Quantitative Easing with Chinese Characteristics
It comes to something when the news that Chinese house prices have fallen 6.1 per cent in the last year is greeted with optimism - because they hadn’t gone down for four weeks.
The fortune of the formerly one-way property market is closely related to the feel-good factor in China, at a time when indebted property companies, forests of see-through tower blocks by day, and dark estates by night, are obvious signs of distress.
A seemingly never ending run of bad data reveals the parlous state of the Chinese economy. Some independent economists estimate current overall economic growth to be closer to 2 per cent, rather than this year's target of 7 per cent.
Just this week it was announced that April exports were down 6.2 per cent in a year, and capital outflows were the highest ever, as funds leave the maturing economy for global investment.
The service sector is showing milky growth and the April HSBC purchasing manager’s index shows manufacturing shrinking to 48.9 (50 being neutral). This was the worst deterioration in 13 months and was joined by a further fall in manufacturing employment. We are in a hard landing.
Money supply is slowing, new loans issued by banks have again missed their targets, taxes were down 35 per cent in the first quarter, and government spending was up 33 per cent; a temporary blip, but reflective of the slowdown and the needs of infrastructure and welfare.
The government is pressuring the banks to buy new low-interest rate bonds issued by insolvent provincial governments with a nod and a wink that they will stand behind any defaults. This programme is expected to put as much as RMB 1 trillion (US$160 billion) into the economy.
Local government debt could now be at an eye-watering RMB 30 trillion (US$5 billion), dwarfing the size of the 2008 global financial crisis recovery programme.
There is yet more in the revelation that inflation is expected to be 0.5 per cent this year. Low inflation may help the man in the street, but China needs to inflate away its total debt, which stands at a huge 200 per cent of GDP.
The real cost of capital for business is as high as in any respectable economy. Real interest rates for local governments (with an implied government guarantee) are currently around 7 per cent; in most Western economies, it is a percent or two.
So far official measures to cut interest rates and relax the ability of the banks to lend have been pathetically small – almost as if to cut rates is to lose face.
The authorities were hoping that the pace of economic reform, recently surged into a gallop, was going to fill the gap. But reform takes too long. So we should expect measures to trim rates, turn dodgy local government short-term bank debt into long-term bonds, and to underpin bankruptcies - to actually be Quantitative Easing with Chinese Characteristics.
The banks may be on to a safe thing; the government lost its bottle to let a company go bankrupt two weeks ago. There is apparently a sovereign put option in play that comprises intervening at critical times to prevent emergencies, like bankruptcies, excessive behaviour, and liquidity choke points.
This economic shambles relates perversely to a Chinese stock market rising 120 per cent in the last year and nearly 40 per cent in 2015; after falling five years in a row. In a response to the market flattening from mid-April, the official Xinhua News Agency said that we weren’t at the end of the bull market but were instead entering a “slow bull” mode – which the authorities are clearly keen to maintain.
Investors hope that the Chinese authorities will do more than slow bull the stock market, but slash interest rates to get things moving.
The big wild card to help the stockmarket is the long-deserved inclusion of China into global investor indices, such as the FTSE and the MSCI Emerging Market benchmarks. China’s inclusion will mean that anyone who has a significant portfolio of emerging market shares will have to buy the market.
The current foreign investment quotas (QFII, Stock Connect, and RQFII) amount to 5 per cent of the index. If the RMB became largely convertible in the next 2-3 years, as is threatened by some authorities, the full stockmarket would be weighted over 24 per cent of the index, worth as much as US$1.3 trillion (23 per cent of today's Shanghai market).
Now, if the economy were to turn around at the same time as that wave of money hits the stockmarket – that could launch China into the portfolios of global investment managers in some style.
It might be that a bubbling-over stock market, that is priced way above its fundamentals, is the least-worst outcome for the authorities – especially if the foreigners are paying for it.
Richard Harris is chief executive of Port Shelter Investment Management