The fundamental
problem of credit expansion is that it only applied to the heights of the
economy and not to the base of the economy where expansion naturally draws down
over capacity in both assets and credit.
No one has ever really got this correct except somewhat by accident.
China has rushed
largely into a similar trap and is setting up for a serious financial crisis in
which all the winners will be forced to flee their debts. We are already seeing plenty of early
activity presaging just that. Recall
that the individual who operates a business in China can read his balance sheet
and see that his position is neither sustainable nor escapable. At that point he sets up his personal escape.
The solution is
to slam credit guarantees deep into the economy itself to the purely local
level including credit management as quickly as possible. A burgeoning rural and small business sector
will swiftly overtake this credit bubble which needs to be slowly unwound. That then fuels general consumer demand which
stabilizes the whole economy.
Or we can do all
this the hard way.
China's
Economic Predicament: Why Pain Is Coming No Matter What
By Mamta Badkar |
Ever since China's new leadership took the helm in November 2012,
they have been pushing through economic reforms rather aggressively.
These reforms have not been without pain. They have, in part, contributed to slower economic growth, and to a rise in
defaults.
So, why have policymakers traded high growth for slower growth?
What would happen if China abstained from any reforms? What if Beijing didn't
try and curb lending, or shadow banking?
More liquidity and would probably lead to continued inefficient
allocation of resources. It's likely that the property market would swell,
China's excess capacity would worsen, and money would generally go into
projects that were basically intended to drive GDP.
Banks can continue to roll over debt and continue to finance new
projects with increasing amounts of credit. While this would stave off any pain
at the moment, it would just push the problems further down the road and risk
exacerbating them.
In recent years we've noticed that credit growth has far outpaced
economic growth, prompting Societe Generale's Wei Yao to ask where all the
money has gone. According to Yao, China is facing its own Minsky moment where periods of speculation
and credit growth inflate assets can only to lead to a crisis.
Runaway credit train
In a Bloomberg View column, Patrick Chovanec, chief strategist at
Silvercrest Asset Management, wrote that "China’s leaders are riding a
runaway train that they don’t quite know how to stop. And they’re running out
of track."
And when this does go sour, its impact will be felt beyond China.
"China’s credit-fueled investment boom has been a driver of
metals prices and machinery exports," wrote Chovanec. "China has
become the world’s largest automobile market, its largest oil importer, and its
largest buyer of gold. Although foreign banks have relatively little direct
exposure to Chinese financial markets, capital flows into and out of the
mainland are potentially large enough to have a significant impact on asset
classes not normally associated with China. A financial train wreck would send
tremors through global markets."
The end result
"Japan’s debt didn’t start to rise at a similar speed until
the mid-1980s," wrote Lombard Street Research's Diana Choyleva.
"China’s debt has surged sooner because its economy is much bigger than
Japan’s was."
She added that debt has grown much faster in the last five years
than it did in Japan during the same stage of development. And the rate of debt
increase is "as important, if not more important, in precipitating a
crisis than the absolute level of debt."
###
"The world is just not big enough to let China continue to
increase its income per capita and waste its savings on a vast scale for years
to come," she said. "The financial crisis was the beginning of the
end of China’s export and investment-led growth model."
Choyleva warns that China's burgeoning debt has made it, so that
its 'Bear Stearns moment' may strike at any time.
This would basically change the market's perception of inherent
credit risk in the Chinese economy and cause a liquidity crunch. If China were
to "mop up the mess while still wasting capital, it could be only 2-3
years before a major financial crisis hits the economy."
Alaistair Chan at Moody's told Business Insider that if China
fails to push through reforms "the end result would be that the
economy stagnates in a middle-income trap."
"Zero reform would mean that productivity growth would
continue coming entirely from adding more capital to labour, rather than from
improved efficiency. This method of growth is already hitting diminishing
returns and if it continues then China’s potential growth rate would fall sharply."
If reforms aren't pushed through, Standard Chartered's Stephen
Green thinks inequality and corruption will rise as growth slows and it would
leave China vulnerable to foreign and domestic shocks. "At the same time,
more money and talent would leave for sunnier and clearer skies. Its not a
pleasant thought – and the sense of crisis, and the need to avoid such a
future, is partly whats driving Beijing these days."
Not everyone is as gloomy. Chan says "it should be noted that
this won’t necessarily result in a financial crisis or hard landing because if
productivity is slow then the government won’t need to pile on much
debt/investment to boost employment."
Yao meanwhile is far more blunt on the subject.
In the absence of reforms, "China could potentially face its own lost
decade."
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