Note: In response to many complaints by people who were confused by the headline — I was being sarcastic. Puerile humor, perhaps, but the point is that over the last year it seems that we hit absolute bottom roughly every fifth week.
Have we reached a bottom? A lot of analysts are pointing to the improvement in both measures of Chinese PMI to suggest that Chinese manufacturing may finally have reached a bottom, even though both PMI measures are still well below 50 and so indicate a contraction in manufacturing. More impressively the stock market has rebounded, with the SSE Composite bouncing off its January 13 close of 1863 to reach, as of yesterday 2108 (up 13.1%). Today it traded up another 2.0% in the morning before giving it all back, and more, during the afternoon to close down 0.5% for the day. Before the market turned Bloomberg today reported a very optimistic fund manager:
“Stocks continue to be lifted by speculation more stimulus measures are on the way,” said Michiya Tomita, a Hong Kong-based fund manager of Chinese stocks at Mitsubishi UFJ Asset Management Co., which oversees $61 billion. “There’s a growing perception that China’s economy will recover surprisingly fast.”
Surprisingly fast? I’ll take that bet. Aside from the normal excitement we all get from the right kinds of stimuli, part of the recent optimism seems to reflect the huge upsurge in bank lending I reported last week – with loans in January rising by RMB 1.3 trillion. Nearly one-quarter of that was provided just by ICBC. According to an article in today’s Bloomberg:
Industrial & Commercial Bank of China Ltd., the nation’s largest, said it offered 252.1 billion yuan ($36.9 billion) of new loans in January in response to the government’s stimulus plan to avert an economic slowdown. The bank lent 69.3 billion yuan to power grid, railway, roads, and hydroelectric power projects, and 135 billion yuan in discounted bills to small and medium-sized companies, the Beijing-based firm said in an e-mailed statement, without giving comparisons. New loans to individuals, including mortgages, amounted to 16 billion yuan.
China dropped lending quotas and unveiled a 4 trillion yuan stimulus package in November to maintain economic growth and counter the global financial crisis. Banks have responded by raising lending targets and focusing on railways, roads, power grids and other infrastructure projects with stable returns. Domestic banks offered a record 1.2 trillion yuan of new loans last month, representing almost a 50 percent gain from a year earlier, the China Securities Journal said yesterday.
ICBC aims to advance 530 billion yuan of new loans in 2009, about the same as last year, the 21st Century Business Herald reported today. The bank plans to complete 45 percent of the loan target in the first quarter. ICBC attracted 271.2 billion yuan of deposits in January, equivalent to a quarter of the total increase in 2008, according to today’s statement.
I have long argued that credit is a much better gauge of money supply in China than any of the monetary aggregates, so this explosion in bank lending should suggest at least that China is making the right moves from a monetary point of view – pumping liquidity into the system to avert a contraction in money supply that would exacerbate the contraction in demand. But I have three very serious problems with the optimism associated with the latest numbers on credit expansion.
First, this credit expansion is not all that it may seem. Aside from the fact that a lot of this new credit has consisted of an increase in bill discounting, in order to understand what is really happening to total credit in the Chinese economy we need much better data. There are persistent rumors that part of the increase in bank lending consisted of putting back on balance sheet loans that were taken off balance sheets in 2007 and 2008 when the PBoC was trying to constrain bank lending. It isn’t really new credit. We also don’t have a very good feel for what is happening in the informal banking sector, and in the past there was evidence that contraction and expansion in the informal banks counteracted what occurred in the formal banking sector.
What is more, there is clearly an increase in lending games aimed at making policymakers happy by showing fat loan books. One of my students just visited me today with an example that involved his father. I don’t want to get into too much detail, for obvious reasons, but the net effect of the transaction involving his father was that an entity was created to borrow money from a bank, the proceeds of which were deposited in a CD, which was then assigned in ownership to the real borrowing entity, which then used the CD as collateral for the “real” loan. Aside from the complications used probably to get around credit restrictions, one single loan was recorded as two loans plus a CD deposit. Apparently the lending bank knew about all the intermediate steps. Surprise, surprise! It turns out that if your career prospects depend on increasing the total amount of loans outstanding, with less focus on the quality or structure of the loans, in fact it isn’t hard to show very nice, fat loan book.
