Fiscal stimulus

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China\’92s August data confirms both optimists and pessimists

September 11, 2009 in Consumption and production, Fiscal stimulus by Michael Pettis | No comments

Regular readers of my blog will have noted all sorts of unfortunate goings on here in recent days. \’a0It has become impossible to get into the comments section, or indeed into any other section of my blog except the front page, and so to my great dismay the excellent discussions that have been so useful for me have been temporarily halted. \’a0I am not sure why this is the case, and now that school has started again I hope to get one of my terribly smart Peking University students to find out and fix it. \’a0

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Actually in recent months a large number of China scholars who I know \’96 and me too \’96 seem to have been targeted by very specific viruses, with emails and attachments cleverly disguised to look like something we would want to read from someone we would trust.\’a0 I am not smart enough to know what those viruses do, but I have been warned that they probably allow someone access into my computers. \’a0

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Perhaps for the same reason my own blog has been hacked in some way, but it seems to me that if anyone really wanted to close me down they would have closed down the blog altogether and not just the comments section, so unless there is a commenter that regularly raises the ire of some censor out there, I suspect the problem has more to do with my blog site than with any malicious intent.\’a0 Of course if my blog suddenly begins posting pornographic pictures, spewing venom, or otherwise does some unexpected and obnoxious things, please know that it was probably not me who came up with the idea.

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I have also had a lot of trouble getting my regular proxies that allow me to jump the great firewall and post onto my blog. \’a0That is why my posting has slowed a bit, but it seems that yesterday and today the anti-proxy regiments have been at least temporarily defeated.

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That\’92s good, because of course today the National Bureau of Statistics has released a whole lot of data.\’a0 A European TV station asked me to comment on the import of the data, and while I hate to make too much of a few data points, I was able to say rather glibly that the data pretty much confirmed the hopes of the optimists as well as the fears of the pessimists. \’a0

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I will explain why I think this below, but I should note that most analysts were pleased with the results, and the stock market surged on the news.\’a0 The SSE Composite was up 2.2% today.\’a0 Surprisingly it was down 0.7% yesterday, suggesting that there was probably no information leakage.\’a0 Things seem to be improving on that front.

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To summarize the data released today, manufacturing output was up by 12.3% year on year, better than last month\’92s 10.8% and higher than consensus, although I think last August, during the Olympics, a lot of factories were closed so that this number may not be as impressive as it seems.\’a0 Steel output was up 29% and auto production was up 90%, which as my friend Mark Williams at Capital Economics points out is not likely to soothe worries about overcapacity creation.

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Urban fixed-asset investment was up 33.0% for the first eight months of the year, which slightly exceeded already-high estimates of 32.5%.\’a0 This suggests that it is still investment that is in the driver\’92s seat, as far as growth is concerned.\’a0

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This might not be as obvious as all that.\’a0 A lot of people were excited that retail sales climbed 15.4%, slightly higher than consensus and the highest growth rate all year after seasonal factors are stripped out, but remember that retail sales are not a very good proxy for consumption growth. \’a0Also remember that this surge in liquidity can easily cause consumption to rise in a temporary way without indicating anything structural about changing consumption and saving patterns in China. \’a0In 1988-89 consumption in Japan also surged, probably as a consequence of the investment boom, but it was unable to survive, if I remember correctly, the contraction in that boom in the 1990s.

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The most interesting piece of information is that net new lending for the month was RMB 410 billion, less than half the monthly average this year (RMB 1,105 billion).\’a0 This seems small given the huge numbers we\’92ve seen but, as I pointed out two weeks ago, last August new lending was around RMB 272 billion, and if you strip out the bills coming due the real increase in medium- and long-term lending is closer to RMB 550-600 billion. \’a0More importantly, RMB 410 billion is a lot more than the rumors of RMB 300 billion that had panicked the market last week.\’a0

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The one piece of news that everyone read as negative was the trade data. \’a0Exports were down 23.4% and imports down 17.0%, both substantially worse than expected, although leaving the trade surplus at a still-hefty $15.7 billion, which is roughly average for the year.\’a0

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For the optimists, the economic numbers, with the exception of the trade data, were all positive and suggest that China is on track to recovery.\’a0 For them, the great risk to China was that the global contraction in demand would result in terrible damage to China\’92s export industry and, with it, would cause factory closings and soaring unemployment.\’a0 Rising unemployment would lead to a collapse in consumption, and of course would not make China\’92s transition easier

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The main purpose of the stimulus package, in this view, was to forestall an economic contraction and with it the possibility that the economy would fall into an ugly process in which rising unemployment would cause a contraction in Chinese consumption which, when added to the contraction in foreign demand for Chinese exports, would push the economy into a tailspin.\’a0 In that sense the stimulus has proven to be a great success.\’a0 Chinese growth has slowed, but by a lot less than expected, and unemployment seems to be manageable.\’a0 The August data points pretty solidly to continued growth.

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And yet, and yet\’85.

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For pessimists like me the global contraction underscored Chinese vulnerability to out-of-control US consumption, and the need to develop a more balanced approach in which Chinese consumers take a larger share of China\’92s production.\’a0 This vulnerability existed in large part because China was overly reliant on investment for its growth.\’a0 China has had probably the highest investment rate ever recorded for a large economy, and for years there has been widespread concern that much of this investment was misallocated.\’a0

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It is only because the cost of capital is artificially so low (thanks to Chinese households, who are forced to earn a miniscule return on their savings) that many companies are able to show profits at all. \’a0A few months ago I wrote about an HKMA paper that suggested that the implicit interest-rate subsidy to SOEs \’96 not relative to the \’93right\’94 interest rate in China (whatever that may be but which is certainly many percentage points higher than the official lending rates) but relative to the borrowing cost of large Chinese private corporations \’96 accounted for 100% of SOE profitability. \’a0If China had reasonable interest rates, in other words, (and in fact there were negative real rates for much of the recent past), SOEs would on average be value destroyers.

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This, by the way, is why China\’92s supposedly puzzling addiction to capital-intensive growth rather than labor-intensive growth \’96 more befitting to an economy with lots of unskilled labor and very poor technology \’96 is not so puzzling. \’a0If you artificially lower the price of a particular input, it is not surprising that producers will use more of that input than might otherwise be considered optimal.\’a0 With capital practically free, capital is everyone\’92s favorite input in spite of incredibly low labor costs.

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With the recent surge in government financed investment (and I include most bank lending in this category), it would be surprising to me if much of this year\’92s new investment were not of even lower quality than the older investment, with very low or even negative expected returns.\’a0 If this turns out to be true, it means that the only way these investments could be viable is by effectively continuing to \’93tax\’94 Chinese households to subsidize state-owned enterprises and large manufacturers.\’a0 This tax of course will come mainly in the form of low wage growth and extremely low deposit rates on the savings of Chinese households.

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This is why we all hope Chinese growth will become more reliant on rising consumption rather than on rising investment, much of which is certain to be unprofitable.\’a0 The current path requires a large trade surplus to absorb the difference between what China consumes and what it produces, but it is not clear that foreign consumers will absorb the balance.\’a0 China is trying to plug the gap by a surge in government-financed investment, but this is likely only to widen the gap in the future.\’a0

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So the August data suggests that while China is growing, it is actually more reliant, not less reliant, on investment.\’a0 What is worse the very poor import numbers suggest that in spite of high retail growth figures, consumption growth in China is still sluggish.

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For the pessimists, then, the August numbers confirm that the stimulus package may be boosting production solely because of government-financed investment, and that a serious misallocation problem will result in more future pressure on Chinese households to foot the bill.\’a0 The export numbers show that China\’92s external accounts continue to deteriorate, and it will take more than simply an end to the global crisis to return to the good old days.

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So who is right, the optimists or the pessimists?\’a0

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In fact both are right.\’a0 If the purpose of the stimulus package was solely to protect China from the immediate employment impact of the global contraction in demand, it has been an almost unqualified success.

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But if at least part of the goal was to help China shift its unbalanced growth model to one less reliant on foreign, and especially American, consumers, it is not clear that any progress has been made.\’a0 In fact to the extent that a significant share of new investment has been wasted, it may actually make future imbalances worse.

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China\’92s response to the global crisis needs to be seen as a two-part process.\’a0 The first part is to goose economic growth in response to the rapid deterioration in the external environment.\’a0 The second part is to rebalance the economy away from its excess reliance on investment and foreign demand.\’a0 The August data seem to confirm that China is very successfully managing the first part.\’a0 Whether it has made any progress on the second part is still very much open to question.

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The Shanghai market calls the tune

September 3, 2009 in Fiscal stimulus, Stock market by Michael Pettis | 23 comments

The Shanghai and Shenzhen stock markets are still hogging the spotlight.\’a0 Although down 18.0% from its recent peak exactly one month ago, the past three days have been good for Chinese stock market investors.\’a0 After rising 0.60% on Tuesday and 1.17% on Wednesday, the SSE composite was up a very smart 4.79% today.\’a0

So what happened?\’a0 Better-than-expected earnings from Chinese corporations?\’a0 A surge in US household income and a decline in US unemployment boosting the prospects for China\’92s tradable goods sector?\’a0 A huge new loan number for the month of August?

Actually, none of the above.\’a0 In fact the US numbers look especially bleak for China.\’a0 In spite of some seemingly good news on the macroeconomic side, unemployment in the US is still rising, and even that masks the depth of the problem.\’a0 Many Americans who have lost jobs have since then found new jobs, but at lower pay, so that although they don\’92t show up adversely in the unemployment data, they nonetheless represent lower income to workers as certainly as rising unemployment does, and this will have an impact on future private consumption.

Societe Generale\’92s ever bearish Albert Edwards had an excellent piece on the subject on August 6, in which he argues that:\’a0

US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.\’a0

If US household income is declining so sharply, we can\’92t really expect a sharp pick-up in imports, even ignoring the fact that households are also in the process of deleveraging, and so cutting back even more sharply on consumption that their incomes might indicate.\’a0 But in spite of still-bad news in both the external or internal environments, the markets are nonetheless in a much better mood than they were just a few days ago.\’a0 Why?\’a0 The People\’92s Daily explains:\’a0

Chinese equities climbed Wednesday after the country’s securities regulator said it would take measures to promote the steady and healthy development of the market.

Or, if you prefer Bloomberg\’92s slightly more forthright explanation:

China\’92s stocks rose the most in two weeks on speculation regulators will adopt measures to boost the nation\’92s equities following declines in the past month.

The main cause of the surge seems to be a statement made Liu Xinhua, vice chairman of the China Securities Regulatory Commission, at a forum in Beijing yesterday which was proclaimed on the front pages today of China\’92s two biggest financial newspapers, the China Securities Journal and the Shanghai Securities News.\’a0 Mr. Liu promised that regulators will promote a \’93stable and healthy\’94 market.\’a0 This has been interpreted to mean that the authorities will not let the market continue falling, and will introduce measures to force it up.

Bloomberg continues, with something that is widely acknowledged but wasn\’92t covered in the People\’92s Daily article:
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The government may take measures to stabilize the market before the 60th anniversary of the founding of the People\’92s Republic of China on Oct. 1, the start of a weeklong holiday. \’93They want everything to be stable and in harmony,\’94 said Francis Lun, general manager of Fulbright Securities Ltd., in an interview with Bloomberg Television today. \’93They will approve more stock market funds and allow them to buy into the market.\’94

There is a general sense that no one wants the markets to misbehave before the all-important October 1 celebration of the sixtieth anniversary of the birth of the People\’92s Republic.\’a0 Needless to say this begs the question about when exactly should you, as an investor, get out of the market?\’a0 The day before?\’a0 But if everyone knows that, then shouldn\’92t you get out two days before, or maybe three, since everyone has presumably figured that one out too?
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In 2006, 2007 and 2008 I wrote often about the dangers of this sort of market signaling.\’a0 There may be perfectly good reasons to want to manipulate the markets with non-fundamental information, but every time this happens it further undermines the development of a healthy capital market that allocates capital based on economic prospects by undermining the value of fundamental information and reinforcing the value of speculation on government intentions.\’a0 Still, on such an important anniversary I suppose it was totally unrealistic to think that the authorities would let angry investors spoil the party.
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The stock markets may have also taken some heart from a good, although sobering, speech from Premier Wen when he met with World Bank President Robert Zoellick earlier this week.\’a0 According to an article in Xinhua, Premier Wen said that
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China’s government would continue to pursue proactive fiscal and moderately easy monetary policies. \’a0″We will not change the orientation of our policy,” Wen said.
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Wen said China would fully implement and continue to enhance and perfect policy in response to the international financial crisis to achieve the goals of economic and social development.

