Monetary easing won't resolve China's economic imbalance
Andy Xie says China can no longer monetise away its bad credit decisions, as it did when the economy was smaller and simpler. Quantitative easing only delays the inevitable: painful reform
China may have already begun its own version of quantitative easing, putting local government debts directly or indirectly onto the central bank's balance sheet. Corporate and financial-sector debts could eventually make their way there, too. As quantitative easing in the US, Japan and the euro zone has led to currency devaluation in those places, stability of the renminbi could soon become a challenge.
Since 2008, China's M2 money supply has tripled and debt has quadrupled, while nominal gross domestic product has doubled. The massive leveraging in such a short time span reflects the rise of a gigantic property bubble. As China's credit system functions on collaterals, when land prices are surging, credit and money supply accelerate too, which further inflates land prices. The spiral is the reason for so much debt in such a short period.
China's domestic debt is likely to reach 300 per cent of GDP, with 230 per cent of it in the real economy and 70 per cent financial sector debt. The mountain of debt is primarily with local governments and property developers.
The land market is pretty much dead in most cities. If appraised realistically, over 90 per cent of developers may already be effectively bankrupt. But, in China's government-controlled financial system, they have merely become zombies.
As property developers have become zombies, so too have the local governments they finance. Some local governments, even among the rich coastal provinces, have trouble paying their employees and are resorting to squeezing businesses to prepay their taxes to stay afloat.
Obviously, something has to be done about liquidity for local governments. But, should it be just about money? If the debts are merely forgiven, the same would surely happen again, as it has many times before. Further, if sound reforms are not undertaken, the quantitative easing is likely to lead to a devaluation of the renminbi, as has happened to the dollar, euro and yen. In the case of China, currency devaluation has unpredictable consequences for domestic stability. In the past, every significant devaluation has been followed by some social instability.