RBS Issues Warning that China Credit is About to Burst

RBS Issues Warning that China Credit is About to Burst

Dire warnings about the true extent of China's credit bubble are now materializing in mechanisms designed to protect against a sovereign debt default, as the Royal Bank of Scotland has advised clients to take out protection against the risk of a sovereign default by China as one of its top trading tips for next year.

"Many see China's monetary tightening as a pre-emptive tap on the brakes, a warning shot across the proverbial economic bows. We see it as a potentially more malevolent reactive day of reckoning," said Tim Ash, the bank's marketing director, according to comments carried in The Guardian. RBS warns that the Chinese government will have to puncture the credit bubble before inflation reaches levels that threaten social stability.

Official statistics released by Beijing state that inflation was 4.4 percent in October, and may have climbed to 5 percent in November. However, this is not borne out by on the ground economics, which show that the cost of vegetables have risen 20 percent in the last 30 days.

The bank is recommending credit default swaps on China's five-year debt. This is not a forecast that China will default. It is insurance against the risk of a hard landing, a situation that would have serious implications throughout Asia.

The newspaper quoted Diana Choyleva of Lombard Street Research, who said that China's money supply rose at a 40 percent rate in 2009 and the first half of 2010 as Beijing kept up the pressure on a credit boom in order to sustain growth, but that the costs of this policy now outweigh the benefits. Experts agree that China's economy may be entering a depressing cycle of stagflation where credit-pumping leaks into speculation and price spirals, even as growth slows. The excess is being transferred into property, and there is intense debate whether or not China has managed to outdo America's subprime bubble, or even match the Tokyo frenzy of the late 1980s. The International Monetary Fund's position straddles the two opinions and has advised in Beijing's favor by suggesting there is no meaningful property asset bubble of concern, but that home prices in Shenzhen, Shanghai, Beijing, and Nanjing seem "increasingly disconnected from fundamentals."

However, real estate prices are a multiple of 22 times disposable income in Beijing and 18 times disposable income in Shenzen, compared to 8 in Tokyo. The U.S. bubble peaked at 6.4 and has since dropped to 4.7. The price-to-rent ratio in China's eastern cities has risen by over 200 percent since 2004. The IMF said land sales make up 30 percent of local government revenue in Beijing. This has echoes of Ireland where "fair weather" property taxes disguised the erosion of state finances.

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