One of the readers of this blog, yesterday gave another very interesting example of what might be included in this new lending. He says:
As for the sudden surge in lending, this looks to me to be an accounting exercise, clearing or otherwise funding non-bank debts piled up by SOEs. Many large SOEs (not central ones, regional/local ones, though the central ones win no prize themselves) are behind on paying wages, suppliers etc, and the stimulus provided by this lending surge is really just to ease the log-jam of triangular debts. This implies that there will not be much “bang” for all of this lending
Second, exploding credit may provide a fillip to growth in the short term, but if it leads to a future increase in bad loans, it will have exactly the opposite effect in the near future. As I discuss in my previous blog entry, this represents a big bet on the duration of the slowdown.
Third, the biggest problem has to do with how much credit expansion will make a difference. Andrew Batson at the Wall Street Journal (sorry, I don’t have the link) makes this point when he discusses the “string of dire profit warnings has signaled a rapid deterioration in the financial health of Chinese companies.” His relevant paragraphs:
Corporate investment is hugely important to China’s economy, where capital spending accounts for more than 40% of annual output, one of the highest ratios in the world. The profit decline will have major effects across the economy as companies have less money to buy new equipment or expand their businesses.
…Economists have long warned that Chinese companies’ heavy reliance on retained profits would tend to exaggerate swings in the nation’s investment cycle. Official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds, which include retained profits. That’s up from just below 50% a decade ago.
Basically Chinese corporate profitability in China is dropping sharply, and nearly everyone expects the trend to continue over the rest of 2009. If nearly two-thirds of investment in China was funded by retained earnings, a sharp drop in profitability should result in an equally sharp drop in investment funded by retained earnings. I don’t know the magnitude, but I would guess that a very large increase in real bank lending aimed at real investment, far more than has been reported, would be needed just to make up for the decline in investment out of retained earnings. This, by the way, is an argument that has also been made by my friend Sam Baker at TNR.
For these three reasons (and a few others), I am not as impressed as many others are by the recent expansion in credit. I acknowledge, of course, that I may be hemming myself in intellectually because of my very strong belief that China will be forced one way or the other to make a necessary but difficult adjustment from export orientation to growth based on domestic consumption, and so I am blind to the good news, but for now I am sticking with my belief.
Aside from doubting the beneficial impact of credit expansion a larger part of the reason for my continued skepticism is that I am much more impressed by the expectations of hordes of workers returning to work after the Spring Festival and not finding jobs. Today’s South China Morning Post starts off an article today
One of the world’s leading luxury furniture makers has folded in Shenzhen amid the economic crisis, leaving more than 2,000 unpaid workers blocking traffic in protest until the local government paid more than 10 million yuan (HK$11.3 million) in back wages. DeCoro, the Shenzhen-based Italian sofa manufacturer employing nearly 3,000 people, had gone into liquidation with all assets seized by a local court in Longgang district, the National Business Daily reported.
Less anecdotal is another article, also in today’s edition:
Guangdong authorities are expecting millions of unemployed migrant workers to pour into the province in search of work, despite official warnings that the prospects are slim. Provincial labour authorities say 10.25 million migrant workers left for the Lunar New Year holiday, and of the 9.7 million expected to return soon, about 20 per cent would find it extremely difficult to find work.
But the biggest problem I have is that anyone taking a global view, and not just a very local view, cannot fail to be impressed by how bad the numbers out there are. For one thing, US GDP contracted by 3.8% in the fourth quarter of 2008. Normally that would be a horrible piece of news, but most analysts were pleasantly surprised because they expected something closer to 5.5%. Does that suggest that the US, too, is bottoming out? No, because apparently what saved the US from a much larger contraction was heavy orders from factories, including foreign factories, based on a surge of optimism during the summer. According to an article in Monday’s Wall Street Journal (I don’t have the link because I read it in the plane, but for those interested the article is titled “US Economy Dives as Goods Pile Up”):
While the fall wasn’t as steep as expected – most forecasts had GDP falling by 5% to 6% — output was boosted somewhat by a rise in inventories of goods that were produced but not sold in the fourth quarter. Excluding the inventory adjustment, GDP fell at a 5.1% rate, which economists say more accurately reflects the nation’s weakness.