This was taken by everyone as a pretty clear conformation of what I discussed in last week\’92s entry \’96 that although there were increasing worries about the cost of the fiscal stimulus package and the lack of an \’93exit strategy,\’94 in the end the State Council and the policy leadership were still more worried about a sharp slowdown in growth than about the risks of excessive investment:

I wonder, and I know I am not the only one wondering, what Zhongnanhai is thinking as it sees the impact of these rumors of a contraction in the furious rate of credit expansion. For one thing it seems that there are only two positions on the switch \’96 \’93surge\’94 and \’93swoon\’94 \’96 and I suspect that very quickly we will see the switch turned back to \’93surge\’94. Although there seems to have been a little upward blip in US import numbers, I think this represents more of a temporary bounce from a steep earlier decline, and that the external environment continues to be very poor.
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My guess is that if the local stock markets do not soon recover their bounce (and they won\’92t without government help) and, even worse, if we start to see the awful sentiment seep into the real estate sector, Beijing will once again push forcefully for credit and fiscal expansion. In my opinion there is simply no way that domestic consumption \’96 unless it is primed with government giveaways \’96 can make up the slack quickly enough.

A recent report by CLSA also says that the PBOC apparently believes that one of the causes of the lost decades of Japanese growth was premature tightening in the late 1990s which \’93killed the momentum of economic recovery when it was only in the budding state,\’94 and so the PBoC has cautioned against doing the same in China.\’a0 It is better to be too loose than too tight.\’a0
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Although I think perhaps the right comparison is not with Japan in the later 1990s but rather with Japan in the late 1980s, this \’93lesson\’94 was reinforced by another, according to the same report:
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Beijing seems to agree with Ben Bernanke that \’93The correct interpretation of the 1920s, then, is not the popular one–that the stock market got overvalued, crashed, and caused a Great Depression. \’a0The true story is that monetary policy tried overzealously to stop the rise in stock prices. \’a0But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy \’96 both domestically and, through the workings of the gold standard, abroad. \’a0The slowing economy, together with rising interest rates, was in turn a major factor in precipitating the stock market crash.\’94

Although I think I agree with Bernanke, again, I am not sure this is the right lesson for China.\’a0 The problem is that loose monetary policy is exacerbating the imbalance that China needs to work though, since most of the expansion is being directed at investment in expanding current and future capacity, but this comes at the cost \’96 which was not the case in the US \’96 of constraining the future growth in domestic consumption. \’a0Without rapid future consumption growth, as I have argued many times, I just don\’92t see how China can support rapid GDP growth once the huge fiscal push becomes unsustainable and runs out of steam.
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Clearly this concern is still part of the internal debate.\’a0 Chi Fulin, president of the China (Hainan) Reform and Development Research Institute and a member of the Chinese People’s Political Consultative Conference had an interview which was reported in an article in today\’92s People\’92s Daily.\’a0 In his comments he makes many of the same points I have been worrying about, albeit perhaps in a more politically acceptable way:
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Chinese leaders should rethink the country’s reform package amid changing global and domestic situations and take “quicker and radical” steps to move toward a market-oriented economy by 2020, said a senior political advisor.\’a0 The reform measures should speed up urbanization, break down industry monopolies by the State, deregulate energy, offer equal social welfare for both rural residents and urbanities, and improve the government’s efficiency.

“Our top leaders should take quicker and radical measures in these endeavors within the coming two or three years. By doing so, China can do a better job in post-crisis management as well,” Chi Fulin, president of the China (Hainan) Reform and Development Research Institute told China Daily in an exclusive interview.\’a0 “Looking at the goal of realizing a market economy by 2020, we cannot afford to lose the time window of the next two or three years in the reform.”

\’a0Several times in the interview Chi mentions the \’93urgency\’94 of the need for reform, which included removing many of the production subsidies, price deregulation of resource products, and reducing the State’s industry monopoly.\’a0 My interpretation of his comments is that he is, as politely as possible, warning that the government still hasn\’92t taken the necessary steps to restructure the economy. \’a0He concludes “Whether consumption can become a leading engine of China’s economy depends on how successful the reform is.”

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On a very, very different subject, I hear that there were more demonstrations and unrest in Urumqi today.\’a0 My understanding is that the large group involved met in a square over claims that people in Urumqi have been attacking innocent people with syringes.\’a0 There have already been demands for retribution.\’a0 Here is what China Daily says:
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URUMQI: Police have seized 15 people for stabbing members of the public with hypodermic syringe needles in northwest China’s Xinjiang Uygur Autonomous Region, a senior local official said Wednesday.\’a0 Of the 15, four were officially arrested and prosecuted, said Zhu Hailun, head of the political and legal affairs commission of the Communist Party of China (CPC) committee in Xinjiang.

This is way outside my area of expertise, but ever since the early days of AIDS there have been persistent reports around the world of AIDS victims randomly attacking people with syringes and injecting them with infected blood.\’a0 I have no idea of what has happened in Urumqi, but I wonder if this talk about syringe-wielders isn\’92t underpinned by these kinds of rumors. \’a0I am not a weapons expert, but it seems to me that attacking someone with a syringe would otherwise be pretty inefficient. \’a0Even an ordinary beer bottle has to be a better weapon than a syringe.

For what it\’92s worth, it seems that as widespread as these AIDS-infected-syringe claims have been in the past, and as certain as many people are that they have occurred, there has apparently never been any credible confirmation of such an attack — no eyewitnesses, no police records, no medical records. \’a0This is apparently one of those urban myths that we seize upon for reasons that may have more to do with our own fears than with any reality.\’a0 I\’92d be curious to see whether or not these attacks in Urumqi are confirmed and, if so, to get a better sense of why anyone would use such a weird weapon.

It\’92s not yet the end of China\’92s massive stimulus

August 31, 2009 in Consumption and production, Fiscal stimulus by Michael Pettis | 31 comments

\’a0According to a recent article on Reuters, on Saturday Lou Jiwei, the chairman of the CIC, China\’92s sovereign wealth fund, said at a conference on Saturday in response to a question about his expected performance: \’93It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.\’94
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In my last entry I noted that after the recent \’93green shoots\’94 period, during time which it seemed hard to find anyone who was skeptical of our seeming ability to turn the corner on the crisis without actually having addressed any of the underlying imbalances, it was good to see that more and more analysts, and especially policymakers, had begun to worry again.\’a0 President Hoover went down in a blaze with his \’93light at the end of the tunnel\’94, and of course one of my favorite stories of that time is his response in June 1930 to a delegation requesting a public works program to help speed the recovery: \’93Gentleman, you have come sixty days too late. The depression is over.\’94
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As I see it the more policymakers worry, the better. This crisis is far from over. Until we know how the continued adjustment in US household consumption and debt will evolve, and how this adjustment will play out in China\’92s own changing consumption rate \’96 most importantly whether it will complement the fiscal and credit expansion embarked upon by Beijing or, as I believe, conflict enormously with it \’96 the crisis won\’92t be over. We need policymakers to resist the green-shoots nonsense and to worry about what happens when fiscal, monetary and credit tools stop working.

Although I thoroughly disagree with the \’93So we can\’92t lose\’94 part of Mr. Lou\’92s statement \’96 I have been a trader for too long to hear those words with anything but the deepest dread, and I am sure he didn’t intend\’a0the way it read\’a0\’96 it is nonetheless interesting to me that by now skepticism is so widespread that a major investor can even propose our inability to work through the imbalances as a reasonable investment strategy.

We need skepticism. For one thing it has caused Beijing increasing worry about the risks of continuing to extend the stimulus package, to the point where they are now making serious noises about cutting back. My biweekly column in today\’92s South China Morning Post argues that in spite of the damage this has done to the stock market, it is undoubtedly a good thing that they are thinking about cutting back.

So Chinese policymakers have had to choose between policies that boost employment in the short term while making the overcapacity problem in the long term worse and, on the other hand, force a more efficient adjustment in the domestic imbalance while increasing job losses.

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Until now, Beijing had come down resolutely on the side of boosting employment. It had shifted a massive amount of resources, mainly through the banking system, into new investment in infrastructure and new production facilities. This created jobs and boosted consumption, but it did so by expanding current and future production even faster, only worsening the domestic imbalances and making China even more reliant on US consumption.

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It probably had no choice. As in nearly every major economy, the first instinct of policymakers since the crisis began has been to enact measures to slow unemployment growth. If unemployment grew too quickly and caused consumption to fall, it could easily tip the economy into a long-term and irreversible contraction.

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But there was always a limit to how far Beijing should push. It could continue spending like crazy on good and bad projects to keep workers employed, but if all this spending simply increases capacity faster than it raised consumption, the net result would be an unsustainable debt burden and a more difficult reckoning.

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That is why we should welcome the signs that Beijing may be reaching the limits of its investment push. The government believes that it has created enough momentum to avoid the worst consequences of the global crisis and the contraction in the export markets, but it is also stepping back from creating a worse crisis.

But it won\’92t be easy, and I suspect that already the effect of rumors about slowing the fiscal expansion is strengthening the hands of those who want to stomp again on the gas pedal. For example the stock market was down 6.7% today, bringing its total decline since August 4 to 23.3%. Even my superstar PKU student Gao Ming, who has so far ridden this chaos pretty well, admitted to me today that it was not a good day for him.

Why did the market collapse? Forget about fundamentals. As I have argued many times before, China lacks the necessary tools that fundamental investors use (e.g. good macro data, good financial statements, a clear corporate governance framework, a stable regulatory environment, a market discount rate) and so no matter what people say, there are no fundamental investing here. There is only speculation, and the two things above all that drive the markets are those old speculator favorites, changes in underlying liquidity and government signaling.

The whole market is worried about both, and the most important is concern that the days of explosive bank credit growth are behind us. On Friday, for example, Bloomberg reported that:

Bank of China Ltd., the nation\’92s third-largest by assets, plans to slow credit growth in the second half of the year and improve loan quality after posting an unexpected profit gain in the second quarter.

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\’85Lending in the second half will be \’93much smaller,\’94 with new credit in July and August dropping from the monthly averages of the first half, President Li Lihui told reporters yesterday.

Today the mainland newspapers were even more worrying. Several reported that new loans in August would be just RMB 300 billion, after last months\’92 new loan total of RMB 356 billion, and RMB 1,231 billion on average during the previous six months.

RMB 300 billion is nothing to sneeze at, especially since that probably nets out a lot of bills coming due \’96 so that new medium-and long-term investment is likely to be substantially higher. It is also worth remembering that August is normally a bad month for new lending \’96 last year net new loans were only RMB 272 billion.

Still, after the deluge of new lending for the first half of the year, it clearly represents a significant contraction in the rate of credit expansion, and if you believe, as I do, that China\’92s \’93impressive\’94 growth rate this year is actually a very disappointing consequence of a huge fiscal and credit stimulus, any indication that the stimulus will slow down cannot be good for sentiment.

Speaking of which I saw an interesting article in today\’92s People\’92s Daily. On the one hand it seems positive for an eventual generational-inspired rise in consumption, and on the other hand it seems negative about structural impediments:

College students, once a major demographic for banks issuing credit cards in China, are now finding that many lenders such as China Merchants Bank and Bank of Communications have recently steepened their application requirements or stopped issuing credit cards to students altogether.

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The changes in policy originate with a notice issued by the China Banking Regulatory Commission at the end of July. According to the notice, other than parents authorizing access their account, banks are not allowed to issue credit cards to those under 18. For students over 18 unemployed or without income, a cosigner is required.\’a0\’a0 Paying with plastic is really common on campuses, and is not unusual for a student in China to have up to 3 to 4 credit cards.\’a0\’a0“Whenever I go back home, I use a credit card to buy plane tickets, because at the end of the semester I’m usually short on cash,” said Sun Chenghao, a senior student at the China Foreign Affairs University.\’a0\’a0

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But such convenience also has its drawbacks. Of all recent credit card debt cases heard at the People’s Court in Beijing’s Xuanwu District this July, about 25 percent involved college students.

