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  • Dec 28, 2014
  • Updated: 12:51pm
CommentInsight & Opinion

Why economic stimulus no longer works for China

Mainland monetary policy is adding to the total stock of money without having a noticeably pro-growth effect on the economy

PUBLISHED : Monday, 23 June, 2014, 10:42am
UPDATED : Tuesday, 24 June, 2014, 8:08am

There is a dispute between those who see mainland economic policy as merely being "fine-tuned" and those who see active stimulus. The debate is misguided: the level of stimulus may be relevant to the current state of the economy, but it will not affect where the economy is headed.

Regardless of whether it is scattered or intense, monetary stimulus no longer works for the mainland economy and cannot boost growth.

Consider using a hose to fill an empty swimming pool with water. At first, the hose has a dramatic effect. When the pool is filled, though, the hose merely causes the water to overflow.

This is the situation in many countries where stimulus has been applied for most of the past decade. Chinese conditions, unfortunately, resemble less a pool and more a small lake.

The Federal Reserve says the stock of broad money (M2) in the US was US$11.2 trillion at the end of the first quarter. Using Beijing's statistics, China's M2 stood at US$18.7 trillion, a staggering two-thirds larger.

The ratio of M2 to national wealth is a measure of how much money is circulating within an economy. Gross domestic product should not be used here because it resets each year while M2 accumulates over time.

The stock of wealth in the US is at least twice as large as in China. This means China's M2 to national wealth ratio is three times higher than in the US, even though American monetary conditions are quite loose in themselves.

The ill-advised post-Lehman credit boom is one reason for China's predicament. So are years of negative real interest rates - the ultimate sign of irresponsible monetary policy.

The extent of excess liquidity can be seen in commodities fraud. Stocks of metal are being illegally used as collateral, because firms have become accustomed to an endless amount of credit.

The debate of fine-tuning versus active stimulus is a debate over how fast the water is coming out of the hose. It does not matter how full the hose is, though, because the water is flowing into a lake.

One counter-argument is that stimulus must be important because it worked in May, when there were signs of modest economic improvement. But mainland economic data is not nearly accurate enough to render the very slight upticks in industrial production, retail sales and other indicators at all meaningful.

First, there is a simple question of accuracy. It takes smaller, richer countries months to compile the same numbers China publishes in two weeks.

Second, there is also the Communist Party's implicit requirement that no sharp downturns be acknowledged, for instance when policymakers in Beijing panicked in early 2009. A few months of negative results in early 2014 called for stabilisation to be reported.

This is where stimulus is actually informative. Its extent indicates how policymakers view the economy - strong enough to leave alone or in need of official medicine, even if the medicine no longer really works.

The good news: those who see only minor stimulus can claim, with some justification, that it is because the economy is performing adequately. After all, employment is the top priority and the jobs situation is acceptable.

While the property market is suffering, from a national standpoint it needs to suffer. Higher property prices and sales would only heighten macroeconomic risks.

Similarly, slower growth in fixed investment is long overdue. Rebalancing towards consumption cannot occur without a check on investment and such rebalancing is necessary for living standards to continue rising.

The principal worry about the economy seems to involve GDP growth, but the obsession with GDP is misplaced.

The Party will only permit a gradual decline in officially announced GDP growth. And if jobs are available and the economy is truly orienting towards consumers, the pace of true GDP growth is almost irrelevant.

So stimulus will not work but, happily, is probably not needed. Instead, what is worrisome is that implementation of fundamental reforms has not begun.

Implementation of a few pro-market changes should occur later this year. But powerful steps to promote clearer land rights, labour mobility through the hukou reforms, financial competition and corporate innovation have not moved forward.

China did not proceed with additional market-oriented reforms in 2005 in large part because there did not seem to be a need - the economy was strong. Then it did not reform in 2009 because the economy was fragile.

Now economic performance is middling, there is a government which has loudly promised change, and yet little action has taken place. What is the justification this time?

If the economy needs to be as vigorous as a decade ago for another round of market reforms, they will never occur. The era of extraordinarily rapid increases in employment, production and exports is over.

