China: Not Quite the End of the Massive Stimulus

According to a recent article on Reuters, on Saturday Lou Jiwei, the chairman of the CIC, China’s sovereign wealth fund, said at a conference on Saturday in response to a question about his expected performance: “It 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.”

In my last entry I noted that after the recent “green shoots” 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. President Hoover went down in a blaze with his “light at the end of the tunnel”, 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: “Gentleman, you have come sixty days too late. The depression is over.”

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’s own changing consumption rate – most importantly whether it will complement the fiscal and credit expansion embarked upon by Beijing or, as I believe, conflict enormously with it – the crisis won’t 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 “So we can’t lose” part of Mr. Lou’s statement – 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 the way it read – 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’s 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.

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.

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.

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.

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’t 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 genius 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’s 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.

…Lending in the second half will be “much smaller,” with new credit in July and August dropping from the monthly averages of the first half, President Li Lihui told reporters yesterday.

Monday the mainland newspapers were even more worrying. Several reported that new loans in August would be just RMB 300 billion, after last months’ 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 – 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 – 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’s “impressive” 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.

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 – “surge” and “swoon” – and I suspect that very quickly we will see the switch turned back to “surge”. 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.

My guess is that if the local stock markets do not soon recover their bounce (and they won’t 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 – unless it is primed with government giveaways – can make up the slack quickly enough.

Speaking of which I saw an interesting article in today’s People’s 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.

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. 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. “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.

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.

Comments

[Michael Clark:]

Always enjoy your reports. I know you take a lot of flack for questioning the obvious. So did Galileo. Keep your articles coming. It helps to see what other people are seeing, people who know their subject matter so well.

Aug 31 09:41 AM

[doubleshortetf:]

Some sober data on China for people fascinated with POOR China (3rd world country ruled by 1 party communist). Similar to the adoration US had for Japan 20 yrs ago right before the mother of all Japanese bear markets starting in 1989.

China would have to triple the size of its economy - and the US would have to stand still - if China were to pull even with the US in GDP.

Consider the following numbers, culled from official Chinese statistics:

1. About 65 million Chinese people live in households with more than $20,000 a year in income.
2. Around 165 million make between $2,000 and $20,000 a year.
3. About 400 million Chinese have household ­incomes between $1,000 and $2,000 a year.
4. About 670 million have household incomes of less than $1,000 a year.

As you see China is a land of extra­ordinary poverty.

And some dreamers to think that China can pull US and the world out of financial rut...

Aug 31 10:33 AM

[gloria1234:]

It seems quite likely that Geithner bilateralism aside, China mercantilism will continue to thrive, just in different continents & sub-continents--stating the obvious, greater Asia + sub-equatorial.

Aug 31 01:22 PM

[Crispus:]

doubleshortetf

Nice job of culling. After watching the parade of various American CEO and assorted Western business executives wax glassy eyed on the need to be in the game for a piece of the 1.3 billion Chinese consumer market, I have to chuckle at your numbers.
A few years ago I decided the EEP (Effective Economic Population) of China was about 300 million Chinese. Your numbers tend to indicate my guess to be a bit high.

However, I tend think the Chinese government has only a vague idea of income levels. For the purpose of creating the façade of a harmonious, happy, growing, enlightened, soon to be superpower, I think propaganda has overloaded statistical assumptions.

First, Chinese statistical collection suffers from a Chinese propensity to under report income outside of SOEs. SOE income, on the other hand is, again my feeling, overstated. Additionally, aggregate statistics are fitted to the propaganda message of the moment.

I am confident the Chinese ability to collect and process economic data has greatly improve over the last decade but this enhanced capability has created significant opportunities and problems for China’s NBS. Firstly, the big number, the awe generating GDP growth has been, and is still, understated.

The problem is restating GDP to even higher levels would strain credibility for a regime not particularly credible.

Luckily, the global economy has provided China with a golden twofer. Some of the unreported GDP can be shown as current growth to maintain impressive, if mysterious, quarterly numbers. The propaganda value is immense, Socialism with Chinese characteristics rebounds as the West (US) wallows in its Capitalist greed generated swamp. Macro control of economic forces, production, resource allocation, and markets triumphs! Chinese intelligence, skill and 5,000 years of cultural perfection cannot be denied.

The façade endures despite a billion Chinese living on household incomes of less than $2,000 year.