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More debate about the validity of economic data

August 3, 2009 in Economic growth, Fiscal stimulus by Michael Pettis | 34 comments

Some of the blog readers have noticed some weird goings-on with recent entries.\’a0 From time to time an entry will pop up that seems totally inappropriate to current events.\’a0\’a0\’a0

Sorry.\’a0 This is because the old host of my blog, when it was on a different site, is closing down, and I have been going through the time-consuming and boring task of trying to take as many entries as I can from the old site and posting them in the archives on this site. \’a0The repetitive nature of this process leads me sometimes to forget to post the original date of the entry, in which case it shows up as the current entry until I see the mistake and change it.\’a0

I am still planning to post the longish piece I wrote, on my view of what the SED discussions should have been about.\’a0 However since I am beginning tomorrow an eight-day trip organized by two different banks to meet with and speak to their clients (full disclosure: since one of the meetings is in Bangkok I am sneaking out to Phuket for a couple of days to get in some beach time), I thought I would save that post for during my trip and talk about a few other interesting things.\’a0

First off, a lot of investors and government officals have recently been trudging to Beijing in spite of the heat and mugginess and seem to be eager to discuss the outlook for China.\’a0 Perhaps because the press, and more importantly a lot of Chinese academics and think tank types, are beginning to worry much more in public about the medium term outlook, the conversations seem to be a lot more worried than they have in the past.\’a0 On my upcoming trip I hope to get some more idea of what big investors are thinking, and if I am allowed to repeat their views, I will.\’a0

Next, I see that recent US GDP numbers are getting a mixed reception. \’a0Second quarter GDP contracted by an annualized 1.0%.\’a0 That isn\’92t a good thing, of course, but it is much better than the 6.4% contraction in the first quarter, and also better than the 1.5% contraction that the market was expecting.\’a0 According to an article in today\’92s Financial Times:\’a0

While the contraction was much smaller than in the previous three quarters and slightly better than economists had expected, the data showed that the government stimulus and a slowdown in imports had cushioned the drop.\’a0\’a0

Of course most analysts continue to be worried about, and debate, whether the US is better off slowing the stimulus, and so reducing debt while speeding up the needed adjustments at the cost of higher unemployment, or continuing pushing forward \’96 a debate very similar to that taking place in China. \’a0Given my focus on China my main concern \’96 no big surprise \’96 was US consumption, which declined by more than GDP, which I expect to be a regular feature of the next few years.\’a0

Consumer spending, which represents about two-thirds of GDP and has traditionally been the engine of US growth, fell a much worse-than-expected 1.2 per cent as Americans continued to cut back in the face of rising unemployment and the falling value of their homes and investments.\’a0

In Japan, a country that I am spending more and more time learning about because of some worrying parallels between their 1980s and China\’92s current condition, the numbers continue to be very poor.\’a0 Again the Financial Times today tells the story:\’a0

Wages in Japan suffered their sharpest drop in nearly two decades in June, fuelling concerns that the economy would remain under pressure from depressed consumer spending.\’a0 Monthly wages, including overtime and bonuses dropped 7.1 per cent from a year earlier for the 13th decline in a row to Y430,620, according to the Labour Ministry.\’a0 It was the steepest drop in wages since the government began compiling data in 1990.\’a0

Wages in China, on the other hand, seem to moving in a very different direction \’96 no surprise, I think, given the extent of the stimulus package.\’a0 Here is what Xinhua said on Wednesday:\’a0

Average wage per capita for Chinese urban employees grew 12.9 percent year on year to 14,638 yuan (about 2,149.78 U.S. dollars) in the first half of this year, said the National Bureau of Statistics Wednesday. \’a0The growth rate was 5.1 percentage points lower than that in the same period last year, the bureau said.\’a0\’a0

Even acknowledging all the distortions, and recognizing that this year\’92s growth rate in wages was much lower than last year\’92s (will this put pressure on consumption growth?), this still seems like a very healthy growth rate. \’a0Funnily enough however the numbers were questioned in, of all places, today\’92s People\’92s Daily. \’a0In their article they had this to say:\’a0

Banter and sarcasm erupted in the wake of a National Bureau of Statistics (NBS) report Wednesday saying the average pre-tax wage per capita for urban employees grew 12.9 percent, year-on-year, to 14,638 yuan (2,142.43 U.S. dollars) in the first half of this year.
\

\
The seemingly inspiring and encouraging news did not draw much applause, but a hail of criticism from the public, with many being skeptical of the figures’ credibility. The term: “I’ve been given a raise,” referring to the furor over the NBS’s statistics, has become increasingly popular among China’s mass of Internet users.
\

\
On the popular online forum tianya.cn, a commentary read, “The statistics released by the NBS are miraculous, as the increase managed to surpass the GDP growth of 7.9 percent registered in the second quarter against a backdrop of the global financial crisis.” \’a0However, the poster noted, most people’s pockets remain shallow.
\

\
\’85A poll on tom.com showed as many as 88 percent of 2,816 respondents believed it is reasonable to doubt the income rise announced by the NBS.\’a0
\

I was impressed by the fact that the article just reported the skepticism and didn\’92t make much more than a very half-hearted attempt to explain why the public is wrong to be skeptical.\’a0 As an aside, in recent weeks it seems to me that there has been an increasingly heated, but not always on-the-record, debate about the conflicts and contradictions implied by official Chinese growth numbers and other indirect measures of growth \’96 with Marc Faber last week giving an especially blunt assessment.\’a0 I have been hearing from a lot of Chinese and foreign colleagues about challenges to the data, and although I am not smart enough to contribute much to this debate, I expect it to become more public \’96 already there have been several articles in the Chinese press referring obliquely to disagreements about the data and defending the quality of the NBS statistics. \’a0Perhaps the People’s Daily is now leading the charge for prosecution?\’a0

Speaking of prosecution in the Chinese press, Caijing continues to feature a series of excellent articles questioning the impact of the stimulus package. \’a0I won’t summarize them all, but I found this article in this week\’92s issue, by Chen Changhua, interesting:\’a0

Through bank lending and money supply, liquidity has been ample in the market. However, nominal GDP growth lagged far behind the growth in lending and money supply, which could raise suspicion that a large portion of the funding has entered asset markets.\’a0

In the next one or two years, the global economy won’t be able to recover and, due to overcapacity, consumer price index (CPI) will not be able to rise sharply. Even if the central bank wants to tighten money supply then, various aspects of society won’t support it. It’s no longer a question of whether the central bank should rein in its loose monetary policy, but whether or not it will actually do it.\’a0

China’s fiscal and monetary policies in the past few years have placed growth before anything else. It is unlikely that the Chinese government will raise interest rates when economic recovery has not yet been secured.\’a0\’a0

Chen’s basic argument is that policymakers should be encouraging private enterprises to compete with SOE\’92s because when the \’93bubble implosion\’94 occurs (he doesn’t seem to think that the \’93if\’94 is worth pondering), China will be better served by the productivity-enhancing private sector:\’a0

How quickly a country can recover from an economic slump is determined by the productivity of the country. Japan has not been able to recover from the 1990 slump mainly because there are not enough competitive new-generation enterprises to replace old enterprises.\’a0\’a0\’a0\’a0

If it is difficult to avert a new round of asset bubbles, then opening domestic markets to private enterprises is a good option.\’a0 In the past few years, state-owned enterprises have become larger and stronger while playing the role of the offense while private enterprises have been on defense. Maybe it’s just a hope of mine that private enterprises will muster their forces soon as well.\’a0

One of the big worries about the stimulus, of course, is that it is forcing a further concentration of credit and economic activity into the SOEs, who are among the least productive players in the Chinese economy \’96 even when you don\’92t question whether or not their profits are real or simply a function of highly subsidized interest rates.\’a0\’a0\’a0

Meanwhile the debate about the duration of the fiscal stimulus rages on.\’a0 On the one hand Andy Xie, former chief Asian economist for Morgan Stanley, and someone well plugged into Chinese policymaking circles, said in an interview with Bloomberg:\’a0

\’93The government is worried that this bubble is becoming too big so they\’92re going to cut credit growth by probably half in the second half,\’94 said Xie, now an independent economist, in a Bloomberg Television interview in Hong Kong today. \’93I think the property and stock markets will come under pressure probably around October time.\’94\’a0\’a0

China\’92s banking regulator said yesterday it plans to tighten rules on work capital loans, seeking to prevent misuse of funds. New loans in July may be less than 500 billion yuan, the Shanghai Securities News reported on its front page, without saying where it got its information.\’a0\’a0

It\’92s \’93undeniable\’94 that a portion of this year\’92s new lending entered the nation\’92s stock and property markets, Cheng Siwei, former vice chairman of the standing committee of the National People\’92s Congress, China\’92s parliament, said in June.\’a0\’a0

On the other hand Vice Premier Li Keqiang (a graduate of Peking University, I am proud to say) wrote recently in Qiushi, according to an article in today\’92s Bloomberg:\’a0

China will maintain its \’93proactive\’94 fiscal and \’93moderately loose\’94 monetary policies to help the economy recover from a slump, according to Vice Premier Li Keqiang. \’a0The foundations of the recovery aren\’92t yet solid enough, as evidenced by the continued slide in exports, lower corporate earnings, falling prices and industry overcapacity, Li wrote in the Aug. 1 issue of Qiushi, a twice-monthly Communist Party magazine.\’a0\’a0

The outlook for the global economy is still uncertain and recovery is being hampered by rising trade and investment protectionism around the world, Li wrote. There\’92s been no \’93fundamental change\’94 to the dollar\’92s dominant position in the international financial system, though the trend of diversifying away from the greenback will continue, he added.\’a0\’a0

Finally, and on a separate point, like me Nouriel Roubini has been wondering about the impact of recent Chinese commodity stockpiling. \’a0According to an article in Reuters today he gave a speech in which he discussed the impact of future commodity prices. \’a0Among other things he said:\’a0

“In the short term there has been a massive stockpiling of commodities by China,” he said. “My concern is that China might have accumulated an inventory of commodities that is probably excessive to the growth of their own economy.”\’a0

I agree.\’a0 I am pretty sure that a lot of recent purchases represent many quarters and even years of future demand, and so they are distorting the trade numbers by implying the country is importing more than current demand implies. \’a0By the way for those interested in my argument as to why China should not be stockpiling commodities quite so quickly, here is today\’92s version of my bi-weekly column for the South China Morning Post.

\’a0

Squeezing out the exporters

July 29, 2009 in Balance of payments, Consumption and production, Exports and imports, Fiscal stimulus by Michael Pettis | 42 comments

I am working on a fairly long entry that I will post this weekend about why a trade rebalancing and a consumption/savings rebalancing will take place in both China and the US whether or not we want it.\’a0 This week has been crazy, among other reasons because a festival in Taiwan has invited one of our indie bands and one of our experimental bands (Carsick Cars and White) to perform this weekend at the Music Terminals Festival in Tao Yuan City.\’a0 Getting visas for these kids has been brutally difficult and they actually had to cancel one of their club gigs, on Thursday, because of problems with getting things done on time.\’a0 Still, if any of my readers are going to be in Taiwan this weekend, I strongly recommend that you check out the festival, which besides the two Beijing representatives features a lot of great bands from around the world (or if you prefer club gigs, check them out Friday night at a pre-festival show at The Underworld, in Taipei).

So much for the good news.\’a0 The bad news is described in an alarming article in today’s Wall Street Journal which shows that trade tensions are continuing to rise.\’a0\’a0

European Union trade officials approved pre-emptive penalties on imports of steel pipe from China, a precedent-setting move that suggests the trading bloc is growing more protectionist in the face of the economic downturn.\’a0 Tuesday’s vote by trade officials from the EU’s 27 member states is significant, say trade experts, because they accepted an argument from steel producers \’96 including the world’s largest by volume, ArcelorMittal \’96 that punitive tariffs are needed to protect them from the threat of underpriced imports from China.\’a0 Previously, complainants have had to prove the imports had already hurt their businesses. Trade lawyers say they expect a host of industries to ask the EU for protective tariffs in August.\’a0\’a0

I have been hearing rumblings for a while about tougher stances being taken in Europe and the US in response to the perception that China is exacerbating the global contraction in demand by increasing subsidized resources available to manufacturers, most importantly by channeling a huge increase in lending at interest rates subsidized by Chinese household consumers and socializing the risk.\’a0 These new protectionist moves seems to be an expression of just this.\’a0 The article goes on to say:\’a0\’a0

Basing a claim on the threat of injury “is a perfectly legal strategy, but it has simply not, until now, been used as a matter of EU policy,” says Nikolay Mizulin, a Brussels-based trade lawyer with Hogan & Hartson LLP. \’a0This case “is a sign of growing protectionism and could open the floodgates to many more industries who believe they deserve protection.”\’a0 Mr. Mizulin and other trade lawyers say they expect many industries to seek protective tariffs next month.\’a0\’a0

As I have been arguing for over a year, as unemployment around the world rises and as the necessary contraction in US net demand picks up pace, there was inevitably going to be a conflict with China as Chinese policymakers responded to the collapse in trade in the only way they could, by substantially stepping up investment.\’a0 The result is that China\’92s trade surplus has contracted very slowly \’96 much more slowly than the contraction in the US trade deficit \’96 and the result was a huge squeeze on the tradable goods sectors around the world.\’a0

