Perusing financial newspapers lately seems to provide an element of certainty in one area.
China is tightening. It is an article of faith among economists and investment managers that China is slowing lending, removing liquidity, and putting the brakes on its economy.
China certainly has been successfully stimulating its economy. It announced a government stimulus package in the fall of 2008 worth Rmb4 trillion ($585 billion). Over the past year its banks have lent an astonishing Rmb9.6 trillion ($1.4 trillion). Together this amounts to about 44 per cent of GDP. In contrast the United States' stimulus package was $780 billion, only 6 per cent of GDP. If the US were to emulate the Chinese, the stimulus would be over $6 trillion.
The effect of this wall of money on the Chinese economy has been predictable. The Chinese economy has now achieved a growth rate of over 10 per cent.
This has been very good news for Asia. Many Asian markets dependent upon exports to Europe or the United States have been devastated by the recession. They have been saved by China. Commodity exporting countries like Australia and Brazil are particular beneficiaries. Exports to China by other Asian economies have grown dramatically. Chinese growth has forced the IMF to revise its forecast for the world economy upward by 0.8 per cent to 3.9 per cent.
Of course, if the Chinese stimulus ends, this could mean trouble for much of the world where the recovery is still very much in doubt. It is hardly surprising that many stock markets dipped at the end of January in response to rumors of tightening. Recently China has tried to slow the growth of its lending and money supply.
It did so in several ways. First, it raised reserve requirement ratio that big commercial banks are required to keep at the central bank from 15.5 per cent to 16 per cent. Second, it increased the lending rate on some government paper. Finally the authorities ordered large commercial banks to stop making any new loans at the end of January. The question is whether these actions are signs of things to come?
The answer is not really. The attempts to slow the economy are really only a matter of degree. The government new loan target for 2010 is a mere Rmb7.5 trillion ($1.1 trillion). Maybe this is a 20 per cent decrease from the new loans in 2009, but is still 90 per cent more than the Rmb4 trillion ($585 billion) in new loans extended in 2008. For the Chinese the concept of monetary policy is going from an insane cascade to exceptionally loose.
The problem is really structural. The issue is one of agency. Just because government officials have the authority, does not mean that all of minions follow directions. In game theory, agents act for themselves, often contrary to the wishes of their principals. In a market economy there are many decision makers. In a command economy, there is only one. Sometimes a command works only too well. This is what is happening in China.
A particularly revealing anecdote concerns a provincial governor who told a prominent Chinese economist that his greatest political achievement for 2009 was that a bank lending in his province had outpaced the national average.
Turning the monetary spigot off has turned out to be much harder than turning it on. One of the reasons why the Chinese regulators suspended new loans in January was because they were totally out of control. In the first two weeks of January Chinese banks lent out a total of Rmb1.1 trillion ($161billion). This was 40 per cent more than the 2009 average, over three times the monthly average in 2008. If the January rate continued for all of 2010, the total lending would be Rmb30 trillion, ($4.3 trillion), which would probably result in hyper-inflation.
In fact, the attempts by regulators to tighten lending did not start in January 2010. They began back in February 2009, when the central bank withdrew a net Rmb63.5 billion from the interbank market to soak up excess liquidity. The central bank lectured bankers to slow lending again in April, May, July, and August 2009 to no avail. The western markets did not notice, but the Chinese ones did. The Shanghai Index is barely above its June high.
The cascade of money provided particular strength for the housing market. In Shanghai alone mortgage lending soared 1600 per cent over 2008. Nationwide it is estimated that real estate prices have jumped 40 per cent.
With an enormous amount of money flooding into the economy, fraudulent games reminiscent of the US subprime problems have begun to surface. The banks have been able to remove Rmb734 billion ($107.53 billion) of loans from their books by repackaging them as trust products. The toxic assets in the system are no doubt massive. The banks have not even disposed on the toxic assets left over from the 1999-2001 recession. A lending fraud case involving Rmb9.8 billion ($1.43 billion), three times the previous record, recently surfaced in Guangzhou. Certainly others will appear in the coming years.
China is now basking in its accomplishment of defeating a nasty recession.
Its system appears to be superior to those of other countries, especially the United States which is perceived as both the source of the disease and helpless to cure it. With the amount of money China is throwing at its economy, its growth, the growth of Asia and the strength of certain commodities will no doubt continue for the coming year. But there will be a terrible price which at some point must be paid.
Disclosure: No positions
