Micheal Pettis has a great post up at his always worth-a-read blog China Financial Markets. In “The Myth of the Blithe Consensus,” the Carnegie Endowment fellow and Peking University finance professor reviews the evidence that China’s madcap loan growth of 2009 has returned with a terrible fury in the first weeks of 2010, with dire implications for China’s economy, while giving a nice glimpse of the backroom economic debates that are currently raging among China’s economic and political decision makers. Pettis, from his vantage at Peking U., has access to some of the best and brightest Chinese economists around, so his posts now and then reflect the issues and gossip preoccupying that elite group.
The most major revelation is that in the first few weeks of 2010, China’s financial institutions were said to have issued 1.42 trillion yuan in new loans, about 15% of the central bank’s much discussed 7.5 trillion yuan target for all of 2010. According to caing.com’s piece “Cloudy with a Chance of Torrential Credit,” the new loan growth so disturbed monetary policy regulators that they convened an emergency meeting with the heads of China’s major commercial banks on January 18. Despite ordering some banks to halt new loan approvals altogether and having raised reserve requirements on some banks, new loan growth jumped by another 300 billion yuan in the two days following this meeting. The frenetic pace of lending so for in 2010, already set to exceed last January’s record-breaking 1.6 trillion yuan in new loans, is a shocking indicator that China’s economy has only barely (if it all) begun to wean itself off the easy credit that drove the heavily imbalanced growth of last year. When “the State Council [the equivalent of China’s Cabinet] is looking at the credit numbers daily,” as one source close to the central bank put it in the caing.com article, it is very, very ominous news.
For those not familiar with China’s economic policies, the Communist Party in the reform period has historically relied on requiring – literally, ordering by administrative decree – the country’s major commercial banks to open wide the spigots of credit to drive growth in times of economic uncertainty, often while implicitly guaranteeing government assistance in dealing with the hangover of bad debt that inevitably follows. After the new funds are released into the economy, strong demand for new loans is usually maintained as ongoing projects require further financing and local governments, pressed by the center to maintain high economic growth rates, vie to grab the biggest possible share of the credit pie for their locality (check Victor C. Shih’s “Factions and Finance in China” for more on this phenomenon historically). This is what more or less happened to an unprecedented extent last year, with the total quantity of new loans issued doubling the 5 trillion yuan released in 2008. While this boosts headline GDP growth dramatically, it stimulates a dangerous addiction to easy credit that central government macroeconomic policy makers have difficulty reining in. The caing.com article reported that an “intense dispute erupted between central and local levels and between decision-makers and commercial banks as to the scale of new loan growth for the year” at last month’s Central Economic Work Meeting, a key economic policy-setting meeting, underscoring that resistance has already set in to economic regulators’ intentions to extricate the economy from its stimulus-induced overdrive.
While I’m not an expert in the macroeconomics, the upshot of the most recent lending figures seems very negative on a number of levels. First, Victor Shih’s arguments that the events of 2009 would return China’s banking system to the dysfunction and inefficiency of the pre-reform 80’s and 90’s look yet more prescient. Second, it seems as if the Chinese economy will indeed have a difficult time extricating itself cleanly from its various stimulus policies. Another year of uncontrolled, blockbuster credit expansion could trigger inflation, further distort income inequality and leave China’s balance sheet weighed down with an even heavier burden of non-performing loans (check here for Arther Kroeber’s back of the envelope math on this question).
Last, and perhaps most damning, another year of tremendous credit growth bodes very poorly for the ability of the Chinese polity to make the structural transition away from an investment-driven economic growth model, a point that has many important Chinese economists extremely worried. Here is a piece by the Sydney Morning Herald’s China correspondent John Garnaut where he relates his correspondence with Yu Yongding, a very well respected Chinese macro-economist who formerly advised the central bank’s monetary policy committee and headed up the World Economics and Politics section of the Chinese Academy of Social Sciences. The piece gives a concise account of the real problem with worsening structural imbalances, so I’ll quote it here at some length.
[Yu] believes China is trapped in a cycle where constantly rising growth in investment is constantly increasing China’s supply, but consumption has conspicuously failed to grow fast enough to absorb it. And so China is forced to increase investment in order to provide enough demand to absorb the previous round of increased supply, thus creating ever-widening cycles of oversupply.
In this manner, the investment share of gross domestic product has increased from a quarter of GDP in 2001 to at least half.
“There is sort of a chase – demand chasing supply and then more demand is needed to chase more supply,” he says. “This is of course an unsustainable process.”
From 2005 China’s overcapacity problem had been “concealed” by ever-increasing net exports – but that strategy was interrupted by the financial crisis. Then came last year’s globally unprecedented stimulus-investment binge, which might not have been so worrying if it were delivering things that people needed.
But the Government’s hand in resource allocation has grown heavier since the crisis without reforms to make officials more responsible for what they spend.
“As a result of the institutional arrangements in China, local governments have an insatiable appetite for grandiose investment projects and sub-optimal allocation of resources,” as Yu previously said, in his Richard Snape lecture for the Productivity Commission in November.
So there are now airports without towns, highways and high-speed railways running parallel, and towns where peasants are building houses for no reason other than to tear them down again because they know that will earn them more compensation when the local government inevitably appropriates their land.
As Garnaut goes on to discuss in his back and forth with Yu, the scary thing is that this cycle could conceivably continue on a for a number of years if the economy were given a break for an intervening year or two by a return to booming exports. But the export and investment driven model must at some point reach what Garnaut calls a “Wile E. Coyote moment”: a point where this unsustainable cycle becomes unsustainable and, well, falls off a cliff. Here is Huang Yiping, a Peking U. economist writing in East Asia Forum earlier this month and quoted by Pettis, on the other really ominous thing about these structural imbalances in the economy:
Almost all policymakers, from the Premier down, are talking about adjustment of economic structure in order to improve quality of growth. This is very positive. But the measures being considered, such as better credit allocation, remain administrative in nature. In fact the government has been doing the same for at least seven years. But the imbalance problems continued to worsen. I don’t see any difference this time round.
The imperative of re-balancing the Chinese economy is one that is clearly widely recognized at the highest levels of power in the People’s Republic of China. And yet, largely due to the entrenched nature of local interests and their tendency towards crony capitalist waste and corruption, this seems like an impossible task, or perhaps one the Communist Party’s leadership seems unable or unwilling to force itself to confront. This inability to effect this needed change is perhaps a hidden brittleness that lurks within the supposedly dynamic and efficient Chinese model. It is a topic very worthy of further consideration in the weeks and months ahead.
