What is Really Worrying About the Chinese Credit Bubble
Lots of ink or ones and zeros in today’s world has been spilled about the explosion of credit propping up the Chinese economy. So much so that I really will not rehash this plot of land. I think what is interesting, and really most worrying, is how little impact the credit explosion has had on real economic activity.
The current credit explosion we are witnessing in China is bigger in absolute term than some of the post-GFC pops in credit and by some relative measures even bigger in relative terms. Only the most resolute of perma-panda and the ~~Communist party press office~~ Xinhua editorial board dare argue that China isn’t propping up growth with more credit. Most everyone understands the credit side of the story.
What is most interesting is how this impacting the real economy. Here is what’s happening with that explosion of credit: nothing. All this money that is being tossed around like an after party at a rap concert is not generating any notable uptick in activity. In fact not only is economic growth not accelerating, activity continues to decelerate (grow but at an increasingly slower rate).
Let me rephrase what is happening: China is stepping on the gas pedal, they put jet fuel in the gas tank, and the car does nothing but rev the engine and coast forward slower and slower. All this credit is accomplishing is a slower rate of decline.
This has a number of important implications. First, this implies that the Chinese economy is in much worse shape that most outsiders wish to acknowledge. You don’t give an economy this much stimulus unless you are really worried about the fundamental level of activity. The PBOC may not give the type of minutes and commentary that the Fed does, so if we look at their monetary actions as a reflection on the confidence in the economy, they are telling us that they believe the Chinese economy is incredibly weak. If you think this overstates the degree of weakness, imagine that the PBOC and Beijing had not decided to drop cash everywhere. What would have happened? My favorite statistic is that total social financing rose almost 16 trillion RMB in 2015 but nominal GDP grew only a little more than 4 trillion RMB. That is a tiny boost to GDP relative to the amount of money that was poured in. Imagine what GDP would have been if Beijing had not been dropping money from helicopters.
Second, the near complete lack of real economic response to monetary stimulus is telling us very clearly what is and is not the problem in the Chinese economy. The problem is most definitely not a lack of access to credit, investment, and financing. The problem is that money is not being put into tangible projects but rather being used to keep old loans from going bad and speculating in commodity/real estate/stocks/bonds/egg futures/online purse startups/Kanye’s new record/hotel chains/or whatever new investment fad the giant ball of money targets this week. It is such standard practice in modern monetary economics to when the economy slows just push money but I think there are so many micro-problems in the Chinese economy that are not being addressed. The problems are fundamentally different and shoveling money and most importantly new debt are not solving anything.
Third, this then tells us about the policy response which implies that more money is notthe solution. Part of the transition that China needs to face is that some industries need to seriously reduce their capacity while others need to increase and potentially most difficult, labor needs to transitions to new productive activities. Arguably, the biggest signal in any transition (i.e. pushing people/capital away from some activities and towards others) is the price mechanism which China is avoiding as much as possible. The credit boom which drives up commodity prices keeping dying firms in business a little longer and unproductive on the payroll of a dying firm a little longer is a short term solution. The flowing money is merely suppressing the price signal that tells labor and capital where to go for new opportunities. Does anyone seriously think that the recent run up in steel prices is anything more than a blip on the screen over the next five years? Of course not, but it gives a misleading signal about the health of the industry, long term prognosis, and labor/capital allocation in a transitioning economy.
Fourth, the lack of real economic activity despite the flood of credit implies that the Chinese economy might be entering an increasingly concerning state. As an example, Total Social Financing has increased through Q1 2016 37.4% over Q1 2015 and by 10% in 2015 but evidence of this flow of credit into real activity in corresponding amount is difficult to find. While real estate development has ticked up, it is nowhere near the level similar to this flood of credit. We do not see a corresponding increase in output of industrial outputs that would accompany such an increase in total social financing or fixed asset investment. For industries with data, FAI is up 11% Q1 2016 from Q1 2015 but physical output of most industrial output is up minimally if at all. Crude steel and steel material output is down 3.2% and flat at 0%. We see similar numbers. Given the explosion in TSF and significant growth in FAI but utter lack of pick up in real activity, this implies that financing is being used simply to prop up historical investment. It also implies that there is simply no demand anywhere in the economy. We know cash flow is slow with rising NPLs and rapidly growing receivables. That simply isn’t positive.
The rapid growth of credit is starting to worry even the most bullish but what is even more worrying is the near complete lack of responsiveness of the real economy to the monetary stimulus.