China is biggest danger for financial world

Germany’s Constitutional Court confirmed as expected the legality of the euro zone’s bailout fund that approved the legality of the European Stability Mechanism (ESM). The court stated that the 700 billion euro fund did not violate the law system of Germany. All politicians and public representatives considered the verdict as “a good decision” both for Europe and for Germany. German Ministry of Finance said that “It’s important that we have certainty about the legality of the ESM in the eyes of Karlsruhe because it is central to the financial stability architecture of the euro zone”. The court in Karlsruhe has a history of delaying EU treaties to test their compatibility with German legal system usually imposing the condition that parliament has to be consulted fully. We will see how history will treat this decision if there some real problems arise within Eurozone which are likely.

The EU is set to complete the final piece of its ambitious banking union after lawmakers agreed a deal on rules for winding down failed banks. The common rescue fund worth € 55 billion will serve to help banks with problems to overcome it. But is this fund enough? Probably not. Why? Because if crisis repeated as it was in 2008 we will need much more funds. Optimists could replay that for this occasion we have here ECB and its ability directly to buy any problematic governmental bond by the OMT mechanism. That is also a solution but then I do not understand why we are playing ourselves with meaningless funds; probably to pretend some political action.

The biggest danger for the financial world is coming still from China. According to Morgan Stanley China is crossing so called Minsky moment. It means that any Ponzi finance scheme (and Chinese shadow banking system is the Ponzi scheme) will reach some moment when borrowers have insufficient cash flows to pay either principal or interest and therefore must either borrow or sell assets to make interest payments. Morgan Stanley stated that China’s economy has arrived at that unstable state where speculative and Ponzi finance appears to dominate. It means that this could have strong impact on economics growth in country and consequently for global economy. And Morgan Stanley is not alone in describing of dangerous situation. According to Nomura the number of ghost towns has spread beyond the well-known disaster stories of Ordos and Wenzhou to at least eight other sites. Nomura believes that this real estate bubble followed by potential property market correction could lead to a systemic crisis, and is the biggest risk which China faces in 2014. And the problem is real. Actually there is another potential default in China. This time Zhejiang Xingrun: a real-estate developer which has some CNY3.5 billion ($560 million) in debt and furthermore the company was revealed to have been taking deposits from individuals offering annual interest between 18% and 36%. The situation is not that serious yet according to local officials because the developer is not big enough to activate chain reaction. But this kind of risk with connection of excessive debt and credit based expansion of China´s economy could trigger something which ends badly; and not only for China but for other global players as well.

The US finance sector is in a good shape; actually according to the FED. The annual FED´s stress tests showed that US largest financial institutions are strong and able to withstand economic downturn. The Fed said 29 of the 30 largest institutions have enough capital to continue lending even when faced with a hypothetical jolt to the U.S. economy lasting into 2015, including a severe drop in housing prices and a spike in the unemployment rate. The lowest performer among big banks is Bank of America. The only question remains how much are these stress tests relevant in case of the same kind of counterparty failure chain as happened in 2008.

Matúš Pošvanc

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