The fact that policymakers in Europe, China, Japan and the US seem to have no clue as to how difficult the transition for each of the other countries is likely to be, and so are doing not nearly enough to coordinate their response (in fact lecturing and finger waggling seem to the favorite forms of policy coordination), makes trade conflict almost a dead certainty. \’a0I don\’92t think there are necessarily any bad guys here \’96 each country is desperately doing what it can to get itself out of this mess \’96 but there is a lot of failed opportunity and I am pretty sure that the trade environment will continue to decline.\’a0

The problem is illustrated in two interesting recent pieces. \’a0My friend Dan Rosen, of the Rhodium Group, has a very illuminating July 17 report that shows the composition of Chinese growth in the past decade.\’a0 He shows that for the past five years net exports accounted for about 10% to 15% of Chinese GDP growth, before collapsing\’a0to minus 41% in 2009 YTD.\’a0

Until recently investment’s share of GDP growth peaked at around 65% in 2003 \’96 a very high share by any standard \’96 and going back the full thirty years of China\’92s reform period achieved an historical high astonishing of 81% in 1985.\’a0 From 2005 to 2008 the investment share of GDP growth averaged around 40% \’96 still high \’96 and then in the first half of this year accounted for a mind-boggling 88% of this years GDP growth.\’a0

This year\’92s growth, in other words, is almost wholly a function of the massive increase in investment, and this increase in investment started out largely in the form of reopening production facilities and producing more \’93stuff\’94, without any significant rise in consumption.\’a0 As we know, when production increases faster than consumption, either the trade surplus or inventories must rise.\’a0

On that note Xinhua published the following article on Monday:\’a0

The per capita consumption spending volume of Chinese urban residents stood at 5,979 yuan (875 U.S. dollars) in the first half of this year, up 8.9 percent year on year, the National Bureau of Statistics (NBS) announced Monday. \’a0Deducting price factors, the growth reached 10.3 percent.\’a0\’a0 The per capita disposable income of Chinese city dwellers rose 9.8 percent year on year to 8,856 yuan in the first six months. Deducting price factors, the increase reached 11.2 percent, said the NBS.\’a0

Consumption has been rising at around 9% a year for the past several years.\’a0 Notice that if GDP growth slows to under 9%, the savings rate in China will automatically decline.\’a0

The second interesting piece is put out by the Economic Policy Institute, a group I believe not noted for its commitment to free trade. \’a0It shows China\’92s share of the US trade deficit excluding oil. \’a0According to their numbers:\’a0

Year

2000

2001

\
\’a0
\

2002

2003

2004

2005

2006

2007

2008

2009

Share

26%

27%

\
\’a0
\

28%

31%

35%

40%

45%

54%

69%

83%

Perhaps as a consequence of a fiscal stimulus aimed at boosting investment and production, China’s share of the US trade deficit has grown significantly. \’a0Since the US trade deficit is shrinking quickly, this means that other exporters are getting killed.\’a0 As I have argued for a while, this is not sustainable and will almost certainly cause trade tensions to erupt.\’a0

Does this mean China is behaving in a predatory way?\’a0 I don’t thinks so.\’a0 I have warned for a long time that it would be very difficult for China to make the necessary transition to a consumption-led economy quickly enough to accommodate the global adjustment taking place. \’a0Unless it is willing to see its economy collapse, there is simply no way China can reduce its negative net demand quickly enough to match the contraction in US demand and so avoid squeezing the hell out of the global tradable goods sectors.\’a0 That is why policy coordination is so important, especially between China and the USD, and of course that is why I continue to be a pessimist. \’a0I do not think this policy coordination is taking place.\’a0 I will write about this more later this week.\’a0

To continue the discussion of last week, we are getting more conflicting signals about policy confidence. \’a0On the one hand Bank of China seems to love this party. \’a0According to an article in today’s Bloomberg:\’a0

Bank of China Ltd., which doled out the most loans among Chinese banks in the first half, plans to keep expanding credit unless the government clamps down on the nation’s record lending boom.\’a0 The nation’s third-largest bank will maintain its original target of generating about 10 percent of China\’92s new loans in 2009, Beijing-based spokesman Wang Zhaowen said by telephone yesterday. Bank of China may \’93fine tune\’94 its strategy in line with any government policy changes, he said.\’a0\’a0

\’85Bank of China will continue to lend to 10 key industries with government policy support, including steel, shipbuilding and automobile, Wang said. About 30 percent of its loans went to those industries in the first half.\’a0\’a0

On the other hand two of the other members of the Big Four seem a lot more cautious. \’a0Today\’92s South China Morning Post has this article:\’a0

Mainland\’92s two biggest state-owned commercial banks have put a lid on their lending targets for the year, according to domestic media reports, in a move that will significantly slow overall credit growth in the second half. Industrial and Commercial Bank of China (ICBC) is aiming to issue full-year new loans of 1 trillion yuan (HK$1.3 trillion), while China Construction Bank (CCB) has set a goal of 900 billion yuan, Caijing magazine reported.\’a0

The two banks, mainland’s largest by market value, granted new loans of 825.5 billion yuan and 709 billion yuan, respectively, in the first half. \’a0If they stick to their reported targets, this would imply that ICBC would have already issued 83 per cent of its full-year lending total, while CCB would have already issued 79 per cent.\’a0

It is surprising to me that these members of the Big Four are responding so differently, at least in public. \’a0I wonder if the management of the different banks belong to different factions and so interpret the fiscal stimulus package differently. \’a0Perhaps my friend Victor Shih, who understand these things better than I do and who sometimes reads my blog, might comment?\’a0

Finally the Financial Times on Monday continued the thread discussed in my Saturday post with an article called \’93China warns banks over asset bubbles.\’94\’a0

Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming.\’a0 The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier.\’a0

\’85Beijing\’92s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation.\’a0 regulators are now concerned that too much money is being lent by the state-controlled banks and the country\’92s tentative economic rebound could come at the cost of a stable financial system.\’a0

In statements published last week, Wu Xiaoling, who recently retired as deputy governor of the central bank, warned new lending this year would probably reach as high as Rmb12,000bn, a staggering increase of 40 per cent of the entire stock of outstanding loans in just one year.\’a0\’a0

\’85Ms Wu hinted Beijing may soon raise the amount of money banks must hold on deposit with the central bank, marking a change of policy from last year when it aggressively slashed the reserve requirement ratio and interest rates.\’a0 The central bank has also ordered 10 banks, including Bank of China, to buy Rmb100bn worth of central bank notes with a maturity of one year and a return of just 1.5 per cent, according to Chinese media reports.\’a0 This move is interpreted as a warning to banks that have been the most active lenders that they should now start to rein in their excessive behaviour.\’a0

More public worrying about the Chinese stimulus

July 24, 2009 in Fiscal stimulus, Labor and unemployment, Money growth, NPLs, Real estate by Michael Pettis | 44 comments

Although I am often surprised by how eagerly foreign commentators have embraced the Chinese fiscal stimulus story and see it as a great, shining success, I am happy to say, mercifully, that in China there is a lot more skepticism.\’a0 There seems to be a serious debate among Chinese policymakers over the stimulus package.\’a0\’a0\’a0

The debate lists, on one side, people centered on the PBoC, the CBRC and the National Bureau of Statistics, who are worried that the stimulus may be exacerbating Chinese imbalances.\’a0 On the other side are people in the State Council, the Ministry of Commerce and in the provincial and municipal leadership who are more worried that any half-heartedness will lead to a significant rise in unemployment.\’a0\’a0\’a0

In the past week or so the former, with whom I am of course in complete sympathy, seem to have become increasingly worried and have been making a lot of noise.\’a0 The formidable Hu Shilu, editor of Caijing, (and by the way Evan Osmos wrote a very interesting article about her in the current New Yorker) recently made a strong case against continuation of the current fiscal program when she wrote in an editorial this week that \’93a policy that encourages loose lending and investment is driving China’s economic engine down an old, unsustainable path.\’94\’a0

Various signals suggested China’s economy had returned to a stable track by the end of the second quarter, giving us an opportunity to reassess macroeconomic policy.\’a0 Data released by the National Bureau of Statistics showed that China’s GDP rose 7.1 percent in the first half of the year, and 7.9 percent in the second quarter alone. Apparently, China’s economy has bottomed out.\’a0

Arduous efforts contributed to this upward trend. External developments have had a much more serious impact on China’s economy recently than during the Asian Financial Crisis a decade ago. However, first half growth was only a bit below the level recorded in 1998. And although heavily dependant on exports, China may yet achieve its 2009 growth target of 8 percent, even while other major export countries report contractions.\’a0

These achievements could intoxicate Chinese policymakers. But we see no miracles here. In fact, economic growth recovery in China is being driven by investment. Some 6.2 percent of the country’s first half GDP growth rate can be credited to investment, while consumption accounted for 3.8 percent. The net export business contributed a minus 2.9 percent to the growth rate figure.\’a0

Hu makes the point that the \’93surprisingly high\’94 Chinese growth is neither surprising nor cause for celebration.\’a0 It is the automatic outcome of a huge stimulus, and the real question, as I have argued many times, is not whether high current growth indicates that China has turned the corner on the crisis (it most certainly has not, in my opinion), but whether the cost of achieving this growth is excessive and will lead to more difficult conditions in the future.\’a0

It’s long been acknowledged that China’s traditional methods of achieving economic growth cannot be sustained. However, we are now racing down this traditional path of economic development.\’a0\’a0

Dramatic increases in the currency supply and lending have been backing this investment, the single most important engine of economic growth. M2 increased 28.5 percent and yuan-based lending rose 34.4 percent in the first half, setting new records for each. But nominal GDP growth was only 3.8 percent during the first six months of 2009. And these astronomical increases in currency and lending are a double-edged sword that can support GDP growth as well as endanger the economy.\’a0

\’85It’s high time we re-emphasize the actual policy of moderation. A moderately loose monetary policy is necessary for an unpredictable, downward-sloping economy. However, monetary policy that’s too loose will have more drawbacks than merits once an economy levels out. It’s only a matter of time before loose monetary policy leads to inflation and asset bubbles.\’a0

She concludes, very diplomatically I think:\’a0

In the current economic environment, the more quickly China’s economy grows, the greater the effort needed to adjust future methods of economic development. Now is the right time to consider the timing of exit from stimulus. The third quarter can be a crucial juncture.\’a0

She is not alone in criticizing the stimulus.\’a0 Another formidable lady, Wu Xiaoling, former People\’92s Bank of China vice governor, was interviewed by National Business Daily on Wednesday, and warned that the combination of excess capacity and excessively loose monetary policy was leading to asset bubbles.\’a0 According to an article in yesterday\’92s South China Morning Post,\’a0

“Under conditions of overcapacity, excess money supply will not lead to rises in price indexes, but it could generate asset bubbles,” she said at a forum in comments reported by the Chinese-language National Business Daily.\’a0\’a0″The money has really gone out and if it is a time when there is no investment in the real economy and no one will put the money in banks to earn interest, then the funds will flow into the property market and stock market,” she said.\’a0\’a0

China’s central bank may have to raise banks’ reserve requirements to mop up excess liquidity, she said, adding that this was simply a tool for managing the money supply and should not be misunderstood as monetary tightening.\’a0

\’85Ms Wu said that China faced a dilemma in easing the rate of loan growth. Inflationary pressures would arise if lending continued at the same pace, but without sustained lending, many big projects may wind up unfinished because they are contingent on longer-term financing.\’94\’a0

Although an increasingly large number of Chinese academics and think tank researchers have been raising warning cries, I think she is the first official or ex-official to go so public with her worries. \’a0That doesn\’92t mean other public officials don\’92t act as if they are worried.\’a0 The CBRC for example announced this week the good news that the NPL ratio declined from 2.42% at the end of 2008 to 1.77% at the end of June.\’a0\’a0\’a0

Part of this reflected an actual decline in NPLs, and most of it of course reflects the surge in new loans, but the CBRC is not acting complacent.\’a0 They have reinforced credit control policies on second-home purchases and their spokesman insisted earlier this week that there would be \’93strict enforcement\’94 of the CBRC’s mortgage lending policy.\’a0\’a0

According to another article in Caijing, \’93the authorities have consistently been encouraging banks to raise their loan-loss coverage, reflecting fears that the massive surge in new credit extended in the first half may lead to a rise in bad loans.\’94\’a0 The South China Morning Post had this to say on that subject:\’a0

Beijing has required banks to raise their bad-loan reserve ratio to 150 per cent at the end of the year, forcing the lenders to set aside an additional 70billion yuan ($79HK.4 billion) as provision amid deteriorating asset quality, a fresh sign of China’s mounting worries about a backlash from its stimulus package.\’a0\’a0