For every month that passes without powerful action, the mainland eases further into the middle-income trap, where once fast-rising economies slowly drift towards stagnation. This gradual failure, not the extent of stimulus, is what matters.

Derek Scissors is a resident scholar at the American Enterprise Institute


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This article is now closed to comments

I Gandhi
The 4 rounds of QE by the Fed and the 17 trillion USD in stimulus by the US is targeted at the greedy bankers who have returned to massive profits and fat bonuses. In China the 2009 stimulus of 1 trillion USD have been targeted at the real economy. It succeeded in stopping the 2008 financial crisis from having too great an impact on China. The Chinese stimulus have been a bigger bang for less money. Considering that 300 million Chinese in the countryside and 100 million Chinese in the urban areas are classified as poor, a further stimulus targeted at the poor and the Western regions is exactly what is needed. All China have to do is to spend a further 2 trillion USD stimulus between now and 2020 and the Chinese economy will be able to transform into a middle income country by 2020 with another 200 million lifted out of poverty. China needs more stimulus not less.
Have you heard of the following ?
In the past, Premier Wen practised strong stimulative policies;
now, Premier Li practised lukewarm stimulative policies.
Unfortunately, you have to grasp the Chinese language to really appreciate the pun.
(過去温總強刺激, 現在強總温刺激.)
Why lukewarm policies now ?
There are several reasons.
(i) The authority has noticed the bad side effects of the last 4-trillion-yuan strong stimulation, which had led to the problems of inflation, overcapacities, zombie enterprises, bad debts, wastefulness, and corruption.
It had also disturbed the expectation of the enterprises, and hindered the structural readjustment of the economy.
(It’s rumoured that there was a version 2 of the 4-trillion-yuan strong stimulation, practised in 2012. Very few people know about it, because it was not publicized.)
(ii) Now, the central government still has money to invest in high-speed rail and the like, but not the highly-leveraged local governments, which have no more usable resources to engage in further investments.
(iii) The central government this term depends more on reform dividends for coming economic growth.
They prefer to open up the state-controlled markets, simplify the administrative procedures, reduce the extent of official approvals, and so on.
(Chinese readers: ****money.163.com/14/0523/17/9SUPS8VV00254STO_all.html)
If economic stimulus no longer works for China, then China's statistics department should be cancelled.
Now, each time bad economic data are announced by the department, the stock market reacts negatively, and the too-caring Chinese authority thinks that they have to do something about the economy, for the short-term benefit of the country, by enacting stimulative policies of one sort or another, while forgetting that what's really crucial for the long-term health of the economy is to make those sorely-needed real institutional and structural reforms.
Short-sightedness should be replaced by accurate long-term adjustments, for the sake of ourselves, our children, and our children's children.
I'm not kidding, removing the statistics department was once really suggested by Hong Kong's former Financial Secretary, John J. Cowperthwaite, when he was talking to Milton Friedman.
He said that, if a poor country wanted to become rich, the first thing she should do was to abolish the statistics department of the state !
He was worried about the government’s constant pressure of having to unnecessarily fine-tune the economy.
He, and Philip Haddon-Cave, with their positive non-intervention policies, had made Hong Kong what she is today.
The subsequent Financial Secretaries in Hong Kong have mainly been following their policies, perhaps too conservatively at the present time.
(Chinese readers: ****finance.ifeng.com/news/special/caizhidao224/)
China's present M2/GDP ratio is almost 2, one of the highest ratios in the world, if not the highest one.
The ratio is even larger if we consider the possibility that the country's GDP figure is inaccurate and is probably overstated.
The water of the lake will not overflow if the added water can really be diverted to the right places --- the efficient, competitive and innovative SMEs and technology and service companies which together provide most of the jobs in the country and contribute a large part of the country's GDP.
But if the added water all goes to those zombie enterprises in the industries which are suffering from the problems of overcapacities, increasing bad loans and inefficient production, then it is simply wastefully overflowing to the wrong places.
In China, only those truly competitve SMEs, which have been able to raise greatly their productivity, can survive in the harsh jungle,
because they are constantly being attacked by the wild beasts of extremely-high interest costs, high wages, the possibly-overvalued yuan, lack of investment opportunities, and local government regulation and discrimination.
The rest simply leave the forest, emigrate, or forsake doing their own real businesses, and speculate in the property market, or become loan sharks in the shadow banking market.
'Regardless of whether it is scattered or intense, monetary stimulus no longer works for the Chinese economy and cannot boost growth.'
It's like a boy constantly blowing air into a deflating balloon.
He has to blow harder and harder each time to ensure that the size of the balloon doesn't diminish in the short run.
This never-ending balancing act performed by the Chinese government and central bank has to continue in the foreseeable future, if 'implementation of fundamental reforms has not begun', like 'clearer land rights, labour mobility through the hukou reforms, financial competition, and corporate innovation'.
Regarding China’s economic performance, many people are still arguing about the choice between strong, mild or no stimulative policies.
But the problems of income distribution and urban-rural gap cannot be solved by the traditional fiscal and monetary policies.
They have to be solved through big adjustments and intensive reforms.
It’s said that proper investment in urbanization is the only kind of investment that can truly connect present investment with future consumption.
(Chinese readers: ****finance.sina.com.cn/zl/china/20140615/150419416442.shtml)

