China's Economy: a cycle of arson and firefighting (II)

China's Economy: a cycle of arson and firefighting (two)
Written by He Qinglian on September 29, 2011
(translated by krizcpec)

On September 25 Euromoney named Zhou Xiaochuan, the governor of the People's Bank of China, as Euromoney's Central Bank Governor of the year 2011. The interesting thing was what Zhou Xiaochuan listed as the reasons for being awarded in his speech delivered at the award presentation ceremony.
The reasons he gave were:
First, in response to financial crisis, China's central bank has taken a moderately loose monetary policy and expanded the money supply, effectively supporting the real economy;
Second, since the beginning of this year China has adjusted timely its monetary policy and implemented a prudent monetary policy, namely monetary tightening.
To put it simply, it meant that within two to three years, China's Central Bank first followed instructions to issue excessive money and blow the economic bubble, then drastically tightened money supply, and squeezed the bubble that it itself had blew out of proportion—that was the main reason China's central bank governor got awarded.

Those who are familiar with China's economy would understand at first glance that the first point referred to the excessive currency, issued by China's central bank since 2009, that the government used as an investment to stimulate the economy.

How much was issued?

Since 2009 the central government had invested four to five trillion yuan of funds in the market; to stimulate the economy, local governments had also used extensively the financing platform to borrow nearly 14.4 trillion yuan, roughly half of which was said to have entered housing and stock markets, thus these two economic bubbles of China could continue to expand.

And the second point was about the central bank's having to grit its teeth and tightened the money supply. In the first half of this year, the People's Bank of China raised six times the statutory deposit reserve ratio. 
This tightening measure aimed to squeeze the real property bubble which had been made to expand with every possible means in the past few years. The attempt to achieve this goal bankrupted many China's SMEs which liquidity had dried up. The yet-to-be-fully-unfolded trend of business owners running away from debts that is happening in Xiamen, Fujian and Wenzhou, Zhejiang is a product of tightening money supply and the rupture of the capital chain.

There are no better points to illustrate the role the Chinese government has played in the fourth round of economic overheating than these two reasons of Zhou's being awarded. The first one: the government had done its job by stimulating the economy, that is, “arson”; the second: it had succeeded in squeezing the bubble, in other words, “firefighting”. Either way, it had done something. What a prize to be received for these! I must point out though that for various reasons, Zhou Xiaochuan as the governor of the central bank has no authority over China's monetary policy. The central bank under his leadership is at most a tool of the Politburo and the State Council.

I began this article with the reasons of Zhou's being awarded only because it outlines so vividly the absurdity behind China's economic trend in recent years.

If at the times when the second and third rounds of economic overheating took place, China's economy was driven by three carriages: domestic demand, foreign trade and investment—with the latter two hit by overheating. That was not the case for the fourth round of economic overheating.

The fourth round of economic overheating, triggered almost entirely by the staggering over-investment from the government, inherited nearly all the problems of the third of overheating, and doubly magnified them: local governments over-dependence on land revenue; the two major problems with resource-based industries—blood-stained GDP and high degree of environmental pollution; and gave rise to an economy that is highly externally dependent, troubled by gross inadequate domestic demand, and developed serious imbalance in industrial structure.
The only visible major achievement was the surge in government revenue, which of course was accompanied by the proliferation of social resistant incidents, which had increased to 180000 cases last year.

The traps laid by the fourth round of economic overheating are unprecedented both in number and depth.

The trap of high inflation 
China's inflation rate during this period has been so high that it far exceeded the figure that the State Statistical Bureau was willing to admit. The main cause of inflation was excessive money printing.

According to official data, the broad money supply in 2009 was 60.6 trillion yuan, 1.8 times of the GDP, or a surplus of 27.1 trillion yuan compared to the GDP figure. And in just the first three quarters of 2010 forty-three trillion yuan was issued in excess.
The two speeches by Premier Wen Jiabao—the one delivered during the annual meetings of NPC and CPPCC this year that stated the need to "eliminate the monetary base of the rise in housing and commodity prices", and the other during the State Council executive meeting on April 13 that stressed it is necessary "to eliminate the monetary factors that drove up inflation"—have formally acknowledged that excessive amount of currency was issued.

