The indebted consumer's guide to growth in China

Growth rate of increase in loans key to fuelling country's economic pace but the credit-driven model is clearly not sustainable

PUBLISHED : Friday, 19 April, 2013, 12:00am
UPDATED : Friday, 19 April, 2013, 4:05am

Earlier this week, Monitor described the divergence between Chinese credit creation and economic growth as "puzzling".

In recent months, China's financial system, including its shadow banking market, has been making new loans at a blistering pace. In the first three months of this year, total social financing - Beijing's broadest measure of credit creation - expanded by a record 6 trillion yuan (HK$7.5 trillion).

Yet economic growth has remained lacklustre. In the first quarter, China's gross domestic product grew at a year-on-year rate of just 7.7 per cent; a feeble performance by China's turbo-charged standards.

Normally, you would expect some time lag between credit creation and a pickup in economic activity, but as Goldman Sachs economist Andrew Tilton pointed out in a research note last week, the link between credit and growth is more subtle than simple cause and effect.

For one thing, it is not the amount of outstanding credit that affects economic growth, nor even the rate at which credit is growing. According to Tilton, it is the rate at which credit growth itself is growing which drives growth in China.

He explains this with an illustration. Imagine you earn HK$400,000 a year, and have bank debts of HK$1 million. On top of that, imagine you spend all your cash flow.

If the bank expands your credit line by HK$100,000 each year, you will spend your HK$400,000 salary plus your HK$100,000 of new credit to make total spending of HK$500,000 a year.

So even though your debt is growing by HK$100,000 a year, your spending is constant. There is no growth in your personal economy.

Only if the bank increases the rate at which it expands your credit line, say by giving you an extra HK$200,000 this year, can your spending rise and your economy grow.

If the bank freezes new lending and restricts itself merely to rolling over your existing credit line, your spending will have to contract, falling to HK$400,000 in line with your salary. Although your stock of credit remains constant, your personal economy will suffer a severe recession.

As with indebted consumers, so with whole economies. According to Tilton, a 900 billion yuan increase in the quarterly flow of China's total social financing typically boosts the following quarter's annualised rate of GDP growth by about 0.8 percentage point.

If the relationship holds, the surge in credit creation over the first quarter of this year should add about 1.9 percentage points to the country's annualised growth rate in the second quarter.

There is of course a problem with this credit-driven growth model. To maintain a constant rate of economic growth, credit growth has to accelerate indefinitely. That's clearly unsustainable. At some point, China's growth has to slow.

And that point may not be too far off. Yesterday, Goldman Sachs downgraded its 2013 growth forecast for China from 8.2 per cent to 7.8 per cent.

Gold isn't the only thing that has crashed recently. The price of bitcoins has also collapsed.

An esoteric form of internet money, bitcoins are beloved by monetary survivalists because they exist independently of any central bank, and because their supply is limited.

As quantitative easing gathered pace, their price rose. And as the price went up, from HK$200 in February to HK$1,800 earlier this month, more and more people jumped on the trend in what rapidly turned into a classic momentum-driven bubble.

And then last week it popped, with the price falling back to HK$722 yesterday.

But the true believers are not dismayed, arguing bitcoins have a great future in China, because they allow investors to evade Beijing's capital controls.

I doubt it.