Rising inventories, in other words, accounted for the better-than-expected US economy in the fourth quarter of 2008. But now those inventories have to be sold. That means however bad we expect US demand to be in the next few months, US companies will buy even less because they have excess inventory that needs to be run down. The unexpectedly good results for the last quarter will cause an unexpectedly bad result this quarter (not unexpected, of course, but you know what I mean).
And there is more. The US savings rate dropped to below zero in 2005 and 2006 but since then has been rising as Americans are forced to pay down debt and save more. Savings rose to nearly 3% of disposable income in the fourth quarter, from 1.2% in the previous quarter, according to the same article. But 3% is not enough. My guess is that this represents less than a third of the total adjustment that needs to be made. Remember that every dollar the US saves is a dollar that doesn’t go towards consumption.
Here is another way of looking at the same data. David Pilling has a very sober piece in yesterday’s Financial Times in which he argues that “China should raise wages to stimulate demand.” Of course he is right and of course they should (at least this is what I have been arguing for a while), even though it seems completely counterintuitive. Most analysts both in and out of China are arguing that China should try to increase the competitiveness of its manufacturers and the profitability of its businesses, and in this light raising workers’ wages seems stupid, but in fact I would argue that this is the best medium-term strategy to minimize the cost of the downturn to China. I will argue this more fully another day, but I do want to extract two paragraphs from Pilling’s article:
To see why, look at US personal consumption, which hovered around 67 per cent of gross domestic product in the last quarter of the 20th century. That was already high by the standards of the previous 25 years. But from 2000 to 2008, it shot up again to an unprecedented 72 per cent. That trend has now gone into painful reverse. As Stephen Roach, chairman of Morgan Stanley Asia, notes wryly: “We are already all the way down to 71 per cent.” In other words, it will be a very long time before Americans are again filling up their shopping carts.
…In 1980, 65 per cent of output of developing Asia was accounted for by consumption. Today it is about 47 per cent. The main reaction to the Asia crisis of 1997-98, when economies’ vulnerability to financial flows was exposed, was to build up exports. In doing so, Asia has swapped one kind of dependence for another.
US consumption dropped from 72% “all the way down” to 71%. Of course Stephen Roach is joking. US consumption has to decline by a lot more than that, and it will. Any attempt to understand China’s economy without situating it firmly within the global context, and especially within the contraction in global demand (remember as a major trade-surplus country China needs foreign demand to absorb its huge overcapacity) will not get the picture right.
By the way, on a related note, the US “Buy America” plan, which has been both widely criticized and widely replicated – explicitly or implicitly – by a lot of countries including China, is an example of how things are likely to turn when it comes to trade prospects. The good news, I think, is that those of us who worry about an explosion of protectionism are getting so alarmed that there may be a concerted fight to ward it off.
One other piece of mild good news, China yesterday increased the tax rebate for textiles. According to an article in today’s People’s Daily:
China will increase the tax rebate rate for textile and garment exports from 14 percent to 15 percent, an executive meeting of the State Council (Cabinet) announced Wednesday. The move would reduce exporters’ costs and support the textile industry, the Council said.
Increasing the tax rebate is actually a bad thing, in my opinion, since it seeks to improve the trade “competitiveness” of Chinese textiles and so increase China’s ability to export overcapacity, but the increase was much less than the industry expected. Thank god for small favors.