Liu Mingkang, the chairman of the China Banking Regulatory Commission, told a government working conference over the weekend that all mainland-based banks including local units of foreign giants such as Citigroup \’a0and HSBC Holdings must boost their reserve ratio to 150 per cent, as risks were increasing amid a torrent of imprudent loans in this year’s first half.\’a0\’a0

“Rapid growth in banking loans has led to accumulated risks,” Mr Liu was quoted in a CBRC statement as saying. “Reckless operations of banks were seen as some banks rushed to extend loans without due diligence.”\’a0

The article goes on to quote She Minhua, a banking analyst at China Jianyin Investment Securities as saying “The requirement is basically a message that asset quality deterioration is deepening.\’a0 A serious problem will probably surface in 2010.”\’a0

And Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said earlier this week that China, the world\’92s largest steel producing nation, should curtail \’93reckless investments\’94 in the industry by withholding project approvals. \’a0According to an article in Bloomberg:\’a0

China’s demand for steel is about 500 million metric tons, less than the annual output capacity of 660 million tons, Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said at a conference in Beijing today. Zhu is reiterating figures given by the China Iron & Steel Association in February for last year.\’a0\’a0

Crude steel output in China rose to a record 266.6 million tons in the first half as the nation\’92s $586 billion stimulus package spurred demand from builders and carmakers. Annualized, this would beat the 460 million tons output forecast by the steel association for this year.\’a0\’a0

“The industry must produce according to market needs, and avoid adding to the excess capacity,” Zhu said. “They should avoid reckless investments. The government must also take action to curtail additional investments by companies that are already in excess.”\’a0\’a0

Even Justin Lin, the World Bank’s chief economist, and someone who has been more of a cheerleader for China\’92s economic model than a critic, made a statement that suggests to me an indirect criticism of the fiscal stimulus package, although he (and others) may disagree with my interpretation.\’a0 According to a July 15 article in the Telegraph:\’a0\’a0

Justin Lin, the bank\’92s chief economist, said factories running idle around world threaten to trap economies in a vicious cycle, risking further spasms of financial stress, requiring yet more rescue packages.\’a0 “Significant excess capacity has been built up and unless this issue is addressed, we will face a deflationary spiral and the crisis will become protracted,” he told an audience in Cape Town.

\’a0

Mr Lin said capacity use had fallen to 72pc in Germany, 69pc in the US, 65pc in Japan, and as low as 50pc in some developing countries, mostly touching lows not seen in modern times.\’a0 The traditional cure for countries caught in slumps is to claw their way back to health through devaluation, but this cannot be done today because the crisis is global. “No country can count on currency depreciation and exports as a way out of recession. Unless we deal with excess capacity, it will wreak havoc on all countries. There is urgent need for global, co-ordinated fiscal stimulus,” he said.\’a0\’a0

But for all the warnings I don’t want to exaggerate my account of rising skepticism among Chinese economists and regulators.\’a0 In spite of possible back-door attempts by the PBoC and the CBRC to manage the excesses associated with the fiscal stimulus, it is pretty clear I think that policy is still being managed largely by policymakers who are far more worried about rising unemployment in the short term than about asset bubbles and an exacerbation of the unbalanced development model.\’a0

The front page of today’s People’s Daily, for example, makes this clear.\’a0 They cite Finance Minister Xie Xuren’s insistence that “China will stick to proactive fiscal policy in the second half.”\’a0 According to the article, which is also carried in Xinhua:\’a0

China will continue its proactive policy and reform its economic structure in the second half of this year to boost economic growth, Finance Minister Xie Xuren said Thursday.\’a0 Xie told local financial bureaus at a conference in Beijing on Thursday that the proactive policies, which included increased investment from government, tax cuts and subsidies to low income families, had taken effect in stimulating a recovery of the national economy.\’a0

Xinhua today also prominently cites Peking University professor Li Yining as saying that “China should stick to its proactive fiscal policy and moderately easy monetary policy to fuel the economic growth as the foundation for recovery is not solid yet.”\’a0 I was not at the conference, so I wonder if professor Li\’92s comments were spun a little, because according to the Xinhua article he also said that “the current economic advance was pushed by investment, which was not the final demand \’96 stable economic recovery should be sustained by increased consumption,” and warned that Chinese banks should “improve credit quality and structure.”\’a0

So for all the rising skepticism among policymakers and scholars I think there is little doubt that we are going to see still more fiscal stimulus along the lines we have already seen.\’a0 If there is indeed global excess capacity, as Justin Lin says there is, I cannot see how an investment-driven program to increase capacity, and one which is almost certain to involve a huge additional misallocation of capital (after all, 8% growth given the sheer size of the fiscal and banking stimulus is actually a disappointingly low level of growth), can be much more than a short-term stop gap.\’a0 On the contrary, I think it will make the medium term adjustment even more difficult.\’a0

On that note I want to recommend Victor Shih’s excellent OpEd piece in the Wall Street Journal \’96 Asia yesterday.\’a0 He argues that:\’a0

Should this pace of credit expansion continue for the remainder of the year, China may well face a difficult trade-off down the road. The economy is unlikely to face a financial crisis because most of the debt is owed to domestic investors and depositors and China can still prevent large-scale capital flight. However, if inflation spikes next year, the central government will have to choose between shutting off credit, which will reveal a massive nonperforming loan problem currently obscured by a torrent of new loans, or an unprecedented level of inflation. High inflation is destabilizing, as it has caused major runs on the banks before. If additional credit expansion in the face of rising inflation is not an option, the greater the extent to which lending is uncontrolled at the moment, the bigger a nonperforming loan problem the central government will face in the future.\’a0

An often overlooked ingredient to China’s success story is that generations of top-level central technocrats like Chen Yun, Yao Yilin and Zhu Rongji time and again used their political influence to constrain local investment bubbles, thus forestalling high inflation and major financial crises. Past retrenchment campaigns were unpopular and controversial, but senior technocrats nonetheless maneuvered to stop uncontrolled local investment. As credit continues to rocket toward the stratosphere, China is in increasing need of such leadership again.\’a0

Before closing this long post I want to add three additional comments.\’a0 The first involves a conversation I had with one of my Tsinghua students who graduated in 2003 and now works as a currency trader.\’a0 Last year he bought a few apartments in Chengdu, the capital of Sichuan, his home province, for speculative purposes, and in spite of surging land prices he seemed to think it was a terrible trade.\’a0\’a0\’a0

I asked him why, and he said that although real estate prices had gone up dramatically since he bought the apartments, and he needed the money back, he nonetheless found himself unable to sell the apartments.\’a0 That\’92s a little weird, I thought.\’a0 Rising prices should mean eager buyers, but he can\’92t get anyone to take the apartments off him?\’a0\’a0\’a0

Has any other of my blog readers experienced anything similar?\’a0 Of course the historian in me remembers that during the final two years of the Japanese bubble, when land prices soared to levels never before seen in history, there were complaints by sellers that transaction volume was so thin that they couldn\’92t actually sell their land.\’a0

My second comment concerns university unemployment.\’a0 I have been writing for three years that unemployment among college graduates in China was soaring, and that authorities were understandably nervous.\’a0 So nervous, it seems, that they have been putting pressure on university to do more to get jobs for their graduates by limiting their next-year enrollment to the number of graduates this year with jobs.\’a0

There are, of course, two ways to improve statistics.\’a0 One way is to improve the underlying reality.\’a0 The second way is just to fake the numbers.\’a0 According to a Tuesday article in the People’s Daily:\’a0\’a0

A Shaanxi graduate said his university gave him a bogus work contract to inflate its post-study employment figures.\’a0 The former student said the contract was for a job at a local company which did not exist and carried the signature of his tutor.

I had no idea that I already had a job,” the student, who had been hunting for work, wrote anonymously on a website.\’a0 In order to ensure a high employment rate and deliver a satisfactory work report during the global financial crisis, some Chinese universities have been faking work contracts or employment agreement for graduates, Southern Metropolis Daily reported yesterday.\’a0\’a0

“Faking employment rates is not an isolated case and it has existed for years in China,” an education expert, who wanted to remain anonymous, told China Daily.\’a0 Due to fierce competition among universities, especially secondary-tier ones, the performance and reputation of a school largely depends on its employment rate after graduation, he said.

\’a0

According to unwritten rules at many universities, students cannot graduate if they do not find a job, the report said.\’a0 This means many unemployed students have to buy a fake job contract or employment agreement from small companies so that they can get their certificates.\’a0\’a0

This kind of thing will mean that the college employment numbers, a very useful figure for understanding the effect of economic growth in China, are now much less useful.\’a0 Already the People’s Daily article cites differences between the Ministry of Education numbers and a private firm\’92s numbers.\’a0

The Ministry of Education said that nearly two thirds of them [2009 college graduates] had already secured jobs before graduation in early July.\’a0 But this figure differs widely with an employment report from an independent consulting firm on higher education.\’a0 A report from MyCOS HR Digital Information Co said 58 percent of prospective graduates had not signed job contracts by the end of June and that 2 percent had contracts cancelled.\’a0

By the way the article has an interesting graph on the number of college graduates over the past eight years, for those who are interested.\’a0 The total number of university graduates has surged from 1.45 million in 2002 to 5.59 million in 2008 and 6.10 million this year.\’a0 The intervening years saw 2.12, 2.80, 3.38, 4.13, and 4.95 million graduates.\’a0

My third comment is about the great article in today’s Wall Street Journal on the explosive development of the Beijing music scene, a subject that all my friends know is one dear to my heart.\’a0 Anyone who is interested in knowing more about this scene should read it.\’a0

Tags: Steundent employment, Victor Shih

Stimulus \’96 at what cost?

June 8, 2009 in Banks, Fiscal stimulus by Michael Pettis | 25 comments

Today is the second day of the dreaded gaokao, the national college entrance exam that more than half of all Chinese kids in their age cohort will sit to determine whether or not they will go to university (just over 60% of the test takers will start college next September) and, much more importantly, which one they will attend. Throughout Beijing anxious parents are standing glumly in the heavy (but cleansing) June rain waiting for their kids to emerge from the exams so that they can pepper them with worried questions. It is a scary time for a lot of people.

In the previous six years the number of students taking the exam has jumped every year, from 5.3 million in 2002 to 10.5 million in 2008. This year, for the first time, the number of students sitting the exam has actually declined to 10.2 million.

The official position is that the decline reflects a drop in the number of 18-year-olds in China, but there has been widespread discussion in the press that the decline was too large to be explained just by the smaller number of high-school graduates, and that in part it reflects fears of rising unemployment among college graduates. College is becoming a less attractive option to some Chinese.

6.1 million college students will graduate this month and, according to the Ministry of Human Resources and Social Security, about 1 million have been unable to find jobs so far. Over the past three years the number of college graduates finding jobs has stagnated even as the number of graduates has surged, even during the boom years of 2006 and 2007. Part of this was caused by the surge in college enrollment, but at least part of the employment difficulties facing college graduates has been blamed on the very poor quality of university education, especially in the new or newly expanded schools, and its failure to prepare students for the kinds of jobs that the market wants.

Over recent months the government has made finding position for graduates, including in the army and as rural high school teachers, a top priority. The front page of today\’92s People\’92s Daily has an article citing a speech by Premier Wen Jiabao in Xi\’92an (in Shaanxi province) encouraging graduates to widen their job search:

Chinese Premier Wen Jiabao has urged the country’s college students to find grassroots jobs in less developed regions as the economic downturn increases pressures in employment market. Visiting Xi’an, capital of central Shaanxi Province, from Friday to Sunday, Wen said employment was one of the government’s priorities for the sake of the country’s economy and for the future of individuals.

\’93College students, laid-off workers and migrant workers waiting for jobs are my biggest concern,\’94 Wen told job hunters at an employment center. He encouraged graduates from universities and colleges to find work in grassroots regions, and called on employers to create more jobs.
\

\
Since the second half of last year, the government has implemented a series of policies to create jobs. The State Council, or Cabinet, also decided to give living allowances to graduates who went to the central and western regions for internships.
\

Besides exhorting college grads to take the kinds of jobs they usually shun, the government is also still working on boosting growth. The Ministry of Finance recently raised the rebate of export taxes by around 15%, according to another article in today\’92s People\’92s Daily. This is part of the move to increase China\’92s export competitiveness, but I am not sure these kinds of measures are likely to have much positive global impact beyond crowding out export competitors and worsening the global trade environment.

As badly as Chinese exports have been hurt, and exports were down 22.6% year on year in April, Chinese exporters have still done much better than other exporting countries in Asia and elsewhere, suggesting that they have managed to avoid much of the brunt in the contraction in global imports, led by the contraction in the US. This, as I argued in last week\’92s entry, has as much to do with credit and interest rate policies as it does with any inherent competitive advantage.

