Will China stay the course to cleanse its corruption-ridden financial system?
Andy Xie says with regulators making serious moves to rein in excesses, Beijing must also recalibrate its policy and bring monetary growth in line with economic growth, even at the risk of recession, because financial health is vital
This is the first major attempt to reverse the trend of China’s economy turning into a financial Ponzi scheme since 2003.
The creation of high-risk credit has come to a screeching halt. But, as economic slowdown is sure to follow, would China bite the bullet and follow through with the necessary cleansing and reform of the country’s financial system?
China’s economy has been in stop-and-go mode since 2012, when renminbi appreciation expectations reversed and financial speculation was a one-way street no longer. Every short-lived upturn was driven by high-risk credit-fuelled speculation. The current upturn, which began in the middle of last year, is no exception.
It follows a year of rapid growth in zero-down-payment or equivalent property loans. The banking regulator has tightened prudential lending conditions, including that repeat borrowers must put down 70 per cent for property purchase, lenders must track the usage of consumption loans that have been diverted into down payment, and that newly divorced couples cannot borrow separately for one year.
Property brokers and developers are still looking for loopholes, but the China Securities Regulatory Commission is ready to plug any. This commission is the first agency in many years that really means to enforce prudential regulations and protect the soundness of the country’s banking system.
New property sales seem to have slowed sharply. This punctures two myths in the market: cash is fuelling property demand, and the market is mainly of first-time buyers. This again shows that China’s property market is just a gigantic speculative mania fuelled by easy credit. The longer it lasts, the more damage it will do to the financial system.
While it is already late, since the bubble has lasted a dozen years, it is better to reverse its course now than let it linger any longer.
When the economy slows down, the political will is key in balancing the risks from an imminent impact on the labour market with those from further deterioration in the financial system.
I have argued for many years that an economic slowdown, even a recession, would not endanger social stability. China’s labour force has been shrinking for years. Unemployment challenges are largely restricted to areas like the northeast, and they must be solved through structural reforms, not macro stimuli. Construction and manufacturing are already suffering from chronic labour shortages.
On the other hand, financial deterioration poses an existential threat to the ruling party. The current stock of credit is already three times the gross domestic product. As the leverage continues to rise, it will trigger hyperinflation. Inflation, not recession, usually triggers political crisis in China. Therefore, financial heath is far more important than GDP growth.
Financial mania always thrives under two conditions: loose monetary policy and financial corruption. The former is money supply persistently growing faster than the economy and for increasing financial leverage. The latter understates or completely fools savers on risks to their investment: the US subprime market before 2008 was really driven by deception and corruption.
What’s happening in China far surpasses that. The shadow banking system is possibly two-thirds of GDP in size. Wealth management products of fixed return and short duration could fund takeovers of domestic or foreign firms. Financing products are assumed to be rolled over by the selling banks forever. This is not possible without financial corruption.
China’s insurance companies have lately been getting involved in incredibly high-risk activities, behaving like hedge funds. The interaction between the insurance industry and the shadow banking system is especially troubling. China’s financial system is possibly mired in corruption.
The cost of financial corruption can be buried in the balance sheet for years. When it blows up, it usually brings down the whole system.
To rescue the financial system, the anti-corruption drive has to go into its every corner. To be honest, corruption is pervasive.
China’s monetary supply has consistently risen faster than nominal GDP. In its early years, it could be justified on a low base in the financial depth. In recent years, it is entirely about increasing financial leverage. This has fuelled financial corruption and speculation.
The policy is often justified on its short-term impact in lifting GDP. The truth is that it is digging the country into a deeper and deeper hole. It is hard to understand why the monetary authority has been pursuing a policy so obviously harmful to the country.
To reverse the trend to financial ruin, China must recalibrate its monetary policy. Monetary growth must be in line with economic growth. The monetary authority should be tightly constrained in what it can do. The central bank should have less freedom.
The latest developments bring hope about the future of China’s financial and, ultimately, economic health. The danger is that an economic downturn could stop the effort of completely eliminating the cancer in the financial system. If this happens, the cancer will surely return and kill the system. If China does go all out and restores the country’s financial health, even a big recession won’t deter investment from pouring in.
The upside is that a healthy financial system could double the country’s per capita income quickly. Who could resist that?
Andy Xie is an independent economist