P.S. The day after I posted this the South China Morning Post provided a bit more clarity on the composition of ICBC’s loan expansion. According to an article in today’s edition:
Routine “bill financing” accounted for more than half of the loans the mainland’s largest bank by assets granted last month, underscoring concerns that the lending upsurge Beijing recently hailed as a sign of economic recovery may be inflated. Industrial and Commercial Bank of China extended 135 billion yuan (HK$153.12 billion) in “bill discount loans” and 117.1 billion yuan of other loans last month, the lender said yesterday. In discounting a bill, the bank takes on a company’s bill to a buyer before it is due and credits the value of the bill, after a discount charge, to the customer’s account.
Analysts said that of the 1.2 trillion yuan in loans made in January, about 65 per cent or 780 billion yuan were estimated to be “real” loans. That was slightly lower than last year, meaning the loan surge was largely illusory. “Banks are snapping up quality clients and projects,” a credit officer at a large bank said. “The more an enterprise does not need money, the more willing banks are to lend to it.”
…Banks generally only lend to quality small enterprises with loan yields of 6 per cent to 7 per cent, or 10 to 30 per cent above benchmark loan rates, according to Goldman Sachs. With the share of discounted bill financing in monthly incremental loans rising sharply from 5 per cent to 33 per cent over the past five months, the proportion of medium to long-term loans has shrunk from 50 per cent to 32 per cent.
Thus, the strong lending growth’s boost to fixed-asset investment was limited, China International Capital Corp said in a report. The truth may be a blow to mainland officials who are eager to see the economy on track to a recovery, but it could offer relief to bank shareholders in the short term.
P.S.S. On Friday afternoon I had an email discussion with Standard Chartered’s Stephen Green, one of my favorite research analysts, in which I asked if numbers provided by the PBoC branch in Wenzhou (Wenzhou is widely known as the capital of the informal bank sector in China) suggested that the informal banking sector was contracting loans. His answer: “Yep, that seems to be the thrust of it. In Wenzhou informal pool around CNY 600bn in recent years but new report by Wenzhou’s PBoC reports that between Jan and Dec ’08, total deposit in Wenzhou’s banks rose 27.9% to CNY 208.5bn, indication they say that unofficial lending has slowed down. Certainly that was what seemed to be going on when we visited in September, large number of financiers had shut down for various reasons.”
Michael, the optimism over the PMI, commodity destocking and surging credit contains too much wishful thinking, people wanna hear some good stuff after 2008 shocks. Certainly it does have utility in terms of PR afterall premier said ” Confidence is better than gold”, but some detail look at PMI show unprecedented layoff, very depressing export and commodity destocking largely over.
The 30 trillion RMB China economy, like a massive ship, is very hard to turn when both export-property-capex contracting. My rule of thumb, after low teens overheating in 06-07, it probabaly takes at least 3-4 years decceleration just to digest the excess in overcapcity, asset prices, it probabaly take even longer for US-G7 to develerage and repair balance sheet.
so the stimulus -monetary easing-proping up Asset prices are very much needed to stabilize the crash momentum, but it will be very unlikely China sustain trend growth above 8% till export-property resume growth, maybe in 2010.
One factor that can be considered a plus is that such a large migrant labor pool makes this end of the market flexible. However, it is not exceptionally productive, and labor quality may lock a big proportion of the pool into low-end industries. China has been churning out record numbers of graduates from institutes of higher education, but it would appear that growth there has been outpaced by the growth in marginally educated rural surplus laborers. So raising wages above their level of marginal productivity would spell micro economic doom. As a vocal central government researcher said once in an open meeting “you can’t take tens of millions of peasants and make them high-tech workers overnight”. A 1% increase in the US savings rate is equivalent to something like 4% of China’s GDP. Let’s make that 3% for period of a few years, and assume corresponding increases in other major OECD countries, and nations that have relied on increases to capacity (investment) and net external demand will be hurting for a while, as issac says.
Welcome back. How’s the family?
For what it’s worth: Obama is opposed to the Buy America idea; he argues it could lead to protectinism.
Are there any talks of tax cuts for individuals? Are individual taxes significant in China? How about corporate taxes, are they significant?