If providing more money out of thin air is the simple answer to all our problems, there will be no more poor countries in the world !
The only thing we need to do is to produce more money-printing machines !
I think the record of the highest hyperinflation rate in the world is being held by Zimbabwe --- 79.6 billion percent in mid-November 2008 !
In 2009, Zimbabwe abandoned its currency.
As of 2014, Zimbabwe still has no national currency; currencies from other countries are used.
Conversely, each time good economic data are announced by the department, or others, like the latest better-than-expected HSBC manufacturing PMI data, the stock market reacts positively, and the authority's sense of reform urgency also declines --- we can't win both ways.
Looking back over the years including the archives in the SCMP, you get the same dire strait calculation (from different authors) on China’s economic development. The comments are not much different either with their pseudo scientific prognosis. The conclusion is always the same, China is going down the drain - if not this year then the next. You can almost feel the desperate yearning of the authors/commenter hoping against hope that China will experience an economic collapse. But looking back more than 30 years & despite the dire predictions, China has still not even stumbled, not to mention collapse & is still ploughing on stronger than ever. Even if the statistics are screwed, as the author intimates, the common citizen (me with no economic/scientific or entrepreneurial background) can see & enjoy the growth before one’s eyes. This year the Premier forecast China can meet its target growth. So who am I to believe?
this is the point that China can be better at raw capitalism than America and why is that? even if you take away the inaccuracy of data and a measure of disinformation, by 2020 China will be nearing four decades of continuous growth, and it is mind boggling.
singleline, other than expenditure in housing which is smouldering out, automotive (carmaking & highways) plateauing, highspeed rails flatlining, will LKQ' rural-urbanization be the next catalytic GDP mover? what else must PRC do to keep GDP at above 6%?
Another argument for more expansionary monetary policies being used in China is that they will prevent the local governments’ (LGs’) financing vehicles from massively defaulting their loans, which could endanger the country’s most-important banking system.
Well, governments all over the world seldom have to repay their debts.
They can choose to do so, but usually they just need to roll them over.
And China's banks can be expected to be much more cooperative than their western counterparts, for obvious reasons.
Also, we all know that China’s LGs are always short of fund, but arguably this is a situation deliberately made by the central government, through the 1994 tax-sharing reforms.
In 1993, the share of China’s LGs in the country’s total fiscal revenue amounted to 78%, which is 6% more than the total expenditures of the LGs --- the vassals seemed to be stronger than the king, a major and frequent political issue in ancient China.
Hence the 1994 tax-sharing reform, and in that year the tax-revenue share going to the LGs had gone down by more than 30 percentage points.
(Chinese readers: ****xugao.blog.caixin.com/archives/72763)
No wonder the LGs have always been thirsting for money since then.
If this lack-of-fund problem is more a political issue than an economic one, then obviously it cannot be completely solved simply by using only the economic tools.
‘Policy above, tactic below.’
(I always feel that the genius of the Chinese people could have been used in other much more productive ways.)
To compensate for their of lack of fund, China’s LGs have been greatly relying on land finance (and financing vehicles) ever since to partly support their vanity projects (政績工程), which are a means to an end --- winning the provincial higher-GDP competition.
But the country’s property and land prices cannot forever defy the law of gravity, hence the present property market problems.
We see another inevitable tradeoff here --- more political stability means less economic stability.
‘Good’ politics may be ‘bad’ economics.
China’s present property market ‘crisis’, if any, is actually a political issue.
I don’t know how to solve this political problem economically.
Do you ?
One way out is the present widespread issuance of municipal bonds that can help the LGs to alleviate part of their lack-of-fund problems.