Aug 31 06:52 PM

[Alphameister:]

No sane person could reasonably have expected credit expansion in China to persist at the pace of the first half of this year. So the wringing of hands and gnashing of teeth in the face of a development that should have been so obviously predictable seems a bit silly. Even if the first-half explosion of credit did contribute importantly to this year's gains by deeply undervalued Chinese equities, that explosion of credit is also supporting real economic gains that should persist well into the future even as credit growth slows. Profits of Chinese corporations should grow rapidly in 2010 and stock prices will follow (or, more accurately, anticipate) those gains even as credit growth decelerates (as prudence dictates it must). The easy money has been made in worldwide equity markets, but future gains will come a lot more readily from emerging markets than from the US and other developed markets.

Sep 01 11:43 AM

[James Lewis:]

The liquidity in China will not slow down in the short term regardless of new loans being reduced.

More than 1 Trillion Dollars has already been monetised through lending, this will recycle and rotate through the system many times in the short term and there is very little that can be done to stop it. Currently we are seeing a mini-rotation of liquidity out of the stockmarket into property. The property market is already strong, I predict that in around a week or so we will see very very significant new gains.

We are also at the stage that everyone re-stocks inventory for Xmas etc. Even though we all know there are over capacity issues. The huge drop off in inventory building by corporations worldwide for the past 12 months will translate into pent up demand to rebuild inventories in this busy season. Especially due to all the stimulas packages worldwide and other monetary/fiscal catalysts. This will make manufacturing quite strong for a while in China and export levels in China will follow a strengthening trajectory. This will result in more money coming into the banking system due to purchase flows from importers in the west. These flows will not be completly sterilised and the trade surplus will increase having the time-proven effect of increased liquidity in the system.

Liquidity can not be contained in the short term in any realistic policy decision. So in the short term expect liquidity to be very high regardless of the new loan numbers. Other policies such as using increased reserve requirments, making banks hold more capital on their balance sheet etc etc will be all but useless in the short term. In fact action like this will just catalyse rotation of liquidity in the system to other asset classes depending on the rules set by the government.

The above can be positive and negative for China depending on its decision and commitment to structural reform. It is my belief that China does have time to re-structure its economy while this liquidity keeps things moving. And in my opinion because of the huge unemployment in manufacturing we have seen in China during this recession, it does not have to be such a painful transition.We are already at a very low point.

Infact steps toward development of a tertiary (service/consumption) economy would neutralise any further employment fallout from manufacturing due to the restructuring in the medium/long term. And the amount of liquidity in the system, government stimulus and further subsidisation programs will keep things under control in the short term.

Medium/Long Term the agriculture industry can develop as an offshot to development of consumption/tertiary industry which in turn will create more jobs. Food consumption will be the first thing that shows major improvement if China makes serious steps to restructure. After all for consumption to increase and economic structural changes to take place disposable income or net worth among the poor needs to increase significantly. If disposable income or net worth increased significantly among the 1 billion poor people, there would be a very immediate effect first on food consumption. Food being the most basic of needs reacts fastest to improvements in living standards.

Anyone that has seen the development of organic farming in China to meet tier 1 cities demand as consumption has increased in the upper class and upper middle class will be able to connect with this concept. This has brough farmers in this industry great wealth! It is only a small fragment of the industry but very symbolic and illustrative of what broad level in consumption could bring to the agriculture industry.

CHINA HAS THE ABILITY AT THIS POINT TO RESTRUCTURE WITHOUT TOO MUCH RISK OR DAMAGE. DOING SO WILL UNLEASH THE TRUE POTENTIAL OF THE COUNTRY.

If they do, no policies/actions to date will cause a future banking crisis because by re-structuring; China's domestic investments/stimulus etc etc will come good and the banking system will reap rewards from what they have done.
Huge Investments will pay off in China as China moves from developing economic superpower to developed economic super-power. Any investment in infrastructure will be needed, any investment in production will be met by demand by its 1.3 billion people.

However if the Chinese refuse to restructure and do not move past their political and behavioural pattern on not wanting to create more economic equality and move past their affixiation with control. Medium Term there will be very big trouble, the banking system will be hit by non-performing loans and this will set off a whole host of asset deflation stories. This will all but paralyse the balance sheets of the Banks, Corporations and local/municipal governments.
**The long term ability of China to reach its potential will be at risk**

The seeds are not sown and China has every ability to long term prosperity like no one can even imagine. However if China can not evolve spiritually and spread its wealth and loosen control on its people, I am certain the middle kingdom will put itself in a very bad position and it will take at least a generation or two to get back where they are today.

Sep 01 12:30 PM

[Tony Daltorio:]

Why does anyone still read Michael Pettis? The Financial Times has pretty much shown that he is an academic fool - a fool with a fancy degree that understands little about the real world.

Sep 02 01:28 PM