Maybe the situation in China has really improved? Unlike other countries where capital is spread in the hands of super rich individuals (although a tiny fraction of the total population), each with a different agenda of his own, the economic ship is easier to steer in China because most capital is in the hands of the government.
While it is probably too early to predict anything, I am pretty sure the auto market has recovered in China. All the government did was reducing sales tax to 5% on cars with 1.6 L engines or smaller. Auto industry is probably one of the most important industries for China’s future development, besides health service and medical technologies.
Pettis: Economists have long warned that Chinese companies’ heavy reliance on retained profits would tend to exaggerate swings in the nation’s investment cycle.
I’d argue the opposite. If you have large pools of cash then when profits go down, you still have money to invest and are more likely to do so because you are going to find bargains. In any event, you can avoid laying off workers, causing more problems as demand collapses.
If you don’t retain profits then when profits go down, you run out of cash and die unless you are able to get bank credit, and in a crisis banks are not willing to give you credit.
The other thing is that optimism, even crazy, irrational optimism will get an economy out of a deflationary spiral. If people are optimistic, they spend money, when money gets spent jobs are created.
Heard a news yesterday: the Chinese government is paying small and medium rural enterprises CNY600 per month for 6 months for every employee who would otherwise be laid off.
I am anxious to hear Prof. Pettis explaining how China could increase wages when corporate profits are plunging. Government subsidizing corporate payroll doesn’t really reinstate consumer confidence. Unless Beijing also perfects (or at least significantly improves) the social welfare system, all those government subsidized paychecks will simple deposited at banks for another rainy day.
I actually like the idea of taxing monies in an early article.
Pools of cash….to invest in what at this point? Where is more capacity needed?
Twofish said, ” I’d argue the opposite. If you have large pools of cash then when profits go down, you still have money to invest and are more likely to do so because you are going to find bargains. In any event, you can avoid laying off workers, causing more problems as demand collapses.”
Without getting into arguing, the current circumstances already departed from what you said, no? ie. massive layoffs happened
Twofish said, ” If you don’t retain profits then when profits go down, you run out of cash and die unless you are able to get bank credit, and in a crisis banks are not willing to give you credit.”
Problem is, the retained cash has been invested and with the last few months’ turmoils, I would bet that majority of such retained profit has been evaporated. And I believe this echoed with the fact that many firms couldn’t withstand the losses both in invested capital and export orders, thus closing businesses.
Isaac, yes I think the analysis of PMI has been overly optimistic. I just finished reading Standard Chartered’s report on the PMI numbers and he makes many of the same points you do. By the way CLSA’s PMI reading was an awful 42.2 for January. That is better than their 41.2 in December and 40.9 in November, but only marginally, and certainly nothing to cheer over. Of course it is also a lot worse than the official 45.3.
Qingdao, Buy America is a form of protectionism, and not particularly efficient. I think we are going to need sustained statesmanship to avoid protectionism around the world, but with every running around apportioning blame, like junkies squabbling over who forced whom to snort the most, it is hard to be optimistic.
Tyaresun, the poor pay little tax, so there isn’t much to cut, and the rich consume all they want, so tax cuts are likely to lead to higher savings, not consumption. Corporate tax revenues have declined precipitously since the summer, so I suspect the MoF is not eager to see them cut.
Seatrus, that is an argument often heard here – that state control means less disruptive individual behavior. That may well be true, but my instinct is that state control actually slows down the adjustment. Still, maybe that is a good thing in the short term. We shouldn’t overestimate what state control means, however. The myth that there is very tight control by Beijing over government functions has been widely attacked. In fact China has lots of different central, provincial, and municipal governments with conflicting incentives, and different factions that control different bureaucracies. In my opinion that is a good thing overall – I think lots of moving parts add flexibility and the ability to innovate – but it also means the country can face real policy coordination problems. I remember reading a fascinating paper two years about the very unequal transmission of monetary policy among the provinces.