Hopefully, from now on, they will depend less and less on land finance, and no longer need to import Hong Kong's 'high-land-price policy'.
Another way out is to securitise part of the banks' housing loans through the issuance of mortgate-backed securities (MBSs), as in the US, accompanied by the setting up of Chinese-style Freddie Mac and Fannie Mae.
The money so raised by the banks can be used to provide further housing loans to future home buyers.
Rather than further increasing the M2/GDP ratio through RRR cuts, the authority should raise the velocity of circulation of the present money stock instead to achieve the same aim of stimulating the economy (and supporting the property market).
One good side effect is that China's bond market can be further deepened by a greater variety of investment products, which helps prepare for the yuan's coming internationalization.
After the Great Crisis, we should have learnt enough to avoid using the Ninja Loans and those kinds of things.
China's present problem of high leverage is both its strength and weakness.
The weakness is obvious.
The strength is the possibility of further deepening the country's bond market, by using direct financing to channel the Chinese depositors' massive savings into the credit market to fund the needs of the enterprises and the local governments, through the issuance of more sophisticated corporate and municipal bonds.
The junk bond market should be formally developed as well, to gradually replace the precarious trust products, entrusted loans and other loan sharks prevailing in the shadow banking market.
More central government treasuries and perhaps perpetual bonds can be issued to be bought by the Chinese residents, mutual funds, retirement funds, and insurance companies, to increase their investment opportunities.
Fewer people will then speculate in the property market.
Part of the fund so raised by the central government could be lent out at slightly higher interest rates to the local governments to further reduce their present unhealthy reliance on land finance.
This way, the local government's financing vehiclles will further subside.
Also, the local governments will then have to depend more on the central government --- this is good politics.
Without a big enough and well developed domestic bond market, the yuan's development of the global reserve currency status is just cheap talk.
Many people think that the Fed’s lowering of the interest rate after the dot-com crisis had ultimately caused the subsequent Great Crisis.
But in the book ‘The Federal Reserve and the Financial Crisis’, Ben Bernanke used a lot of facts to show that the US property bubble was not a result of the Fed’s low-interest-rate policy.
Afterall, the low-interest-rate policy was not new, why didn’t the Great Crisis occur in the 1990s or earlier ?
A lot of factors combined with each other and caused the big bang.
I think the main culprit should be the US Congress’s policy of encouraging the poor American to own their own houses.
This is a noble objective indeed, but once again, the road to hell is paved with sincerity, especially when the people in charge are not equipped with the basic techniques of simple economic analysis.
The king, the king’s to blame.
(Chinese readers: ****blog.sina.com.cn/s/blog_470dbd1d0102eb9v.html)
Again, good politics is bad economics.
China should learn this lesson.
One argument for more expansionary monetary policies being used in China is that they will keep the country’s precarious, too-connected-to-fail, and seems-to-be-deflating property market from crashing.
(Sorry for the hyphens, because of the word limit.)
Unlike the Anglo-Saxon and Hong Kong property markets, the German property market seems to have been playing the role of a supporting actor, rather than that of a leading actor.
In the Anglo-Saxon economies, housing can do a lot of damage, as is vividly shown by the latest Great Crisis originated from the US.
But in Germany, there has been no big nationwide property boom in the country’s postwar history.
(From ‘Anglo-Saxon economies should envy Germany’s rental culture’
Besides her world-famous apprenticeship scheme, Germany’s peculiar property market arrangement can also explain the country's strong capability of exporting capital goods and cars to the rest of the world --- their people have traditionally been concentrating on their real businesses rather than speculating in the property market.
Of course this doesn’t imply China’s property market can easily switch to the less volatile German model.


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