China is a Scam
August 31st, 2009
A Chinese friend told me this past weekend that one of her cousins recently took out a house loan and instead went on a buying spree on appliances and clothing and other amenities that included a new car. The cousin, apparently, has little interest in repaying the loan. Such, I suppose, is the quality of supervision of the flood of money still pouring out of China’s banks to “stimulate” the economy; and such, I also suppose, is the bank’s assumption that many of the loans will never be repaid – that is, they assume a sizable proportion of the loans will be Non-Performing Loans (NPLs). Add to that a financial system and judiciary so full of holes that it is very very difficult in China to reclaim bank losses. So, it seems the cousin may actually get away with the dough.
Hearing the story put me in mind of something Bill Bonner, author of the books Financial Reckoning Day and Empire of Debt, wrote a couple weeks ago in The Daily Reckoning blog :
But they were not creating wealth…they were consuming it. They were spending money they hadn’t even earned yet. In other words, they were not only consuming their current wealth, they were consuming wealth that didn’t even exist yet – it was tomorrow’s wealth. You couldn’t see this happening by looking at the GDP numbers; instead you had to look at balance sheets. And even then, you needed to look at them with a suspicious eye. On the one side, debt was clearly swelling up; it doubled during the 2001-2007 period. On the other, assets were swelling up too. But the assets were of the overpriced, Bubble Era variety…houses and stocks that were subject to easy correction. And when the correction came, assets declined…and debt grew heavier and heavier.
Bill was talking about the United States in that passage. But it sounds scarily like what China is doing today:
And here…perhaps we should pause. We are about to tell you that China is a scam. It’s not really becoming more prosperous. But before we do, we have to explain what prosperity really is…
Well, here’s a question for you: if China were really growing at 8% per year, how come its electricity consumption is going down?
Answer: Because the Chinese bureaucrats can jiggle and jive the numbers for employment, GDP, and inflation. But the number of kilowatt-hours consumed in China is just a number. It is not computed. It is not seasonally adjusted. It is not tortured by statisticians nor tormented by economists. It is just a number. And that number is a smaller number than it used to be.
Oh, and here’s another number. China’s exports for July were down 22% from the year before. Here’s another question: how can an export led economy grow when its exports are collapsing?
Add to all that deflationary pressures in China of 1.8% annually – which reflects a consumer that’s not buying as much as the government claims – and it would seem that the Chinese stimulus package to buck up infrastructure spending is not actually creating wealth, but is instead taking wealth from the future (by creating debt that will not be increasing the productivity needed to pay off the loans-plus-interest for a very long time to come). And with Chinese households taking on greater debt and speculating on the stock and property markets what cash they do have, it looks as though China will be in for a long hang-over after the party, during which it will have to make the sort of structural changes it hasn’t had to contemplate since it put millions of workers out of life-long jobs at State-owned Enterprises (SOEs) back in the mid-1990s.
Oooh, that’s gonna hurt.
August 31st, 2009 at 11:01 am
Bill
This is an issue that has been explored in depth by Economist Michael Pettis http://www.mpettis.com. China is certainly not a scam and the investment in infrastructure is more than obvious. However, there is also no doubt that part of the RMB7 million given in H1 were directed in speculate in real estate, stocks and land. That does not make it a ‘scam’ in that sense, just a very opportunistic and speculative economy. Nonetheless it was only a small proportion of total credit granted.
Very well reputed economists do not doubt that China’s economy is growing at roughly 8% in 2009. What they question is the massive amount of credit required to generate that growth and whether the future & painful process of repaying those loans is worth it.
While they are real problems with credit here and banks getting repaid, the decision to lend to large SOEs was the ease with which due diligence could be undertaken (compared to SME’s). Large SOEs have significant capital and assets available to the banks should they fall behind in repayments.
The example of a consumer loan to someone who doesn’t plan to repay is besides the point. Such dodgy consumers (who exist everywhere) were not the recipients of the H1 lending binge. Indeed consumer lending in every area besides housing is fairly low in China. The much larger recipients are the SOEs and large companies who will be required to invest the money to generate a return than can both repay the banks and benefit and grow their businesses. That hurts.
There is a risk that large enterprises will damage their capital and asset base if the returns on the projects funded by H1 loans are below the interest cost. If so, that is poor and irresponsible management, but not a ‘scam’.
August 31st, 2009 at 1:34 pm
So China is doomed?
September 1st, 2009 at 10:07 am
Hi, Chris;
Well, you know the old joke about economists, don’t you: “There’s only three kinds of economists in the world: those who count; and those who can’t.” And then there’s the category that figured that markets left to themselves were self-correcting and that large institutions through which the life blood of the financial system circulates would never self-destruct. Or were those two additional categories? So much for experts.
The fundamentals just aren’t there to support the supposition that this is genuine, strong-and-sustainable growth. The current economic activity – nay, frenzy – is wealth being moved about: not actually being created: high-speed musical chairs, as it were. Not like in the old days, in the early 2000′s, when the majority of growth was led by an export sector for which 8% was enough to generate enough new jobs for entrants onto the job market, and FDI to not only bring new money into the economy but also technology and processes to increase the productivity of companies. Take away the government loans and immediately see the real estate and stock market bubbles burst – the valuations of these assets are stratospheric! Remember: bubbles are filled with air. Don’t be fooled by the refracted surface area of the bubble itself, no matter how big it might seem.
What’s going on now is smoke-and-mirrors, a confidence trick. There’s nothing to justify the out-of-control construction of yet more empty commercial skyscrapers and vacant residential high rises. I am sure when you have driven through any city in China – first- through fourth-tier – you have seen acre upon acre of wasted space. Wasted wealth. See Andy Xie’s column in the August Caijing Magazine on the philosophy and numbers behind the-bubble-as-growth model being hailed as a miracle: http://english.caijing.com.cn/2009-08-20/110227359.html.
