Why We Shouldn’t Overestimate the Probability of a Chinese Financial Crisis
As with most everything I write for BloombergViews, I want to write a little follow up especially as I have already gotten a number of messages asking follow up questions.
- I am not saying there will never be a financial or economic crisis. I am saying that a financial crisis will only happen as after all other options have been exhausted and no other options are left. Beijing will employ every tool possible to prevent some type of major dislocation.
- As an example, while we can debate the reasons and wisdom of it, the US was willing to let significant financial institutions go bankrupt. Right now, I think it highly unlikely that Beijing would let any financial institution of any real significance collapse. They won’t let any firms collapse much less the stock market. I see little to no evidence that Beijing is willing to even seriously address some of their economic and financial problems despite press releases to the contrary. Their entire strategy appears to be paper things over and deal with it later.
- It cannot be stressed enough that this is not because I think China has chalk full of top flight economic policy makers. It is primarily because if you look simply at the economic indicators, yes, the risk is elevated and increasing. However, this clearly overlooks the political imperative. Whether it is propping up every bank or firm just so they don’t have mass layoffs or shutting down the internet to prevent communication about economic problems. The political calculus about how a government will handle any potential economic or financial dislocation is radically different. The objectives of Beijing policy makers and other policy makers are very different.
- The current leadership is acutely aware of its place in history and the comparisons to the USSR. They are absolutely determined to not suffer the same fate. Despite talk of delveraging, credit growth continues to expand far more rapidly than GDP growth because quite simply, they are not willing to tolerate any type of official real growth slowdown. Given their concern over this, it isn’t that China will never see a crisis of some type but rather that they will exhaust every means necessary before they yield to something they just cannot stop.
Given everything that is happening in the Chinese markets, I want to hit a couple of major points
- One of the things that you cannot quantify, though I am sure you could but I’ve never seen it done, is the enormity of the psychological weight attached within China appreciating and being fixed to the US dollar. Some have tried to point out that against a basket of trade weighted currencies, the RMB is essentially flat. Psychologically within China, that is completely irrelevant. Chinese firms and people have been taught for a long time about the stability of the RMB because it is fixed to the USD. Even if there is good economic logic to the basket argument, you are essentially telling 1.3 billion people there is no Easter Bunny, Santa Claus is a fraud, and they don’t get any candy. This is going to cause significant worry and concern. A few weeks after the August devaluation, I talked with a Chinese friend and asked him what he was up to and without missing a beat replied “getting all my money out of China.” PBOC for a long time had absolute confidence of people, today, they do not anymore.
- There is somewhat of a debate about whether the RMB is witnessing a devaluation or a depreciation. Devaluation being an official lowering, depreciation being market driven. I would personally call it a “devreciation” or “depaluation”. What we are witnessing is effectively two sides of the same coin. The market is clearly pushing the RMB lower as capital flees China. That is completely and entirely true. However, nor is the RMB value established by the market. The daily PBOC fix has become much less correlated to the previous days close since December 1. The PBOC is spending large amounts of USD, more than $100 billion in December, to support the RMB. What country spends almost $4 billion USD a day propping up the price of something if it is strictly a market driven price? The value of the RMB is clearly not set by the market. If anyone believe this is a market driven depreciation solely, ask yourself what would the value of the RMB be if it was solely market driven tomorrow and the PBOC stopped spending USD? In other words, if CCTV announces on the 8 o’clock news the RMB will be freely tradable beginning at 9:30 tomorrow morning, what is the new value? 7.5 or higher would be a good place to start. What my take would be is this: like with the stock market or other markets, Beijing is happy to allow the market to move when it moves in Beijing’s direction. The market wants to push the RMB lower and Beijing will release some press releases saying “no, don’t, stop. Everything is awesome.” Then set the fix lower. They tap the breaks and set the fix flat, regardless of the market prices as HSBC pointed out, just to keep traders on their toes and hopefully prevent what they hope will be a gradual landing from turning into a 25% break. Clearly isn’t strict market movement, but nor is Beijing letting market do what it wants. Hence, depaluation.
- Inflation data is both PPI and CPI data is bogus. More on the specific later this week.