Twofish, the problem is that when profits go down you have much less cash to fund new investment and when profits go up you have much more. That is highly pro-cyclical. Optimism is good, but only if it is stable. Veering back and forth between optimism and despair undermines credibility.
Isnaciz, it depends on who is getting the paychecks. Unemployed people are likely to consume less than those getting paychecks.
kalasend: Without getting into arguing, the current circumstances already departed from what you said, no? ie. massive layoffs happened.
In the export sector yes. There haven’t been yet mass layoffs in the SOE’s.
kalasend: Problem is, the retained cash has been invested and with the last few months’ turmoils.
No. Most of the retained earnings from the SOE’s are in the big state banks and are in cash. That’s why it is crucial that there not be a banking crisis, and a good thing that there hasn’t been one.
kalasend: And I believe this echoed with the fact that many firms couldn’t withstand the losses both in invested capital and export orders, thus closing businesses.
China has very different firms. There have been closures of firms in the export sector, but no mass closings or layoffs with the big corporates, and their cash positions looks good.
I have a bit of speculation which is that export businesses *didn’t* close because of lack of orders but because of lack of credit. The speculation is that what happened was that when Lehman collapsed, you had a rush of capital outward through Hong Kong which killed the informal financing networks that finance the export industries in South China. At that point the factories just closed because even if they had orders they didn’t have money to pay workers.
This is speculation, but the reason I’m thinking that something like this may have happened is that a demand shock usually takes two or three months to enter the system while a credit shock is immediate. If you can meet payroll, you shut down immediately.
The consequence of this is that if there was a credit shock rather than a demand shock, the Chinese economy could recover very quickly. Maybe even too quickly.
Also any Chinese economic planning should assume the possibility that there is an extended global slowdown, but it’s possible that China could boom while the US is economically stagnant. If this happens then currency will become a big issue again, because China need to cool its economy while the US needs to heat it’s economy leading to huge pressure to appreciate the RMB.
Twofish,
Retained earnings are not cash. The cash in past years has been aggressively reinvested in new capacity over the past 5-6 years. This is why fixed asset investment growth has been so high. But empty plants representing overcapacity are likely a cash drag in the future. And if you have overcapacity today, why would you borrow to invest in creating more capacity tomorrow.
With the Chinese economy’s growth so dependent upon investment growth over the past 9 years, this situation is bound to reverse, with less, not more investment, at least from the private and semiprivate sector. Over the past 9 years, the investment has been mostly driven by the perception of profit potential (sometimes personal rather than at the project level). I don’t think the government can easily flick a switch and make people continue investing out of duty or fear, and don’t think government “investment” can match the levels of investment the semi-private sector reached in past years.
I am of the opinion China has not bottom out yet despite of what the PMI is telling us. This does not match with the export market demand which we all know is still very weak particularly in the US where amongst other factors the saving rate has surprisingly increased from zero to 3 percent. This is telling us the consumers confidence is still extremely weak.
What then has caused the PMI to rise? I believe this has something to do with the recent massive upsurge of bank lending. Chinese are traditionally gamblers and they are speculating on raw materials when they are now comparatively cheaper. Building excess inventories again at this point in time when the market is still very weak is a very dangerous ball game.
The upsurge in bank lending is not supporting consumption but expansion of inventories. This is not the intent of the government’s stimulus plan. Furthemore banks are exposing themselves to a higher rate of NPL when the excessive inventories bubble burst due to weak demands.
The increased in tax rebate for textile and garment export from 14 percent to 15 percent is not really good news as believed by many people to be so when the demand is weak. If nobody is buying whatever rate of increase has no meaning.
Beware the “Ides of March”.
Another negative piece of news I would like to add is the home sales figure in Guangzhou over the Spring Festival Holidays. It is a naked zero!!Ask yourself why?
http://online.wsj.com/article/SB123388103125654861.html?mod=testMod
Nations Rush to Establish New Barriers to Trade
The World Trade Organization is gathering nations in a special meeting Monday to try to stem the rising tide, just two weeks after saying protectionism was largely under control. On Thursday, 10 European Union commissioners headed to Moscow for talks Friday with Prime Minister Vladimir Putin and other Russian officials, where they plan to air complaints over the pace of new Russian trade barriers.