The trade-game has changed and China is not yet willing to make the changes it needs to ground all this frenzied activity: make its currency convertible; float the currency so it realizes its true value in the currency markets; make its stock market transparent, with a watchdog agency that has real teeth; create a real judiciary that can send people to jail for the corruption and collusion that are rampant in the bourses; make the SOEs pay their huge surpluses into society’s pot, instead of just into the pockets of the bosses and the asset bubbles they’ve helped to pump up; increase family wealth (they’ve been getting poorer as a proportion of GDP for ten years now);open up the service sector and stop propping up an export sector that will not be coming back in the same strength and numbers any time soon; get in place a real system beyond guanxi in which the banks can extend loans to small companies, especially to more labor-intensive service industries.
And for crying out loud, Bejing: start producing economic statistics on a quarterly basis that are in line with the way everyone else measures them, and knock off the political sleight-of-hand.
As for the cousin who took the money and seems to want to run: she is merely a metaphor for what I see going on around me on an institutional level (as written, “put me in mind”). Though I’m sure she’d fit in well if she was invited to the real party.
September 1st, 2009 at 10:09 am
Hi, Outcast;
No. But the probability of a hard landing for the economy in two to three years will be higher if the powers that be don’t put in place the economic and policy reforms the society needs to come to ground and continue developing real wealth for its citizens.
September 2nd, 2009 at 4:06 am
Bill
I don’t disagree that much is amiss is the current round of investment and that investment allocations based on genuine and achievable returns have been poorly undertaken, particularly this year. After years of being starved of credit, large enterprises went ballistic in H1.
Nonetheless, the point was that much infrastructure investment continues. The wave of subway lines, highways, high speed trainlines, wind and alternative energy investment etc has accelerated. These are not scams. They are however long term projects from which it is quite tough to get sufficient returns to repay the heavy burden of interest and loan captal.
Yes, the opportunistic side continues with far too much money entering real estate and stock markets. But this is a small proportion of the total. I personally thought real estate had gone so insane that I sold my apartment last month. The return was just too good and I doubt the market will remain this high for long.
However, again, I emphasise that the stimulus package is not a scam. If you take any of the new subway lines in cities across China or the high speed trains, they are absolutely packed. The networks are expanding at an amazing speed. Generating good returns from these projects will not be easy, particularly as they are primarily loan financed. Any enterprise manager knows how tough it is to generate income & profit sufficient to pay interest and capital. So for the bulk of credit granted the issues are not diversion to speculative activity but return on investment and whether that will be sufficient to cover debt burden.
Chinese enterprises particularly SOEs have the advantage of low interest rates on credit – gouged out of hapless consumer low interest rates (1.9% for 6 month RMB deposits with 20% tax payable on the interest). The banks have a larger safety margin because of the higher spread between deposit and loan interest rates.
I agree this will not be sufficient to cover the cost of poor investment decisions based on both potential losses from speculative activities and, more importantly, poor investment returns from genuine projects undertaken.
There will be a price to pay. However China will continue to develop a world class infrastructure at a time when the cost of developing this is relatively low. I visit high schools, Colleges and Universities across China regularly. The country has built capacity to accommodate and teach students in world class facilities at an extraordinary pace. The facilities were unimaginable 10 years ago. The spread of high quality educational facilities has now reached right across the country and well beyond major cities.
Western countries have hit the point where the cost of infrastructure development is simply too high. China remains at a point where these critical projects are still possible and affordable.
All countries are going to have heavy public debt burdens as they emerge from the GFC. China’s official statistics certainly understate this as a proportion of GDP. However, China will develop an extraordinary infrastructure over the next 10 years (and building on that of the past 10) that will be world class and at the standard of developed countries.
This certainly comes at a cost to your average citizen who are paying the price in terms of poor income growth and capacity to consume. Prices for housing for Chinese citizens are simply over the top. Far too high a proportion of both enterprise and personal income are diverted to funds (housing, pension, unemployment, health, etc) that Governments sit on or use to pay current rather than future liabilities. For enterprises the 42-44% oncost on the wage bbill plus the 20% individual employees pay means a huge proportion of individual income is diverted to fund a national social welfare infrastructure. This money is thus not available for individuals to allocate and spend as they would like.
Again, this is not a scam. It is certainly a heavy burden on both individuals and enterprises. It is also a brutal approach to forcing enterprises and individuals to pay for a welfare infrastructure that did not exist 10 years ago. It is an example of govt policy that curtails current consumption, diverts it to investment.
All of the above is a high price to pay for citizens in developing their country and both the hard and soft sides of a national infrastructure.
Nonetheless, I emphasise again and again, it is not a scam or a trick or anything like that. The development of a genuine and productive (though hard to repay if financed by loans) infrastructure is real and progressing. The froth and bubbles in real estate and equity markets a side effect and not the main point of current credit expansion.
September 6th, 2009 at 10:28 pm
I certainly will admit that the Chinese government may be fiddling the numbers, but in terms of electricity usage, my understanding is that this may be impacted by significant cutbacks (in late 2008) in production by the heavy industry (steel, aluminum, etc) that were chewing up much of the electricity. Is the electricity usage still dropping now that we are in mid-2009 and Chinese imports of ore have picked back up again?
September 7th, 2009 at 6:49 am
Hi, Marty;
My understanding is that electricity numbers have troughed and are trending upward as of August 2009 after nearly a year of downward activity.