For much of the past 10-15 years, the Chinese economy has followed a familiar boom-and-bust pattern, although official GDP data has been suspiciously straight.
Central government agencies would flood the market with fiscal and monetary stimulus until activity got too hot, then cut money. Authorities who engage in this financial technique to propel economic growth to a higher target level while always trying to balance the risks in both directions. Why isn’t China stimulating even though the economy is hardly growing even with official data and the market is expecting an upswing?
Even relying solely on official data, the Chinese economy is facing perhaps its most difficult period of this century. Municipal revenues are collapsing, and state revenues are falling by more than 20 to 40 percent in some places. The banks were best off with protests holding back deposits and mortgage holders refusing to pay. As developers grab the headlines, companies across China are facing major debt repayment challenges due to over-indebted balance sheets and shutdowns due to the COVID-19 pandemic. So why hasn’t China pumped money into the system to boost growth?
Unfortunately we just don’t know. Regulators are saying all the right things about not stimulating — but they’ve said the same thing before and still stimulated the economy by increasing debt to staggering levels over the years. It could be possible that Chinese Communist Party (CCP) policymakers made a change of heart, becoming fiscal conservatives and refusing to stoke the fires of moral hazard for fear of exerting undue pressure to bail out state-owned banks. From regulators to banks, however, these are largely the same people who have been in charge for the past decade. So unless Milton Friedman’s readings are secretly circulating, such a profound change in regulatory philosophy seems unlikely.
Chinese leader Xi Jinping has prioritized greater adherence to the party’s central direction and socialist rejuvenation. Is it possible that his policies of capping bankers’ wages, fighting corruption and curbing debt growth are finally paying off? It is possible, but an unsatisfactory answer. We are in the final year of his second term, and these are all strategies Xi has been pushing for years. So why is politics only changing now?
Is it possible that politics are undermining the Chinese economy? With Xi expected to be re-elected to a third term, there have been credible reports of opposition to Xi’s agenda. Curbing the funding that has fueled China’s economic growth since 2008 would be one way to weaken Xi in an election year when the CCP usually floods the economy with stimulus. However, this seems problematic as it would require a high degree of cooperation from many institutions to stand up to Xi given the country-wide problems.
Neither of these options seems satisfactory. There is one final but very worrying possibility. What if China just ran out of money?
Banks are withholding deposits or capping withdrawals and capital levels, even using official data, scratching the lows of regulatory minimums of around 8 percent. That said, even if the government wanted to provide significant stimulus, there is little evidence that China’s financial sector has the capital to absorb a rapid rise in public debt. Also, given their high level of debt, Chinese households do not have the capacity that now exceeds most OECD countries.
That means the People’s Bank of China would be the only source able to buy government or corporate bonds on the scale needed to absorb a significant Chinese stimulus package. This would pose major problems and force the PBOC to fund the stimulus. There are also demand-side problems given the lack of broad-based demand for additional loans from companies or households. In other words, the banks lack the ready capital to absorb large loans and nobody but the central government seems interested in taking on new debt given the large overhang.
Given its debt-driven economic growth model, this poses problems for China. If growth falls significantly, this poses a large risk of repayment. However, if they do not take on new debt, growth will fall and a death spiral will begin.
When the Japanese economy went through a similar period in the late 1980s, asset prices remained effectively unchanged for 30 years, despite 30 years of stimulus and zero interest rates. China is now hoping for that outcome and not something worse.
The views expressed in this article are the author’s and do not necessarily reflect the views of The Epoch Times.