Never mind the debt; grab the loot courtesy of cheap money
The Bank for International Settlements, said China’s credit to gross domestic product gap reached a record 30.1 per cent in the first quarter of the year, far above the 10 per cent level thought to present a risk to the country’s banking system.
Business, Sept. 20
For this 70 trillion yuan economy we are then given a total debt figure 168.5 trillion yuan, which yields a credit to GDP gap of 140.7 per cent, not 30.1. Hmmm.
Of course our inputs may be wrong here. GDP is always an uncertain number in the mainland and there is a big woolly cloud of different estimates for credit, within which the 168.5 figure floats near the upper end.
This, however, is not the reason for the disparity. The reason is that the “credit to GDP gap” is actually a derivative academic ratio based on the work of a professor Hyman Minsky and is meant to measure deviations from normal patterns within any one economy.
I won’t bother with the Minsky equations and for the same reason that I won’t plod my way through the Thomas Piketty book on how we have all gone wrong by not listening to French socialists. It’s Patrick O’Brian for me every time for my reading hours. He’s closer to real world.
I am not saying that this Minksy ratio is wrong, only that it is a classroom exercise and best left there. I accept that many indications suggest the mainland’s lenders are indeed becoming over-extended.
But let’s put some perspective on this. First, we again have a classic comparison of apples to oranges here. GDP is a simplified national cash flow figure while debt (or credit from the lender’s perspective) is a balance sheet liabilities figure.
Comparing the two is like saying that you must be an undeclared bankrupt if you have an annual income of only $500,000 (cash flow statement) to cover a mortgage of $5 million (balance sheet).
Hang about, you say – I get that $500,000 every year but my mortgage debt doesn’t double every year. It actually goes down as I pay it off. I am one of the soundest credit risks around.
No need to belabour the point. You either get it or you are a politician.
Next point: There are really only two ways of financing any venture – debt or equity. Everything else is just derivative of these two. From an entrepreneur’s perspective, do you take on a loan that you may not be able to pay back if things go wrong or do you share the risk and/or reward with others?
Let us take a scenario in which your economy is growing at more than 5 per cent a year, implying corporate earnings growth well above that figure, while finance is available at less than 5 per cent.
Debt is your best choice in this scenario of a booming economy and cheap money. The loot is already almost in your outstretched hand. Why share it with others when it can all be yours for the cost of only a low interest charge?
You may say that risk in the mainland is greater than this scenario portrays but it still describes the basics – high growth with cheap financing and the credit taps open. Why should anyone be surprised then that people seeking finance in the mainland turn to debt more than equity?
Finally, the mainland relies much more on its banking system than the United States does. The ratio of financial institution deposits to GDP in the mainland is just over 200 per cent. The equivalent ratio in the US is only about 68 per cent.
Debt financing in the US is heavily based on non-bank channels and you can thus disregard some of those “Wow!’ statements from the US about the scale of bank credit in China. The New York perspective never sees much past New York.
What matters is how productively debt financing is used, not how much it amounts to in total sum. The BIS knows this but it has been out of the news recently. Invoking the Minsky ratio gets it back in.
I’ll make like a bird – cheap, cheap, cheap.