Heading for the cliff: China rides the tiger of debt and bubbles
Andy Xie says the wild fluctuations in China’s stock market, bonds, property and now commodities stem from a deliberate official policy to delay the pain of dealing with high government debt and economic inefficiencies
China is a good example of how an activist monetary policy can ferment bubbles, ruin the health of a financial system, economic reforms and, eventually, economic growth. Since 2004, China has run a gigantic monetary bubble that has corrupted virtually every corner of the economy.
The depreciating pressure on the renminbi put a stop to wholesale bubble-making. But, as soon as the pressure eased when the US Federal Reserve changed its tune on when to raise interest rates, it was back to the races again. This time, it was in commodity futures.
A couple of months ago, China’s commodity market went totally crazy, fast. It was like a long-term addict bingeing for the very last time. Transaction volumes in steel futures exceeded those for the A-share stock market. One day’s trading volume was greater than the total physical production in a year.
The average holding period was rumoured to be four hours. When the market was surging, most pundits interpreted it as a leading indicator of economic recovery. Now, the market is tumbling. The spin is that it was pointing in the right direction, just overdone.
In my view, it was pure mania. China’s steel production fell by 3.2 per cent in the first quarter, following a 2.2 per cent decline last year. The property market, the main customer, has been a huge bubble. Its bursting is just beginning. Major bankruptcies are yet to come. It is basically a joke to say that steel demand has bottomed out. It doesn’t bottom out until banks come clean on their bad loans and close down zombie developers.
Bubbles occur in China because the financial system subsidises speculation. This one is no exception. Any futures market is highly leveraged. When the deposit is 5 per cent of face value, that is 20 times leverage. But, who is supplying the credit? In China, almost all financial institutions are government-owned.
When the price could move more than the deposit requirement in one day, the credit providers are subsidising speculation big time. The people at these institutions just want to book short-term profits to grease their bonuses. They couldn’t care less about future bad loans.
In the past two years, we have witnessed the crazy subprime debt-fuelled stock market bubble. The subprime debt sloshed into the corporate bond market to prop up demand for bonds from technically bankrupt local governments and companies. A subprime frenzy for down payments in the property market followed. Now there is this commodity mess. Were all these crazy Ponzi schemes random occurrences, as they were nobody’s fault?
In my view, these bizarre frenzies are the consequence of financial regulators and the monetary authority pumping in liquidity to prop up money-losing industries and local governments. All such bubbles have one thing in common: they bring money to money-losing industries and government coffers. The bubbles may be nuts but they bring what the policymakers want. When all industries suffer from overcapacity and the property market faces an overhang close to 100 per cent of gross domestic product, the credit demand for real investment is nil.
So, when the authorities talk about using monetary policy to help the economy, they are really fermenting bubbles, hoping that some money will go into loss-making industries and keep them afloat. That is why I believe the bubbles are policy-induced and on purpose.
China’s financial system, especially its monetary policy, is mainly responsible for leading the country down the path of mushrooming leverage and crazy bubbles. The view on staving off the collapse is to ferment some more. The game is up only when the pressure on the exchange rate becomes persistent, which would put a stop to the crazy liquidity policy.
China is large. When it weakens, there will be a response from the global economy. The Fed has found it difficult to raise interest rates because China’s impact on the global economy is so large. This dance between China and the US could go on for a while. Some may argue that it could go on forever, that is, one bubble after another, ad infinitum.
The trouble with bubbles is that every one increases leverage. Eventually, the leverage is so high that interest rates must be zero to stop interest payments from crushing debtors. When that occurs, savers will take out their money and the whole edifice will fall.
Some may argue that this day of reckoning is very far away; things can carry on like this for years. Unfortunately, political changes are coming soon to upend the bubble path. All US presidential contenders are for raising the minimum wage and increasing trade barriers. One is for limiting immigration. These three policy elements are a consistent package for addressing the escalating wealth and income inequality in the US. But, they will lead to inflation and rising interest rates. When the US interest rate rises to 5 per cent, the global dollar balance sheet has to shrink. Deleveraging pressure in emerging economies is already rising. The new development will turn it into a financial crisis.
China is riding the tiger of debt and bubbles. If it gets off, there will be a lot of pain. But, if external forces were to throw it off unexpectedly, the consequences would be far worse. Is anyone listening?
Andy Xie is an independent economist