Monday, February 29, 2016

China's Economy Policy Akin To Pushing On A string

How Do You Produce Growth In A Bubble?
Currently China's economic policy is akin to pushing on a string. Time and time again history has shown that when an economy has overbuilt, over leveraged, and over reaches a reset occurs. Numbers just released show activity in China's manufacturing sector shrank for the seventh month in a row in February and more sharply than expected. Things are so bad that central bankers and finance ministers from the Group of 20 major economies recently urged China to move towards increasing their fiscal deficit to propel growth forward. China's economy grew an annual 6.9 percent last year, the lowest in 25 years and analysts forecast it to slow further this year. It is anticipated Chinese Premier Li Keqiang will declare a lower growth target at the coming NPC meeting, likely a range of 6.5 percent.

While this sounds like good growth by the standards of countries across the globe few people trust the numbers China puts out. Concerns about how China deals with the issues that for years were masked by rapid growth loom large. Even as this piece was being written news stories of a "surprise" cut started flowing onto the internet.The People’s Bank of China just announced a 0.5 percentage point cut in the capital that banks are required to keep on reserve with the central bank, effective March 1. The measure to cut what is referred to as the RRR frees up an estimated $108 billion worth of funds. The latest move lowers the reserve ratio to 17 percent for major banks. This is the first across-the-board reserve ratio cut since October of last year, when the central bank also lowered it by the same margin. The cut comes immediately after this weekend’s G-20 meeting in Shanghai in which the members endorsed the game plan of China taking a more accommodating stance while urging Beijing not to devalue the yuan. This cut seems to meet both these goals.

The PBoC clarified in a statement on its website the RRR this move is aimed at maintaining liquidity and guiding the steady growth of money and credit. It is clear the central bank wants to make up for a shortage of liquidity and to stabilize the economy. However, we should consider this as further acknowledgment that a reliance on cheap bank loans has run its course or lost much of its magic as a method to boost the economy. As always when they discuss new solutions to support global growth the talk is spun to sound constructive. Both the G-20 and the central banks always claim to  include a focus on fiscal expansion and long-term reform rather than just credit-driven growth. Still the problem remains that persistent worries about Beijing's ability to manage China's slowdown remain and its affects on other economies continues to expand.

This action paves the way for China's State Council to widen the country's fiscal deficit to about 3% of gross domestic product this year from the current 2.3%, according to Chinese officials and government advisers close to the decision-making process. In a recommendation to China's top policy makers a senior official at the People's Bank of China wrote that the government should let the shortfall reach 4% or so because that would allow authorities to slash taxes on businesses to free up more of their funds for investments. "Fiscal policy hasn't been proactive enough," said Sheng Songcheng, head of the survey and statics department at the central bank and the lead author of the recommendation. "The concern over increasing the fiscal deficit is that it could lead to a fiscal crisis. But our research shows otherwise."

China's Money Supply Soared From $10 To $24 Trillion 
Instituting reform is easier said than done and while China is working through debts from massive stimulus spending during the 2008 global financial crisis they are far from turning the corner. As I have stated before it is the nature of political systems to mask their flaws and in the case of China years of rapid growth have made this easy. It is important to remember that much of the growth in China after 2008 came from a massive 6.6 trillion dollar stimulus program. This expanded credit and poured massive amounts of money into the system, but it also encouraged expansion and excesses in real estate and industrial capacity with little regard as to real demand or need.  Even today while many people concede that growth has slowed they still refuse to recognize just how much of past growth has been constructed on a foundation of sand and the misallocation of capital.

China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. For years credit expanded rapidly in China, and now much of the country is mired in debt. It is important to remember lackluster demand means a heavily indebted corporate sector in China has little incentive to borrow more, and Chinese banks are wary of rising bad-loan levels. Corporate debt now amounts to 160% of China's gross domestic product, according to estimates by Standard & Poors, this is up from 98% in 2008. Also rising taxes have become a huge burden for Chinese companies. Surveys by the central bank of some 5,000 industrial companies show that their accumulated taxes from January 2012 to November 2015 jumped 30% while their total revenue grew by only 3.3% during that time. Corporate taxes are said to account for about 90% of government revenue, cutting corporate costs is a main goal in President Xi Jinping's "supply-side" reform agenda

This strategy involves closing down "zombie firms" including large employers such as steel mills mired in overcapacity and reducing the number of unsold homes. This has put the economy in a vise, complicating the situation is the fact that money that has flowed into the country for decades is leaving and taking with it much of the wealth it has produced. Interestingly, many people fail to understand how this great capital unwinding and the money that continues to leave China will affect both currencies and economies throughout the world. In fact many economist and investors are in a state of denial as to just how dire the situation has become. On a daily basis we still hear the faithful tout how China is still cranking out around 7% growth. I contend China is in far more dire straights than most people imagine and the reason it has gone unnoticed is because of the control their government has over the economy which makes it impossible to get accurate or specifically detailed numbers and information.

According to estimates, China’s banking system has grown from $10 trillion to $24 trillion since 2008, but now the reverse appears to be happening, and as the yuan weakens, the central bank will effectively have to buy its own currency using foreign reserves to maintain its peg. Senior Chinese officials say both its monetary and fiscal policies will remain "appropriately expansionary"  to prevent the economy from falling off a cliff during the time they attempt western economists advice to press ahead to remake the economy rely less on investment and exports and more on their own consumers. This is a major shift for China's economy, bottom-line is that we should not be surprised if China's leaders are unable to make the transition  in an orderly fashion.

Footnote; Below is another post concerning China that I consider very important.

1 comment:

  1. A beautifully written article Mr. Wilds. Very insightful as usual.