Not surprisingly, given these moves, expectations of a rise in the value of the RMB are declining. For the fifth day in a row, according to an article in today\’92s Bloomberg, the 12 month RMB forward declined, trading currently at 6.714, implying a 1.8% appreciation over the year (because these forward markets cannot easily be arbitraged, they do not price according to interest differentials, as forwards normally do, and so may contain more expectational content that a lot of other forward markets).

Meanwhile an interesting article in always-hard-hitting Caijing worries about the flood of bank credit, and whether borrowers are earning nearly enough to cover interest costs:

Chinese bank lending increased to more than 5 trillion yuan between January and April, nearly three times the credit level reported during the same period last year. Even if new loans average only 500 billion yuan during each of the remaining eight months of 2009, the year’s total would be more than 9 trillion yuan \’96 more than all loans issued over the previous two years combined.

The industrial sector’s recent performance provides solid grounds for concern over this rapid credit growth. A National Statistics Bureau survey of 22 regions found industrial profits totaled only 323 billion yuan during the first quarter, down 32 percent from a year earlier. That means annual profits for all industries will amount to only about 1.6 trillion yuan this year.

Outstanding loans currently stand at 35 trillion yuan. Assuming companies have kept a moderate debt ratio averaging less than 50 percent, their capital investments now exceed 35 trillion yuan. And profits of 1.6 trillion yuan versus 35 trillion in capital investment means an annual return rate of only 4.57 percent, below the weighted loan interest rate of 4.76 percent we saw in March. In this sense, companies seem to be in a rather weak position to finance debt with earnings.

Although the writer of the piece, economist Lu Lei, thinks that continued expansion in the banking system creates enormous risks, he doubts that the PBoC will put the brakes on bank lending for a number of reasons, the most important being that commercial bank lending is at the heart (and lungs and nearly every other organ I can think of) of the fiscal stimulus program, and without it, there is no stimulus.

Looking at tax revenues, local governments nationwide were unable to collect as much in the first quarter as in the same period 2008. In fact, tax receipts fell 1.4 percent, in sharp contrast to the 34.7 percent increase posted a year earlier. Cursed with double pressure from a directive to invest and shrinking revenue, local governments have had every incentive to use banks as financing proxies.

Now we’re faced with the possibility of undesirable negative GDP growth. Banks, concerned about defaults, may grant only 300 billion yuan in new loans every month for the rest of the year. So we’re stuck with a painful choice between two losing scenarios: a more moderate monetary policy that would cripple fiscal policy, leading to an outright “hard-landing;” or continuing a loose monetary policy backed by fiscal spending, which risks future loan losses and a weaker market. To get around the problem, the central bank may be forced to fill holes at banks by pumping in money, in effect imposing an inflation tax on all consumers

Lu lei\’92s \’93painful choice\’94 is exactly right, and what an inevitable worrier like me has been worrying about since last summer. In January I wrote about this \’93all but the kitchen sink\’94 policy, of throwing everything they can into stimulating the economy, and said that although this would certainly result in higher than expected growth this year, it would come at a real cost. I wrote:

This strategy may be politically necessary but ultimately represents a gamble on the duration of the global slowdown. If the duration is short and the slowdown light, it will have been a winning gamble, and once the world takes off again China can get serious about resolving the internal imbalances.

Of course if the global slowdown is long and deep, the gamble will have failed. That means, dear readers, that if Chinese GDP growth in 2009 is higher than I projected \’96 say 8% \’96 I will not whip out the party hats and favors. Instead I will immediately begin whining about the state of the banking system.

To make matters worse there is a story that appeared a few weeks ago in an article in Australian newspaper The Age, warning about something that has been much discussed over the past year, that the fiscal stimulus package, or more precisely, the way it is being financed, could lead to rising contingent debt at the provincial and municipal level.

Beijing will have to jam on the economic brakes to save cities from bankrupting themselves, says a top Chinese adviser. He Fan, an assistant director at the Chinese Academy of Social Sciences who frequently advises top leaders, says as much as two-thirds of Beijing’s 4 trillion yuan ($A773 billion) stimulus program will be spent by local governments, financed mainly by state-owned banks.

\’93Some local governments will virtually go bankrupt,\’94 Professor He told BusinessDay. \’93Previously, local governments got all their money from selling land. This is not sustainable. Some areas have already sold quotas from the next 30 years.\’94 A number of large cities are thought to be at risk, including Kunming and Hangzhou, with their funding problems exacerbated by a slump in real estate sales.

Professor He goes on to worry that easy money has poured into asset markets as well as questionable projects that were previously rejected by the NDRC.

\’93Banks have strong incentives to lend to NDRC-approved projects because if they end up as a fiasco, there is no political risk,\’94 he said. \’93They can say \’91it is not my fault, the NDRC told us to lend\’92.\’94

When banks are encouraged to lend huge amounts, and with an implicit guarantee against any losses, it is pretty hard to imagine their not embarking on a wild lending spree. On a related but very different subject, I have been corresponding with Steve Keen, a professor at the University of Western Sydney and someone whose blog I often read and whose unconventional insights I find very valuable and persuasive (the fact that he is an expert in and admirer of the works of Hyman Minsky doesn\’92t hurt either).

I wrote to him to ask his thoughts on the implications on monetary policy and debt structures of China\’92s rising savings rate. It seems to me that as savings rise as a share of GDP, this must have dampened the impact of the very loose monetary conditions in China over the past several year. If this is the case, and if savings rates do indeed decline in the next few years, there could be important consequences for monetary policy. I plan to think about this a little more and, if I come up with anything interesting to say, I will write about it. Maybe some of the readers of this blog might have some interesting ideas. Steve Keen\’92s initial response included the following:

Now that the American private sector has stopped borrowing, but both American and Chinese governments are pumping base money into the system, and American consumers and businesses are desperately trying to delever, the dynamics alter considerably. But I expect the overall result will be a relative fall in the Chinese “savings rate” and a rise in the American one.

Obviously I think looking at this from the point of view of savings rather than debt is why we haven’t worked this out to date. A lower consumption rate is definitely part of it, but the debt flows themselves-which generate the monetary flows that then accumulate in accounts depending on consumption rates–are the driving part of the story, not the consumption rates themselves.

Tags: Steve Keen

Exports versus domestic demand \’96 the argument rages

May 8, 2009 in Fiscal stimulus, Trade protection by Michael Pettis | 56 comments

Today\’92s Financial Times and last week\’92s Economic Observer had articles that display the kinds of confusion that economic crises can create among policymakers. The Financial Times article was actually an opinion piece written by Wang Qishan \’96 a Vice premier in the State Council and presumably one of the top three or four economic policy decision-makers in China.

It starts out, correctly I think, by warning that the global crisis is far from over. \’93The global financial crisis is still spreading,\’94 Wang warns, \’93The world economy is going to get worse before it gets better, and the situation remains serious.\’94 Much of the article discusses the same grab-bag of regulatory reform proposals whose purported aim is \’93to prevent a repetition of this financial crisis,\’94 which include financial regulations to \’93strengthen, on the basis of sovereign rules, co-operation in regulating international private capital flows, financial institutions and markets, financial products and intermediaries.\’94

I have already written why I think financial reform aimed at preventing financial crises (as opposed to improving the capital allocation process during \’93normal\’94 times) is largely a waste of time, and to that end I will remind my readers that Hyman Minsky, whose understanding of financial instability surpasses everyone else\’92s, argued that: \’93Stability, in a world with an uncertain future, and complex financial instruments, is destabilizing.\’94 In \’93A Minsky Meltdown: Lessons for Central Bankers\’94, a speech delivered on May 1, Janet Yellen, president of the San Francisco Federal Reserve Bank, explains:

As Minsky’s financial instability hypothesis suggests, when optimism is high and ample funds are available for investment, investors tend to migrate from the safe hedge end of the Minsky spectrum to the risky speculative and Ponzi end. Indeed, in the current episode, investors tried to raise returns by increasing leverage and sacrificing liquidity through short-term \’96 sometimes overnight \’96 debt financing.

Avoiding financial crisis, in other words, is a total pipe dream because to the extent that we are successful and enforce conditions of stability we actually increase the probability of future instability.

But that is an aside. Wang goes on in his article to propose action:

It is imperative for countries to co-ordinate macroeconomic policies and for all to adopt stimulus, fiscal and monetary policies. It is vital unequivocally to reject protectionism of all kinds.

Anti-protection sentiments are, of course, all fine and good, but it doesn\’92t make sense to define protection too narrowly. In contrast to Wang\’92s sentiments, last week\’92s Economic Observer had a very different take on protection.

China should give preference to locally-produced goods in government procurement, the Ministry of Finance said at an April 22 meeting focused on the issue. Assistant minister Zhang Tong said at the meeting that most of the public welfare projects benefiting from the government’s four-trillion-yuan stimulus package announced late in 2008 were closely related to government procurement.

Chinese law stipulates that\’a0government procurement favor local goods. But the EO has learned that many officials were not satisfied with the amount of local goods that the government\’a0had purchased since stimulus funds kicked in\’a0last November. Against this backdrop, China’s State Council ordered on April 10 that government at all levels give preference to domestic goods, and new regulations tightening\’a0government procurement have been slated for legislation in 2009.

It is hard for anyone, especially the country that does most to export overcapacity, to preach free trade while putting into place such blatantly obvious restrictions on trade. Of course some might argue that this is no different than the \’93Buy American\’94 provisions discussed last year by the US congress, but I think in fact it is very different, for at least three reasons.

First, the \’93Buy America\’94 provisions were never enforced and, what\’92s more, they are in many cases against US law. Of course they may also be against the law in some cases in China, but there is a robust legal mechanism in the US that can be used to prevent the US government from enforcing rules that violate US laws or US trade agreements. Importers, American as well as foreign, can sue the US government with every expectation of winning in court, in a way that no one, especially no foreigner, would even attempt doing in China.

Second, US government procurement is a tiny fraction of total US purchases, even taking into consideration the US fiscal stimulus. In China, almost the entire stimulus package is going to expand investment in SOEs and/or government projects, so the share of government procurement in total GDP is much, much higher in China. That makes it a far more trade-constraining measure in China than it could ever be elsewhere.

Finally, and probably most importantly, China is the country that most desperately needs foreign demand to absorb its excess capacity. In a world of contracting demand, China is the country that is most likely to suffer from protection, for the same reason that it is the country that benefits most from absorbing other country\’92s badly-needed demand. In that case it is not enough to say that China is just doing what everyone else is doing (and never mind that it is much harder for foreigners to invest in China or sell to China than it is for China to do either abroad), since any dispute that resolves itself in greater trade protection hurts China worse than it hurts the other disputant.

Meanwhile the Economic Observer had also last week a very interesting (and a little troubling) editorial on just this subject. The title says a lot: \’93A shift is needed, but not overnight\’94. The article starts:

Chen Deming, head of China’s Ministry of Commerce, recently wrote in the Communist party magazine Qiushi that earnings from Chinese exports could trickle down to compensation, and ultimately end up stimulating domestic consumption. He came down against certain popular opinions in China, including that the country relied too heavily on exports, and stressed that although a withering global market has sapped demand for Chinese goods, it has also presented great opportunities. Chinese enterprises needed to push abroad under such circumstances and promote Chinese exports, he concluded.

Chen’s arguments come at a sensitive time for China’s exports. As the Canton export fair opened this past week, the export industry was not optimistic – official data just released showed another slide in China’s export value in March.

The article goes on to discuss China\’92s transition from export orientation to domestic market orientation. Although many foreign and Chinese commentators, including me, would argue that almost nothing was done to accommodate this transition \’96 indeed that China in the past decade actually deepened its over-reliance on the export sector \’96 the editorial gives the government good marks in managing the process:

In the past few years, the government has long sought to transform the economy from a export-oriented model to a consumption-oriented one, while the Ministry of Commerce strove to reduce the trade surplus. But the economy’s restructuring could not be completed within one day, and a consumption-oriented economy never meant wholly abandoning foreign trade. Eagerness for an overnight success could only lead to adverse consequences. In this sense Chen’s article reflected a realistic attitude.

We believe this was a positive sign that the Chinese government has a deep understanding of the necessity of economic transformation, and that the consumption-oriented model would remain the core of future policy. At the same time, it also meant China understood it needed to be patient throughout the process.