The trap of quality and safety of public works

In the fourth round of economic overheating, the Government invested in construction of rail, highway and infrastructure. Rail construction, the most ambitious of all projects and received the largest share of investment, has been plagued by corruption scandals and operational incidents. The Wenzhou train crash incident that happened on July 23 this year exposed serious security concerns with China's high-speed rail, the “independently innovated product” that China put together the technologies that were grabbed from other countries.

Not only has the high-speed rail ceased to be high-speed after that, the country's dream to export its own high-speed rail technology has also gone bust.

The trap of local debts

In order to borrow massively from banks, all levels of local governments set up their own “local financing platform”. How much then did banks across the country lend to “local financing platforms” within the two years that the central bank implemented the “loose monetary policy”? 
According to the China Regional Financial Performance Report 2010 (2010中国区域金融运行报告) published by the central bank, there were altogether more than 10,000 financing platforms of local government (at provincial, city and county levels) by the end of 2010; the loans from banking system totaled 47.92 trillion yuan, of which 30% was loaned to local financing platform, that was about $ 14.4 trillion yuan. A third of this 14.4 trillion yuan was from China development bank, the remainder from state-owned commercial banks as well as city commercial banks. Now it has been confirmed that two to three trillion of these loans are at risk of default.
In addition to the three above-mentioned traps that were laid by the loose monetary policy, monetary tightening dug another—the trap of private lending, a crisis that is still unfolding. 
In the face of huge inflation pressure and the trap of local debts, the central bank has no option but to tighten money supply. Under the big picture of the central bank’s continual monetary tightening, both the scale of private lending and its interest rates are both driven close to madness. Even areas that are less economically developed have begun crazy lending. Such a phenomenon invaded the capital market on a massive scale, and eventually brewed into a Chinese-style credit crisis. 
At present this rupture of the capital chain triggered the phenomenon of borrowers running away from debts and default in vast areas, provinces like Zhejiang, Jiangsu, Fujian, Henan and Inner Mongolia are among the high risk zones. 
According to Wenzhou private lending market survey (温州民间借贷市场调查), of the current 110 billion yuan private lending funds in Wenzhou, 35% have been used in general manufacturing and 20% in real estate investment or speculation.   

Engulfed in the trap of private lending, SMEs collapsed in succession. Financing difficulty prompted SMEs to turn to private lenders for loans, which entailed high interest charges that ate deeply into corporate profits and is becoming the last straw that would crush the SMEs.

The Summer report on China's industrial economic operation 2011 (2011年中国工业经济运行夏季报告), published in early September, showed that from January to July this year, of the 310,000 enterprises above the scale, 40,000 or 12.7% had recorded losses. It is noteworthy that business losses have been increasingly serious by the month
The percentage of increase in losses from loss-making companies rose from 22.2% in January to February to 41.6% in January to June. The figure rose further to 46.9% in January to July.
It has become a recurring content of recent China news report that entrepreneurs who could not afford the interest charges of private loans have fled with their entire family or committed suicide. 

If a simple graph is needed to make things clear and easy to understand, the casual map of the fourth round of economic overheating would be as follows: first, the government issued staggering amount of money, which resulted in excessive investment, which in turn triggered monetary tightening, and rampant private lending ensued. And this induced repeated usury collapses and flights from debts in places like Fujian and Wenzhou and eventually SMEs went bust in succession. 

Then, can Beijing learn the lesson and quit setting things ablaze in one moment and fighting the fire in another? The answer is: no. 
China's Deputy Minister of Finance has said long ago that “there is an old Chinese saying, 'to go up hill is difficult, to come down from it is even more so'. If the role of stimulus policy is seen as going up hill, and the withdrawal policy as coming down from it. I think the decision to withdraw from the market would be harder to make than the one to stimulate it.” 
Indeed, Beijijng would not quit easily. A few days back, official information revealed that Shanghai, Zhejiang, Guangdong and Shenzhen will within this year participate in a trial program to directly issue local government bonds, which in sum will be worth approximately 25.1 billion. If people are not forgetful, they should be able to recall that two or three months ago, the voice of worries that China would be deeply trapped in the quagmire of local debts was at one point the important topic of the media.

With a situation like this, what should premier Wen, who experienced economic overheating twice during his term speak of then? Apart from empty talk on political system reform, there really is nothing else left to say.