China should allow its high-risk trust products to fail
Andy Xie says China must resist pressure to bail out troubled high-risk products like trusts, and instead allow them to default to rid the industry of a toxic asset and hasten the move towards a market economy
A state-owned financial institution recently bailed out a troubled 3 billion yuan (HK$3.8 billion) trust product, purportedly to prevent a systemic crisis. In reality, it will merely delay the inevitable for a short while. Since 2008, so much money has poured into speculative assets that the government does not have the capacity to bail out everyone.
If it insists on doing so, then printing money would be the only sufficient source of financing, which would lead to high inflation and currency devaluation.
China's trust industry has 10 trillion yuan in assets. Most of its products are just pooled money for junk bonds securitised with bubble assets like land and mines. With the economic cycle heading downwards, with no prospect of a quick turnaround, bankruptcy is inevitable, and healthy.
First, there is no systemic crisis per se. Investors who poured money into such high-interest-rate products should know there was a risk; otherwise, the rates couldn't be so high. And, as the minimum investment is large, they are wealthy people too. When they lose money, they are unlikely to go out and riot.
Second, if a bankruptcy blows up their expectations of a bailout, they may refuse to roll over financing for other products. Hence, it may lead to more bankruptcies. This isn't a real systemic crisis. If more trust products go bust, so what? The chances are that they would go bust anyway. What's the point of delaying the inevitable with taxpayers' money?
Third, if the whole trust industry goes under, the real economic impact would be limited. The sound projects that some products support should find new sources of financing. Unsound projects will stop. The resulting dent in gross domestic product is good news. It means less waste. GDP pumped up by wasteful spending is bad news; China has accumulated too much of it since 2008.
Most importantly, China has no unemployment problem. The working-age population is shrinking. Manual-labour wages are rising rapidly, as excessive monetary growth becomes inflation through a tight labour market. The story that China must grow fast to stop an employment crisis is just an excuse for bubble economics.
Accepting bankruptcy is an important step for China to move towards a fully fledged market economy, which is the stated goal of the third plenum.
Chinese banks should take part of the blame for the current situation. They sold such products for unusually high fees. They should know that if someone is willing to accept 10-15 per cent interest rates, and to pay 5-10 per cent commission for a three-year loan, then that person is gambling with other people's money.
Chinese banks should be liable to some extent for the products going under. They should compensate investors with a multiple of their commission income.
However, the investors are most at fault. They bought the products believing that the banks would bail them out upon non-performance. But, how could a bank guarantee a product with double-digit interest rates? High interest rates and no risk are just financial fantasy.
Unless and until they suffer losses, China's financial system can never function normally. Everyone would invest on the premise of a government bailout. The money would go to high-risk borrowers who offer the highest interest rate. Such people, of course, have no intention of repaying.
China's future depends on produc-tivity-led growth, given that there is full employment. Per capita income is still one-sixth of that in advanced economies. China's infrastructure and education level could support per capita income three times the current level.
Government-centred capital allocation is blocking China's path to this bright future.
Trusts, property and local government debt are one giant interlinked bubble. It sustains the inefficient capital allocation around local governments and state-owned enterprises. Feeding this bubble may bring short-term stability, but it makes the monster bigger. Putting growth before reform last year, for example, has made the problem much bigger.
The worry over the fallout from the bubble bursting is preventing China from taking steps towards realising the third plenum goals. This tiger blocking China's road to a bright future must be slain.
China is a big country. One could list a dozen new challenges on any day. The rising international tension, for example, could be used as a new excuse not to focus on economic reform.
But, the big picture is that, if China achieves US$20,000 per capita income, most problems that we worry about now would just vanish.
The international challenges, for example, would melt away. When GDP is twice as big as America's and is growing three times as fast, would any country not want to have a good relationship with China?
China's future depends on successful economic reform. Don't get sidetracked.
Andy Xie is an independent economist