The editorial concludes basically by saying that although China must continue (!) improving the relative importance of domestic markets, it must \’93stabilize\’94 exports since \’93foreign demand must still serve as the engine of the Chinese economy for a period of time.\’94

I think in one sense Minister Chen is right \’96 foreign demand is still the engine of Chinese growth \’96 which is one of the reasons I am so pessimistic about medium-term growth, but of course I am a tad more skeptical than he is that in the past few years there were active policies (as opposed to formal announcements) aimed at reducing China\’92s over-reliance on exports. For example two of the most obvious steps \’96 increasing the value of the currency and allowing interest rates to rise to a \’91natural\’94 level \’96 were never really seriously tried, remembering that any increase in the RMB against the dollar, and other currencies, must be set against an even faster relative increase in productivity. This was almost certainly because polices aimed at assisting the transition would necessarily have slowed export growth, and with it economic growth in the short term.

The fact that the editorial and the original article from which it was draw were both published, and seem to be arguing a case, gives some indication, I think, of the ferocity of the debate taking place about the nature of the stimulus package. One side says: Before we can fix the economy we need relief, and that is most likely to happen by reinforcing the existing economic structure. The other side says: The longer we take to postpone the adjustment, the worse.

For the other side of the debate, Hu Shuli in last week\’92s Caijing insists that \’93Beneath the surface of China’s ‘warming’ economy are structural impediments to long-term growth that demand attention \’96 now.\’94 She dismisses the recent optimism about China\’92s \’93bounce\’94 back with “The ‘warnming’ is more show than substance.” and she goes on to say:

Since we know that credit expansion is not the best economic healer, we should spend the coming days thinking about long-term approaches that will help China survive the crisis and pursue lasting development.

China is being forced to rebalance. It\’92s clear that, regardless of the angle from which we examine the situation, our economy is being squeezed by internal and external crises. Excessive consumption in the United States is a root cause of the global financial crisis. Instead of complaining about this fact, or even quietly congratulating ourselves, China must consider what to do if the United States learns its lesson and, for example, gradually raises its household savings rate. If external demand for Chinese goods is declining, how can internal demand rise?

At this juncture, structural adjustment should not be empty talk. It must involve a series of basic policies that deepen the nation\’92s economic reform. Structural adjustments can only follow the market\’92s lead and, for the most part, involve breaking up monopolies, opening the market wider, relaxing controls, and getting the pricing mechanisms right.

Instead of betting even more heavily on foreign demand to bail China out, in other words, China must urgently move towards policies that force the transition, even if those policies are painful in the short term.

And it is not just Caijing that is voicing criticism about the current stimulus policies. A number of very prominent Chinese economists have been scathing (at least in private, so I cannot reveal their names) about the failure to have taken the appropriate steps when conditions were optimal, and are now insisting that to continue increasing reliance on foreign demand is going to create huge problems for China. Increasingly I am hearing people here say that, although few expect a \’93collapse\’94, whatever that means, China is facing its own \’93lost decade\’94 of sub-par economic growth and a very difficult transition. As regular readers know, I am very inclined to agree.

Next week (Wednesday, I think) I will have a piece in the Wall Street Journal arguing that the surge in lending actually makes China\’92s transition more difficult in the medium term because it will act to constrain future consumption in China. I think Hu Shuli might agree.

Tags: Chen Deming, Wang Qishan

Distortions in the Chinese lending environment

May 3, 2009 in Asian development model, Banks, Fiscal stimulus, Money growth, NPLs by Michael Pettis | 38 comments

Things have been so busy this past week with various writing commitments and with the celebration of the third anniversary of my music club (four amazing shows with some of Beijing\’92s greatest artists and a lot of support and coverage from local music scene participants an the press) that I have been neglecting my blog. For today\’92s entry I don\’92t have any major points to make but I did want to take a look at some of the anecdotal information we are getting about the bank-part of the fiscal stimulus package.

The context is last week\’92s post in which I argued that the almost certain reversal over the next few years of American ability to grow consumption at a faster rate than GDP will put huge pressure on the Asian development model, and will require Asian consumption to grow much faster than Asian GDP. However if the current loan explosion is mismanaged, this may itself sharply constrain Chinese consumption growth, thus locking China into a long transition period of turgid growth.

In that light two weeks ago The Economic Observer, one of the better local newspapers, had an interesting article titled \’93Millions of Small Businesses Still Starved of Credit\’94. The growth of smaller businesses, many of which are in the service industry, is one important way for Chinese net consumption to grow, but it seems that their ability to obtain financing is being sharply limited by formal or informal policies that are driving capital into the investment sector. The article suggested that even with the explosive loan growth in the banking system, smaller companies are finding it extremely difficult to get loans.

New loans in China for the first quarter of this year would amount to nearly 4.6 trillion yuan, but behind the staggering figure, millions of small and medium-sized businesses nationwide were still struggling to raise funds.

\
Data from the National Association of Industry and Commerce (NAIC) showed that in January of this year, private firms had 421 billion yuan in short-term loans, a 700 million yuan decrease from December 2008. That was despite 400 billion yuan in new short-term loans released that month.
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The article goes on to mention a survey of businesses in Chongqing that indicated that 82% of small and medium-sized businesses there considered the lack of funds the main hindrance to their development. Quoting Chen Yongjie, an official with the National Association of Industry and Commerce, the article goes on:

The Chinese government has recently pushed measures to solve financing problems for small and medium-sized businesses – for example, China’s Banking Regulatory Commission has required banks to open loan departments exclusively for small companies. But Chen said it was hard to tell how effective these measures would be: “What we can see clearly now from the statistics is that loans for small and medium-sized businesses are still dropping.”

It would be normally be surprising that loans are expanding so rapidly (we have already increased net new lending in the first quarter of 2009 by more than all of last year\’92s loan increase) while whole sectors of the economy are struggling to find financing, but my friend Dan Rosen sent me a Bloomberg article from Friday with a line which he found very funny and a tad startling. According to the article:

The largest borrower in the quarter was government-owned China Aviation Industry Corp., or AVIC, the nation\’92s biggest aerospace company. The Beijing-based company received 236 billion yuan from 11 Chinese banks, including ICBC, China Construction and Bank of China. It won another 100 billion yuan of credit from Export-Import Bank of China on April 16, without specifying how the money will be used.

AVIC General Manager Lin Zuoming said in an April 16 interview with Beijing-based newspaper Economic Observer that his biggest worry is how to allocate the borrowings to increase returns.

It\’92s the last line, of course, which Dan marked out. The largest single borrower, it turns out, has taken out around $35 billion in loans but doesn\’92t seem terribly certain about why he borrowed the money. I don\’92t want to read too much into a single throwaway line, but it is certainly consistent with all the stories and rumors we hear about banks lending not because borrowers need money for specific (hopefully profitable) projects but rather because they want to show loan growth, and the safest way to do that is to convince large companies and projects with explicit or implicit government guarantees to borrow massive amounts of money. Of course it helps that managers aren\’92t terribly concerned about creating value for their shareholders, but this is almost certainly a recipe for future growth in NPLs.

Obviously I (along with most of the readers of my blog) am not the only ones to realize this. Friday\’92s South China Morning Post had this to say:

Citic Bank Corp, the country\’92s seventh-largest lender, is optimistic about this year\’92s earnings outlook and is reining in loan growth to safeguard against a rise in bad loans. Chief executive Chen Xiaoxian said the bank would adopt stricter loan checks and had sent inspectors to those branches that had recorded a surge in discounted bill financing in the first quarter. \’93Banks need to take more forceful actions to increase risk controls,\’94 he told reporters.

The article goes on to say:

Total lending by mainland banks in the first quarter reached a record 4.58 trillion yuan, close to the government\’92s minimum target for the whole year of 5 trillion yuan. Asked about his top concern, Mr Chen said: \’93Of course, it is asset quality given such fast loan growth.\’94

Mr Chen called the surge unsustainable. He did not disclose how much Citic Bank had lent in the first three months, but he said the pace would slow. \’93No matter how complicated your businesses are, you must clearly know the default rate,\’94 he said of lessons learned from the global financial crisis.

Of course Mr. Chen is right. The current rate of loan growth is unsustainable and the biggest concern must be the risk of a sharp rise in NPLs. One would expect that all of this would quickly cause the PBoC to put the brakes on lending. The always intelligent Jim Walker of Asianomics thinks this will happen, but is nonetheless so worried about continued loan expansion he asks in an April 14 report:

Exactly why is this process dangerous?

First of all, China has an extremely high M2 to GDP ratio to begin with. As Figure 2 shows, M2 in 2008 already represented 158% of GDP. Compare this with money conditions in the US where M2 accounts for just 54% of GDP (the US ratio is read off the left-hand scale). If the US\’92 monetary easing efforts are such that investors are convinced that the dollar is no longer available reserve currency then the conclusion must be the same as regards the renminbi \’96 only much more so. The only reason that the renminbi is not nose-diving in world currency markets is because domestic economic actors are not allowed to sell it.

For Walker, the explosive growth in lending is exacerbating what was already a very big problem, China\’92s huge bank-funded overinvestment. He goes on:

The second word of warning is that this breakneck monetary expansion will have to cease soon. The PBoC says that it will support economic growth through easy monetary conditions. It has certainly been true to its word so far but the problem will quickly become one of having a \’91tiger by the tail\’92. In Hayek\’92s analysis of economic growth he concluded that the only way an economic system hooked on credit could maintain its growth rate was for it to add ever increasing amounts of credit to that already existing. Adding the same amount of credit would result in recession-like conditions.

This, in his view, was the road to hyperinflation. The alternative, putting the brakes on monetary expansion, would lead to economic depression. On the assumption that Beijing will not wish to risk a hyperinflationary outcome we suspect that it will slam the brakes on the banks (which are clearly out of control already) within the next few months, regardless of the comments being made by the PBoC today. The next move in monetary policymaking in China will be to tighten, a move that will be badly received by markets that are already starved off profits.

Perhaps, but most analysts are betting against Walker. Xinxin Li of the Observatory Group points out that Wednesday\’92s decision by the State Council (effectively the equivalent of the executive cabinet) to reduce the capital ratio requirement for financing capital spending for infrastructure \’93is a further effort by the central government to implement its massive fiscal stimulus plan, in order to boost investment demand and support economic growth.\’94 In his opinion the current policy environment \’93makes any hawkish statement from the PBoC politically incorrect. Just a couple of days ago, Vice Premier Li Keqiang said that the global financial crisis is having a deeper impact on the Chinese economy, showing that the top leaders are unlikely to drop their guard on the economic difficulties until Chinese economy firmly is on a recovery track..\’94 In his April 28 report he concludes:

While the PBoC is concerned about the current pace of money expansion, it is unlikely to impose tightening measures to slow lending growth in the near term, due to an unclear economic outlook and the political priority on economic growth. China\’92s loose monetary conditions will likely persist in Q2.

The problem here is that Jim Walker\’92s analysis may be right but Xinxin Li\’92s prediction may also turn out to be right (and I suspect that Li doesn\’92t necessarily disagree with Walker\’92s analysis). Just because there is an urgent need for a policy doesn\’92t mean that it will happen. I remember that in early 2007 I argued aggressively that the PBoC would have to engineer a maxi-revaluation of the RMB because a slow revaluation would create huge hot money problems for the country. Of course the maxi-revaluation didn\’92t happen, and many of my friends seem to find my very wrong prediction a never-boring topic of conversation, but I defend myself by saying the analysis was correct, the prediction of huge hot money inflows was also correct, and soon enough the warnings about how destabilizing these inflows will be will also turn out to be correct. The global crisis intervened, and we will now see that China\’92s failure to have adjusted the currency much earlier, as a way of accelerating the transition from export growth to domestic-consumption growth when conditions were so good, will have a very painful cost.

So even if Jim Walker is right in that Beijing has no choice but to slow loan growth, he can still be wrong about assuming that they will. That of course would be the worst possible outcome.

Before ending, I wanted to cite a line from my friend Justin Winkle, who was responding to the comment discussed above that Dan Rosen found funny and startling. I am sure this has absolutely nothing to do with the topic under consideration, but here it is anyway.

My quote of the year is a line from Lewis Carroll appropriated by my stockbroker to describe the global economy: \’93If you don’t know where you are going, any road will get you there.\’94

As long as I am doing literary allusions I was just rereading PG Wodehouse\’92s classic Joy in the Morning, in which Lord Worplesdon explains to Bertie Wooster, in one of their very rare moments of camaraderie, why an American businessman they know seems so easily startled:

\’93Odd, this neurotic tendency in the American businessman. Can you account for it? I can. Too much coffee.\’94

\’93Coffee?\’94

\’94That and the New Deal. Over in America, it appears, life for the businessman is one long series of large cups of coffee punctuated with shocks from the New Deal.

I guess you can find economic history in the oddest places.