….
WTO members have been busy, too. The U.S. plan to put tariffs on Italian water affects $150 million in Italian exports a year. Italian water exporters also have invested millions “to get FDA and kosher certification” to sell in the U.S., said Maria Elena Giuliani, a spokeswoman for the Italian Ministry of Commerce.
The 27-nation EU’s decision to resume export refunds to dairy farmers — after it suspended the controversial payments in 2007 — could cost New Zealand $2 billion in lost sales this year, as state-subsidized EU products win out in global markets, according to Federated Farmers, a New Zealand farmers lobbying group. The subsidies still fall within EU rules, said spokesman Michael Mann.
Last week, the EU also slapped antidumping tariffs on imports of Chinese screws and bolts. The duties will exclude Chinese products from the European market, costing jobs in China, says an official at the Chinese mission to the EU. EU antidumping measures also had been down in recent years, as the bloc moved to encourage free trade.
The EU is due to decide by March 12 whether to levy duties on U.S. biodiesel imports, in retaliation for a $300-a-ton export subsidy Washington pays to U.S. producers — roughly half the selling price of a ton of biodiesel in Europe. EU officials say the bloc is likely to vote in favor of the duties.
China has bottomed out? Not yet and it will not bottom until “The Third Wave” is over. Talking about “The Third Wave” I have made a
rather interesting observation recently. I am not talking about The Third Wave as many of us are aware in studying and analyzing charts.
Northern China at the moment is having the most severe drought since 1951 which spreads over 300 million mu of agriculture land. Water i.e rain is strategically important and if it doesn’t come quickly China economy will be seriously hit again after the Snow Storm in the south and the earthquake in Sichuan.
I would therefore consider the drought as “The Third Wave”, the snow storm as “The First Wave” and the earthquake as “The Second Wave”.
Based on the above observation I am of the opinion China will not bottom out until the drought in north is over.When it will be over is a six million dollars question. It can drag until the next Spring in 2010. I very much hope this will not be the case. Let’s keep our fingers crossed.
Having said that, however,beginning February 4 the Spring equinox has arrived and it is time to have rain. If rain doesn’t come by March 15 then it will be a big problem. Once again “Beware The Ides of March”.
A. West: Retained earnings are not cash.
Much of corporate retained earnings exists in the form of bank deposits, some of which are set aside as reserves, but other parts are made available for investment.
A. West: And if you have overcapacity today, why would you borrow to invest in creating more capacity tomorrow.
If you have overcapacity, you wouldn’t create additional capacity in the same thing. But if you have retained earnings, you can start new lines of business, or else if you have nothing else to do, you just keep the cash in banks, and let them redeploy the capital.
One note is that corporate forms are usually rational responses to financing constraints. US companies in the 21st century tend to focus on core competency because they get ready cash from the securities markets and there is no need to redeploy cash to and from unrelated businesses.
Chinese corporations tend to be conglomerates because they depend on retained earnings for finance and this structure makes it easier to redeploy capital. In this the tend to resemble US companies of the 1960′s.
A. West: I don’t think government “investment” can match the levels of investment the semi-private sector reached in past years.
I don’t see why not. The only thing that would prevent massive investment is budgetary limitations, but wise investment can increase long term tax revenues. A lot depends not on the amounts of investment but the types of investments, and there is no lack of things in China that would be improved if money was spent on them. In particularly, there is a major lack of public goods in China in health and education. Also there is a huge lack of investment in small and medium enterprises and service industries.
Loo: Building excess inventories again at this point in time when the market is still very weak is a very dangerous ball game.
At that point the thing to do is to drop money from helicopters so that people buy up excess inventories. Building up inventories *is* dangerous since it only buys time, but keeping people employed for six months is no small thing in a crisis.
