Chinese whispers

Listening to a recent news item about China, I was aware that one of my eyebrows was headed towards my receding hairline.

Apparently, global investors are buying Chinese debt at a record pace - unsurprising, I suppose, given that returns on Chinese bonds are so attractive and ahead of those in many other developing economies.

What else to do in the wake of the European Central Bank's shock action in applying negative interest rates  - who wouldn't be attracted by the high yields on Chinese bonds and be tempted to overlook growing concerns over the health of the country's economy?

What are these concerns? Well, growth is slowing and in March of this year, China saw its first corporate bond default when Shanghai Chaori Solar Energy announced that it couldn't service an interest payment of $14.7 million.

According to Chinese news agency, xinhuanet, the default by the solar panel maker hampered investors’ sentiment, although market watchers believe “a normal economy needs such defaults to better price bonds”.

On that note, Bloomberg reckons that the number of Chinese companies with debt double equity has soared since the global financial crisis, suggesting that the country’s first onshore bond default won’t be the last.

To illustrate my point further, I am turning to the world of physics and a quick review of Ohms Law which states that when a positive and a negative charge are connected by a conductor, a flow of electrons will follow.

There we have it - negative (or close to zero) interest rates in the struggling West whereas China remains the land of promise. And the flow of investors' cash from the negative to the over-egged markets of China is unlikely to meet much resistance along the way.

We could add to the mix the prospects for China's super-heated property market and a particular problem defined in Niall Ferguson's Reith Lectures a year or so back. The economic historian quoted Chen Guangcheng, the blind Chinese activist, as follows:

“The fundamental question the Chinese government must face is lawlessness. China does not lack laws, but the rule of law… indeed, China’s political stability may depend on its ability to develop the rule of law in a system where it barely exists.”

Ferguson's lecture also included a quote from legal scholar, He Weifang, who reckons that China’s modern system has been borrowed from the West but that "things often proceed in different ways between China and the West". Really!

Surely China's recent moves to regulate its bond market makers should leave us reassured?

But the biggest danger presented by all or any of the problems China may have is its role as the powerhouse behind South East Asian economic growth and stability.

So, should Chinese bonds carry a "caveat emptor" label? In my view yes - remember, it's only a few years since nobody was losing sleep over the UK, French or Italian economies and Greece was regarded as "fireproof" while Ireland celebrated its "Tiger" economy status.

What goes around comes around and China could be pulling cash into markets that are already undermined. If so, we have seen it all before, but on this occasion, the backlash, should the country's economy start to creak and groan, would be horrific.

Other economies of the East could teeter towards collapse (Japan comes to mind, with Australia following into recession) and ranks of beleaguered bond-holders in the West would set up an inconsolable wail!

Given the past few years, I think the World could do without that and when it comes to South East Asian economic stability, its caveat emptor as far as I am concerned.