Tags: Lewis Carroll, PG Wodehouse, SMEs

The death of the Asian development model

April 25, 2009 in Asian development model, Banks, Consumption and production, Fiscal stimulus, NPLs by Michael Pettis | 77 comments

One of the few areas in which the Chinese fiscal stimulus package is unquestionably having a positive effect is on growth forecasts \’96 although mainly because forecasts seem to be coincident indicators more than leading indicators. In the past couple of week Morgan Stanley raised its 2009 forecast for Chinese GDP growth from 5.5% to 7.0%, while Goldman Sachs upgraded growth forecasts from 6.0% to 8.3%. UBS has raised its forecast from 6.5% to between 7% and 7.5%. RBS has jumped from 5% to 7% and Barclays is up from 6.7% to 7.2%. On the other hand Standard Chartered, worried about the sustainability of the \’93rebound,\’94 has kept its 2009 GDP growth forecast at 6.8%, and the IMF is still at 6.5%

At any rate I\’92ve never provided my own forecast of Chinese growth partly because I am not smart enough to come up with an economic forecast and partly because it always seemed to me that in the short-term Chinese growth was going to depend very heavily not on economic conditions but rather on the hard-to-predict outcome of the fierce policy debate taking place in China. As I see it, one side of the debate \’96 which seems to include people around the PBoC and the National Bureau of Statistics, along with many of the more prominent of the think-tank policy critics \’96 is arguing that as difficult as it is, the crisis is a good occasion to force China to change its development model and financial system in a direction that will provide China with a healthier basis for stable, long-term growth. They are eager to see policies aimed at switching resources from production to consumption, even at the expense of a short-term increase in unemployment, and they tend to see the recent surge in credit and investment not as solutions to the crisis but rather as policies that will make things worse for China in the medium term.

On the other hand a different group of policymakers and power brokers \’96 who include, I think, the Ministry of Commerce, the important exporter constituencies, and above all the powerful provincial and municipal leaders \’96 are much more concerned with enacting measures that immediately address the expected rise of unemployment in the short term. These measures include pouring money into investment \’96 mainly into infrastructure and the SOEs \’96 and of course the huge increase in bank lending. They often point out that these policies saved China after the 1997-98 crisis, and so can save China again.

As an aside, and without wanting to take the 1930s analogy too far, this debate in China is a little like the split in the 1930s between the internationalists in the US who favored hard money (incorrectly, I think) and a rapid liquidation of overcapacity (painful but probably correct), and who vehemently opposed measures, including tariffs and competitive devaluations, to boost employment via boosting the export of overcapacity, versus the large and powerful constituencies, dominated by local congressmen, miners, farmers and many industrialists, who stressed immediate moves to weaken the currency, boost production, and resolve US unemployment even at the expense of the global system. In part because the 1929 stock market collapse thoroughly discredited bankers and economists, and in part because politicians are always more likely to be influenced by large domestic constituencies than by internationalists, the latter group pretty resoundingly won the debate, at least in the early part of the crisis, and clearly not to the US\’92s obvious benefit.

Although the debate is much less transparent in China today than it was in the US in the early 1930s, I think the latter group \’96 the domestic constituency and provincial leaders \’96 is once again winning the debate, at least for now. It is probably no surprise to regular readers of my blog that I largely disagree with this camp, and the main reason I didn\’92t want to forecast very low 2009 GDP growth numbers with much confidence is because I doubt the former group will win the debate. As I see it, the massive expansion in credit and investment we are experiencing is simply more of the same set of policies that, especially over the past five years, have pushed China ever deeper into the Asian development model, and to the extent that they are successful they will keep pushing China, which I think of as exemplifying the Asian development model on steroids, in the same direction. Beijing, in other words, is increasing the dosage of steroids. (I think I am mixing metaphors all over the place.)

The reason I think this is a mistaken strategy is because I would argue that the Asian development strategy is dead, and over the next three to five years it will become increasingly evident that 2008 was the year it died. I may be wrong, of course because it is doubtful but not inconceivable that the great consumption party in the US can resume for a few more years. It would not be the first time that what seemed like an unstoppable correction in the trade imbalances was interrupted. To a certain extent we already saw a dress rehearsal for this event in the 1987 crash, around which time the US trade deficit, which had risen to around 3.5% of GDP the year before (a level which seemed unimaginably high at the time), began its inexorable reversion, to the point where the US achieved a small surplus in the early 1990s.

The period during and after the 1987 crash more or less marked the end of that stage of the Japanese miracle, although by then Japan was so caught up in the monetary expansion that had begun with the automatic monetizing of its massive trade surplus with the US in the early 1980s, that an internal bubble kept the local party going for another 2-3 years before it, too, finally ended, and ended disastrously \’96 although many people, especially here in China believe, mistakenly in my opinion, that the bubble was set off by the Plaza Accord.

But the Asian development model didn\’92t really die then (although the temporary shift in US consumption may have created the serious dislocations that helped lead to the 1997 crisis). At the time the US was itself caught up in great productivity and liquidity growth cycles that kept the model alive by causing a surge in US growth and, later, an even more rapid surge in US consumption.

The rise of US savings

What does the structure of US growth have to do with the Asian development model? As I see it the Asian development model involves polices that aim directly or indirectly at boosting savings and channeling huge amounts of subsidized resources (usually subsidized by savers, and so constraining consumption) into investment and manufacturing capacity. Some people call this mercantilism, and in many ways it does correspond to certain classic mercantilist policies, but I am wary of defining it this way because \’93mercantilism\’94 is such a loaded word.

At any rate because the combination of consumer constraint and producer subsidy meant that growth in production was likely seriously to outstrip growth in consumption, the Asian development model necessarily involved generating large and consistent trade surpluses \’96 either Asian countries exported the difference between consumption and production or they would have been forced to run up ever increasing inventory. Of course for small countries, running trade surpluses didn\’92t matter too much \’96 and it made sense to have a strong external outlook because domestic markets weren\’92t big enough to create the necessary efficiencies and economies of scale to justify the huge investment, and their individual trade surpluses were easily buried within overall global trade.

In other words for small countries the need to export is not likely to be a constraint since they can always generate trade surpluses without creating significant global trade distortions. But when large countries, or a large grouping of countries, have policies aimed at generating trade surpluses they run into a very strict constraint \’96 that some country or group of countries must be capable and willing to run large corresponding trade deficits. Without this willingness to run trade deficits, the Asian development model must inevitably run into brutal 19th-Century-style cycles of rapid production growth leading to overinvestment crises.

This is the main vulnerability of the Asian development model \’96 its dependence on an importer of last resort. We don\’92t often think of this as a weakness because for so long the US was seen as the automatic importer of last resort, so much so that we didn\’92t even consider it a constraint. But we may have gotten lazy in our thinking. Many people who should know better simply write off US consuming habits as something endemic to American culture, and we just assume it as a universal constant, but in fact US consumption levels, like those of every other country, respond to changes in conditions, and these are about to change.

There are at least two reasons for the change. The first has to do with specific policy initiatives, and the second with changes in underlying economic conditions, especially household balance sheets. To address the first, I will refer to President Obama\’92s economic speech last week when he said: \’93We must lay a new foundation for growth and prosperity \’97 a foundation that will move us from an era of borrow and spend to one where we save and invest, where we consume less at home and send more exports abroad.\’94

A New York Times editorial draws from Obama\’92s speech at least one important implication for the future growth of China and Asia:

In a series of comments in recent weeks, Mr. Obama has begun to sketch a vision of where he would like to drive the economy once this crisis is past. His goals include diminishing the consumerism that has long been the main source of growth in the United States, and encouraging more savings and investment. He would redistribute wealth toward the middle class and make the rest of the world less dependent on the American market for its prosperity. And he would seek a consensus recognizing that an activist government is an acceptable and necessary partner for a stable, market-based economy.

\’85Embedded in that approach is a far-reaching implication: that the rest of the world should no longer count on the United States to snap up imported goods or run up large trade deficits. It is by no means clear that Mr. Obama has the policy tools needed to bring about that kind of change; we are, after all, fundamentally a consumer society. His advisers point to his support for innovative ways of increasing personal savings.

We should never underestimate the immense flexibility of the US and its ability to restructure itself at a pace far faster than most other countries can manage (anyone who grew up in the dismal 1970s will remember the dramatic \’96 and seemingly improbable \’96 US economic transformation of the 1980s), and if the Obama administration is serious about creating conditions for an increase in US savings, it probably wouldn\’92t be a good idea to bet heavily against success..

Negative US consumption growth?

More importantly, during the past decade while the US was growing rapidly, the US trade deficit surged from just over 1% of GDP to over 7% of GDP. When consumption growth exceeds GDP growth, which must happen when the trade deficit is growing, it necessarily implies a build-up of debt, and sure enough, debt levels in the US surged while savings collapsed to zero and the trade deficit grew rapidly.

Those days are almost certainly over. Even without Obama\’92s desire to create conditions for an increase in US saving rates, US households have to increase their savings and rebuild their balance sheet, which means that we have several years ahead of us of deleveraging and increased savings. It also means we have several years ahead of US consumption growing more slowly than US GDP. I don\’92t think anyone is expecting much net growth in US GDP for the next three or four years, and so it is not at all implausible that we will see negative growth in US consumption and, as a consequence, a collapse in the US trade deficit, which may even turn into a trade surplus. The pace of this transition will largely depend on US fiscal policies aimed at slowing, but not eliminating, the contraction in demand.

If the US is no longer the importer of last resort, and if no one else can replace the US in that role in the medium term (I stress medium term because in the long term the demographic changes in Europe and Japan \’96 and China for that matter \’96 may well result in rising trade deficits in those countries), then any development model that necessarily results in production growth exceeding consumption growth \’96 high savings development models, in other words \’96 will run into the trade deficit constraint. They must run surpluses to grow, but if no one else runs sufficiently large deficits, they simply cannot run those surpluses.

This is what I mean about the \’93death\’94 of the Asian development model. The not-so-hidden but also not-always-explicit assumption behind Chinese growth \’96 with China, as I wrote earlier, representing the Asian development model on steroids \’96 is that large and growing US trade deficits were vital to its success. But if the US is now entering a period of contracting deficits, the model is dead.

This is why I am worried about recent fiscal and credit policies. It is not just that these policies are slowing down the rate at which China will adapt to the new world of lower US trade deficits. More importantly perhaps is that the only obvious replacement for US demand \’96 domestic Chinese demand \’96 will itself be sharply constrained by current policies, especially credit policies.

Why? Among other things because if the explosion in new lending (loans are up 15% in the first quarter of this year) leads, as it almost certainly will, to a subsequent explosion in non-performing loans, in the next few years just as China is expanding its production and struggling with US reluctance to absorb its rising excess capacity, the resolution of the NPLs will itself constrain Chinese consumption. Resolving future NPLs, in other words, will reduce future domestic consumption growth in China, just as the current resolution in the US of bad loans and shattered household balance sheets must come with reduced US consumption growth.

This is because if China\’92s banks see an explosion in non-performing loans it will have to pay for that increase in the coming years in one or both of two ways. The central government can recapitalize the banks by giving them money, which they have raised by borrowing or increasing taxes, or the regulators can keep deposit rates very low as a way of subsidizing bank profitability so that they earn their way out of the NPL losses. They did both after the last banking crisis, and will probably do both again. There is a third thing they can do, appropriate the money from SOEs, but I suspect that there won\’92t be nearly enough to resolve the NPLs \’96 the World Bank estimates that the last banking crisis cost China 55% of GDP.

Both strategies will represent, ultimately, a large transfer of income from households to banks, and in either case it will also represent a continued drag on consumption growth in the medium term. If the government borrows to bail out the banks, it will divert resources from the real economy and so slow income growth. If it raises taxes, it will reduce disposable income and so reduce household consumption growth. If it keeps interest rates low it will again reduce disposable income (interest income is an important source of income) and so slow consumption growth (in China lower interest rates tend to increase the savings rate).

Since it is unlikely that the US will be in a position in the near future to return to the halcyon days of large trade deficits, and since no other economy can replace the US in the role, turgid consumption growth in China will translate directly into turgid GDP growth for many years. Rising non-performing loans are not a small threat to China\’92s long-term growth. If the Asian development model is dead, China will need domestic consumption growth more than ever, and this is cannot be the best time for China to try to revive the production-enhancing model in a way that may limit future domestic consumption growth.

By the way in their next meeting the Guanghua Students Monetary Policy Committee will debate whether or not the PBoC should cap loan growth. I will report the arguments and conclusions of these remarkably sophisticated students.

« Older entries

Fiscal stimulus

China\’92s August data confirms both optimists and pessimists

The Shanghai market calls the tune

It\’92s not yet the end of China\’92s massive stimulus

More debate about the validity of economic data

Squeezing out the exporters

More public worrying about the Chinese stimulus

Stimulus \’96 at what cost?

Exports versus domestic demand \’96 the argument rages

Distortions in the Chinese lending environment

The death of the Asian development model

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