One other thing. I do think it is *FAR* too early to say that China has bottomed out. Looking at one months data is looking at lots of noise. Something that is striking about the early stages of the Great Depression is how many people (justifiably) thought that the worse was over. One other thing is that over the last two years there have been so many people saying that the “worst is over” that I’m not going to believe anything easily.
Having said that, it is very encouraging that everyone is worried (justifiably) about future NPL’s rather than a collapse of the banking system now. One thing that makes things difficult for US policy makers is that they have to deal with a collapse of consumer demand and a banking system crisis at the same time, and these two crises are interacting.
In China’s case, the major crisis right now is the collapse of export industries leading to migrant worker unemployment, and having banks that aren’t already broken and companies with large cash reserves increases the number of options available.
Michael, maybe you can help me. what is the share of foreign brands( or US brands) in chinese export? nike, benneton, mattel, dell, Hewlett packard, adidas and so on? is there any research on that?
Some other points…..
A lot of my thinking revolves around what I think is the fundamental economic mistake that has been made over the last few years, which is the adoption of what I would call “monetarism” or “Greenspanism.” This belief is the idea that governments should be responsible for only managing high level abstract quantities such as interest rates and government spending, and should not and in fact cannot “micromanage” the economy. The monetarist philosophy is basically that governments should just sit interest rates and let the rest of the economy do its own thing.
The big problem with this is that if you view things like interest rates and government spending as the *only* variables that a government can control, you find that you don’t have enough flexibility to avoid big problems.
For example in China right now, if you argue that the only thing the government can control is the supply of money, you’d be forced to make a decision between understimulating the economy or having large numbers of NPL’s in the future. But I’d argue that you have this dilemma because you’ve intentionally reduced the controls that you have to just changing the money supply. Once you realize that you have other controls, then the dilemma is smaller.
Take what happened to the United States in 2001-2002. Yes it was necessary to cut interest rates, but I think that the mortgage bubble and NPL problems could have been avoided with tighter regulation. The reason that there wasn’t tighter regulation, was the belief that the “market knows best.” However, this belief ignores the fact that the dynamics of the market is heavily influenced by the state anyway. The US financial system was designed to put lots of credit into residential housing so any new credit would have gone there unless you took some active regulatory steps to avoid this.
Similarly, the Chinese financial system is currently biased toward providing capital toward SOE’s, and if you just increase credit and do nothing else, you are likely to end up an overabundance of heavy industry in SOE’s. If you are a supporter of “Greenspanism” then your only choice is to reduce credit and contract the economy, at which point people start to riot. However, I’d argue that this dilemma happens only because of limitations you’ve imposed on yourself, and that the solution is to increase credit and figure out ways to “micromanage” things so that this credit doesn’t result in heavy industrial factories. For example, increase credit while at the same time taking dividends from SOE’s and issuing capital budget restrictions.
Twofish: I agree with you absolutely that the major crisis in China right now is the collapse of the export industries leading to migrant workers returning to the rural areas hoping to farm again but with the severe drought what can they do. The Spring Festival is just over and the real impact will soon manifest itself. Mind you we are talking here about a large number of migrant workers. As reported by Cable TV in Hong Kong today millions of people don’t even have drinking water not to mention jobs. Premier Wen Jiabao is right now touring and inspecting the affected provinces.
One question and one opinion:
1. Could you please tell me what you mean when you say “art of the increase in bank lending consisted of putting back on balance sheet loans that were taken off balance sheets”?
I heard (from you or Yves or Sester) they kept loans off-balance sheet by by structuring them to wealth management products and selling them to depositors.
Now, if the banks are putting this back to balance sheet, that means they are buying them back from depositros. However, this is logistically very difficult not to mention the difficulty of setting prices. I do not think this is realistic.
2. About your reader’s input that part of the loan growth is “an accounting exercise, clearing or otherwise funding non-bank debts piled up by SOEs”:
This still contributes to growth because the employees and suppliers of SOEs who did not get paid before now received cash and they can spend now. if you look at SoE’s balance sheet, there is no difference, but there are clear beneficiaries here.
How do i short the SSE??