The Authoritative Source and BloombergViews Follow Up

Balding's World

The world and China is discussing in hushed tones the recent exclusive interview given by an “authoritative” person which talked about the need for China to deleverage and how debt cannot continue to increase.  Most have called this a shift in economic policy signaling Chinese intent to get the problem under control.

I think we need to be much more cautious about interpreting this as any type of fundamental shift in policy.  Let me give you a number of reasons why.  First, in China an “authoritative person” with control over the policy making apparatus would not need to give a public interview but simply make the change.  This was an act of weakness attempting to use the bully pulpit and gain compliance by nagging.  For instance, let us assume this was one of the rumored parties supposedly close to Xi Jingping. If they were that close to the supreme leader this means they are admitting they have little to no control over financial policy and are much weaker than is widely believed.  Conversely, the interview was given by someone without the relevant authority to control financial policy and nothing more than sniping from someone senior but who does not influence the policy.  In either case, this interview is an act of weakness not a shift in policy.

Second, China will not move away from its debt binge because it is unprepared to make the trade offs that would entail.  Total social financing grew almost 4 times faster than “official” GDP last year and is on a similar trajectory this year.  Assume how bad GDP growth would be if it only grew at twice the official rate of GDP.  China is like me staring down heart disease: I am concerned but not necessarily concerned enough to give up that bacon cheeseburger on two deep fried Krispy Kremes donuts.  Until China is willing to put people on the street, shut businesses, and tell politicians that banks are not just giant slush funds to meet growth targets and send your kids to school in Canada, this discussion is pointless.  China is unwilling to make the tradeoffs of lower growth, failed businesses, and rising unemployment required by lower credit growth.

Third, this tells you how China understands the risks.  In many professions whether finance or medicine, practitioners are always trying to maximize return by lowering specific risks.  One common way of saying it is what risks are you willing to accept and what risk are you unwilling to accept?  Beijing is clearly willing to accept the financial risks but unwilling to accept the risk of people on the street.  Only by maintaining rapid growth at all costs do they maintain social stability.  Financial risks are an existential threat to authority, the unemployed are a direct and eminent threat to authority.

Fourth, these discussions about the Chinese economy are like Groundhog Day.  Numbers of times in the past year or so articles or comments from either officials or even the Party have noted concern about the rise in debt and absolutely nothing happens.  Remember the so called supply side reforms or the deleveraging talked about in December after the big pow-wow in Beijing? In the expat community there is a  made up Chinese proverb that in China there are a thousand ways to say no including many where people say yes.  Personally, after living in China for almost seven years I pay almost no attention to what someone tells me and focus almost exclusively on their behavior. If they want something to happen, they make it happen.  Forget the front page interview and focus on credit market numbers. In December, the Party released initial details of its 2016 plan and “deleveraging” got a lot of play until January loan numbers came out then people realized it was sound and fury signifying nothing. Show me the lack of credit growth!

Turning to my recent piece for Bloomberg Views, there are a couple of follow up points. First, bubbles are typically thought of in emerging markets as driven by foreign fueled inflows of some kind but in this case it is not.  Money and credit have exploded in China and this is pushing up asset prices as real economic activity is investment opportunities have shriveled.  As money and credit continue to far outpace the real economic activity and opportunities, that cash flows into financial assets.

Second, this implies that financial bubbles will become a re-occurring theme of the Chinese financial system.  In the past year, we have seen the giant ball of money hit just about every asset class, come back to some more than once, and we are probably due for the next investment craze within the next week.  This tells you how much surplus money simply cannot find a home and this will continue to happen until there is a better equilibrium.

Third, this implies real GDP and or economic activity is significantly lower.  If money was growing in line with real GDP, this would not be a problem or at least much less.

Fourth, this implies a lot of financial assets are extremely over valued. Michael Pettis balance sheet recession anyone?

Fifth, asset and credit bubbles with a dash of currency make a great cocktail but can leave an incredible hangover.

Sixth, this build up of money and credit through both direct and indirect channels is building pressure on the RMB/$ peg.  It cannot be maintained with this much liquidity much less the lagged effect from the money they have already been pumping into the system.