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Deutsche Bank analyst who called the Russian default in 1998 says the same is about to happen in China

Posted on 23 December 2013 with 4 comments from readers

Senior Deutsche Bank emerging markets analyst John-Paul Smith, who correctly called the 1998 sovereign default by Russia that very few saw coming, now says a similar financial meltdown is about to happen in China. Readers of this website will know that we’ve been of this opinion ever since our two-week tour of China back in April this year and first mentioned this coming over four years ago (click here).

But bearish analysts always look foolish and wrong until they are proven correct, and successful past calls often lead to a certain arrogance on the part of commentators. Take Harry Dent, for example who has not made a single good call in 20 years since getting Japan’s nemesis right (he predicted a massive stock market crash for this year).

Early shorts

On China Jim Chanos, the billionaire hedge fund manager, has been losing money heavily trying to short China for several years. However, it would be wrong to dismiss Oxford-educated Mr. Smith as a crank. He’s been one of the top emerging market analysts of the past 15 years.

His call for a 10 per cent correction in emerging market stocks this year was spot on, only the frontier markets like the UAE have surged ahead. Dubai Financial Market is up an eyewatering 100 per cent.

‘China’s expansion is being fueled by soaring corporate borrowing, a high-risk model that needs to be replaced by the kind of free-market measures and budget cuts that fed Russia’s growth in the aftermath of the country’s default and subsequent 44 percent monthly tumble in the Micex Index’, Mr. Smith told Bloomberg.

Only last week Chinese interbank borrowing costs hit a six-month high. China’s total credit, including shadow banking loans, surged to 190 per cent of GDP at the end of last year from 124 per cent in 2008, according to Fitch. That was faster lending growth than in Japan during the late 1980s or in the US before the financial crisis of 2008.

Overborrowed companies

Mr. Smith argues: ‘It is really at the corporate level and at the micro level in China that the fate of the financial market and the economy there is going to be determined. China is not such a safe haven as most market commentators appear to believe.’

In short we are waiting for a credit event or black swan to occur. It is not hard to imagine that somebody in China is hugely overborrowed and will be pushed over the edge by rising interest rates. How long that will take to happen and whether the government would save them is far less easy to predict.

Mr. Smith’s prediction is a bold one and by sticking his head above the parapit he risks getting it blown off before he is proven right.

Posted on 23 December 2013 Categories: Banking & Finance, Bond Markets, Global Economics, Hedge Funds, Investment Gurus, Sovereign Wealth Funds, US Stocks

4 Comments posted by readers:

Comment by Jon - 24 December 2013

Is this the same path the US will take now that Janet Yellin is the soon to be the Fed chairman. If she will make interest rates so low the banks will be forced to loan out the money causing the same problem as in China?
Either way simply massive inflation is coming. Lots of dollars coming back to the US.
Our friends in the brick countries no longer want them. End of the petrodollar?

Comment by Andy - 24 December 2013

The Chinese will simply print money like the Americans did. They can not afford to see things get out of hand in China. What makes anyone think that in a communist country they would allow this to happen even though they did not allow this to happen in a Democratic country like the US?

Comment by Bernard M.A.Doff - 29 December 2013

Mr Smith does indeed have a respectable track record, unlike many of the individuals quoted on this site. His forecasts on Russia back in the 90’s were impressive. However, he has committed some howlers also.

In December 2007 saying he wrote that the worst in the subprime mortgage crisis was over and that the U.S. market was poised to rally. The worst financial crisis since the Great Depression followed.

He has also been wrongly bearish on oil since April 2011.

Comment by steve from virginia - 01 January 2014

China suffers from the effects of exponential credit growth … where loans are taken on for no other reason but to retire and service previous rounds of loans. There is no escape from this trap as nothing else under the sun can retire or service the loan inventory, either.

The central bank can only offer its own credit but must be very careful as its credit-worthiness is a finite resource. The central bank can become spent and its credit commingled with that of its worthless clients … the outcome is a deleveraging that continues without hindrance until the impulse burns itself out.

This is what it comes to … the world’s central banks have been the last line of defense along with the ability of those in finance to lie to themselves about the state of their own businesses. More lies = more loans … more bad loans.

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