There were a couple of very good analyses this weekend of China’s banking system and some perceived mistakes that the country’s rulers have made in their attempts to right the economy. Neither is particularly bullish for China or for that matter the rest of us.
First, Ambrose Evans-Pritchard in the Telegraph talks about the growing concern of one rating agency, Fitch, with respect to the banks:
China’s banks are veering out of control. The half-reformed economy of the People’s Republic cannot absorb the $1,000bn (£600bn) blitz of new lending issued since December.
Money is leaking instead into Shanghai’s stock casino, or being used to keep bankrupt builders on life support. It is doing very little to help lift the world economy out of slump.
Fitch Ratings has been warning for some time that China’s lenders are wading into dangerous waters, but its latest report is even grimmer than bears had suspected.
“With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary,” it said.
“Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear.”
Note the phrase “able to bear”. Fitch’s “macro-prudential risk” indicator for China threatens to jump from category 1 (safe) to category 3 (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China’s public debt may be as high as 50pc-70pc of GDP when “correctly counted”.
The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a “massive lending spree”.
Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate.
Mr. Evans-Pritchard goes on to discuss how the massive growth in bank loans have been used, a subject I’ll get back to in a second. He comes back to the same point that so many others have made, specifically that China needs an economic revolution that energizes its domestic market. Nothing of that sort is occurring.
It is relying on massive injections of stimulus, protectionism suppressing the value of the yuan in order to keep its export machine alive. That machine, however, has no customers as Western consumers have closed their pocketbooks. Evans-Pritchard postulates that unless China can replace lost demand domestically, the global economy is in for a very long haul.
Now, let’s get back to the lending surge and how the money may have been used. Michael Pettis in China Financial Markets quotes extensively from an article Andy Xie wrote on the lending frenzy. Mr. Xie thinks it has largely fueled a speculative bubble in commodities. Here is his take:
The current surge in commodity prices, for example, is being fueled by China’s demand for speculative inventory. Damage to the domestic economy is already significant. If lending doesn’t cool soon, this speculative force will transfer even more Chinese cash overseas and trigger long-term stagflation.
The international media has been following reports of record commodity imports by China. The surge is being portrayed as reflecting China’s recovering economy. Indeed, the international financial market is portraying China’s perceived recovery as a harbinger for global recovery. It is a major factor pushing up stock prices around the world.
But China’s imports are mostly for speculative inventories. Bank loans were so cheap and easy to get that many commodity distributors used financing for speculation. The first wave of purchases was to arbitrage the difference between spot and futures prices. That was smart. But now that price curves have flattened for most commodities, these imports are based on speculation that prices will increase. Demand from China’s army of speculators is driving up prices, making their expectations self-fulfilling in the short term.
If this is true it would imply that the recent boom in commodity prices world wide has not so much been a harbinger of recovery as a reflection of excess cash looking for a temporary home. If that’s the case, and I tend to think there is a lot of merit to Mr. Xie’s logic, then anyone sitting with a long position might want to consider lightening up or putting on some hedges.
But back to Mr. Xie as he comes to the same conclusions as Evans-Pritchard:
This lending surge proves China’s economic problems can’t be resolved with liquidity. China’s growth model is based on government-led investment and foreign enterprise-led export. As exports grew in the past, the government channeled income into investment to support more export growth. Now that the global economy and China’s exports have collapsed, there will be no income growth to support investment growth. The government’s current investment stimulus is tapping a money pool accumulated from past exports. Eventually, the pool will dry up.
If exports remain weak for several years, China’s only chance for returning to high growth will be to shift demand to the domestic household sector. This would require significant rebalancing of wealth and income. A new growth cycle could start by distributing shares of listed SOEs to Chinese households, creating a virtuous cycle that lasts a decade.
Putting money into speculative investments isn’t totally irrational. It’s better than expanding capacity which, without export customers, would surely lead to losses. Businesses currently lack incentive to invest. But many boom forecasters wrongly assume that recent asset appreciation, fueled by speculation, signaled an end to economic problems. That’s an illusion. The lending surge may have created more problems than it resolved.
There is a lot of anti-green shoots in the views of both of these men. Mr. Xie makes a good case that speculation has been the essential result of China’s massive stimulus and both posit reasonable arguments discounting some of the purported signs of a return to some sort of normalcy in the global economy. As I noted earlier, there isn’t anything new in their prescription for a long-term fix of the Chinese economy. It has to become more consumption oriented but that appears not to be a policy that the government is pursuing.
If you step back and take a look globally, most governments including ours seem to view a return to the status quo ante as the means to a recovery. China and Germany for example wait for demand to pick up and fuel their export machines. The U.S. prints money and counts on government leverage to replace private sector leverage to ramp up its economy. Sadly, all may be waiting for an event that just isn’t going to occur in a meaningful enough manner to truly revive economies. It may be a long, long period of sub-par growth.