, CNY3.7 trillion of corporate bonds have been sold (52% more than last year) and CNY6.7 trillions’ worth of local government paper has also been found a home (79% ahead of 2019’s score). Simultaneously, bank bond portfolios have swollen by an amount equivalent to around two-fifths of that total, so adding to the total effective monetary input.

Not that it has been all plain sailing despite a sharpened foreign appetite for Chinese debt which has been driven by the twin engines of benchmark changes (DOH!) and a widening spread to equivalent, ZIRPy, NIRPy credits in the West.

Indeed, some inkling of the pressure can be had from considering that a rather juicy bear flattening has been underway since the end of April, pushing government 2-year paper up 165bps and 10-years 80bp higher in a  move which has taken the latter from close to an 18-year low and back to the middle of the past six year’s range where it has unwound roughly half of the pronounced rally enjoyed in the latter years of that stretch.

But it has not been in the sovereign debt market where the fireworks have been set off, rather among the lesser credits.

For these, November was sufficiently turbulent for some more excitable types to start taking about the country’s ‘Lehman moment’ finally having arrived.  

Responsible for the ructions were five closely related mishaps – events which served to shake the cosy complacency with which many investors – foreign and domestic – have tended to treat the local bond market.

First among them was the final decision to put the failed Baoshang bank (plaything of the alleged Jiang-faction ‘White Glove’, Xiao Jianhua, a chancer whom – you may recall -was sensationally kidnapped by Mainland state security officials from his Hong Kong penthouse bolt-hole) through proper bankruptcy proceedings, rather than quietly brokering a takeover by some larger, compliant owner.

Second was a court’s accession to creditor demands to force state-owned Huachen – parent of BMW’s local JV partner, Brilliance Automotive – into its own bankruptcy proceedings due to its inability to meet a CNY1 billion bond maturity. Boss man Qi Yumin at first tried to deny the judicial decision had even been taken but, in the face of claims that Brilliance had been quietly transferring assets out of creditors’ reach, he has since been accused of the serious charge of ‘violation of discipline’ by the fearsome anti-corruption watchdog.

Next in line came the first of what threatens to be a series of defaults by state-affiliated chipmaker Tsinghua Unigroup, a company closely associated with the prestigious university of that name. Fourth was the news that Tianqi Lithium –  a company which controls roughly half the output of one of the electrifying world’s sexiest metals – was also facing the drop and hence was forced to undertake urgent talks to sell assets and otherwise secure a means of refinancing a looming $1.9 billion debt maturity.

Quis custodiet ipsos custodes?

Lastly – and perhaps providing the rudest of all these rude awakenings – state-owned and laughably triple-A rated  Yongcheng Coal & Electricity scandalously defaulted on a hefty bond payment just weeks after having issued yet more new debt, complete – one presumes – with a prospectus attesting to its solvency. The ratings agencies, auditor, and members of the bonds syndicate – among them top names such as Industrial Bank, China Everbright Bank, and Haitong Securities – were then subjected to sharp – if somewhat belated – official scrutiny and even outright censure.

From the highest levels of Zhongnanhai, the message went out that all machinations aimed at ‘evading debt’ and moving assets beyond the reach of creditors would bring heavy sanction (good luck with that, chaps!). For a while, the market tottered alarmingly with the debt of similar entities plunging as the buyers finally began to peer through the thin veil of local and provincial ‘guarantees’ and to ponder on their actual underlying creditworthiness. And not entirely without justification, given that Xue Yugan of the MOF’s Government Debt Research and Evaluation Unit (!) warned of the shaky state of the would-be guarantors’ own finances in an admonition forcefully endorsed that same day by former Finance Minister, top regulator, Standing Committee heavyweight and persistent policy critic, Lou Jiwei

Well over a hundred planned issues had to be pulled amid the height of the turmoil but, ironically, the sell-off also attracted the attention of overseas hedge funds eager to pick up ‘cheap’ paper in the hopes of profiting from any future, government-led stabilisation of the market. Shaky real estate securities, of all things, were said to be among the more favoured targets of the raid – the near demise of the biggest shark in that particular tank, China Evergrande, or the year-to-date closure of 450-odd of its smaller competitors, notwithstanding.

For now, a sense of calm has returned and several giant US asset managers have boldly declared their intent to continue to buy into the market in search of those relatively juicy 3%+ yields which it offers.

That the tremors have patently not occasioned any shift in priorities from return ON capital to return OF capital attests to the fact that the ‘Lehman Moment’ has not, after all, arrived. But maybe the ‘IKB Instant’ has.

Just keep that thought in mind as you weigh up whether an initial pick-up of 2% per annum is not much to play against a potential loss of up to 100% in perpetuity.

[Market charts courtesy of Investing.com and Trading View]