By James Corbett
As we reported last month, China is in the midst of a credit crunch that threatens to plunge the Chinese economy (and by implication much of the rest of the world) into the type of crisis we saw with the Lehman Bros. collapse. Unfortunately, since we wrote about it last month the situation has not gotten significantly better.
As you'll recall, the People's Bank of China's loose monetary policy over the past four years has helped the Chinese economy continue to grow at much higher rates than most of the rest of the world (to whatever extent we can believe the government's cooked GDP numbers). However, the constantly expanding liquidity has allowed lenders to blow a dangerous bubble of risky investments and high return ponzi schemes in the Chinese shadow banking sector. Some estimates put the value of the loans in that shadow banking system at over US$10 trillion. In recent months, however, the PBoC has attempted to reign in these banks by tightening the monetary spigot. This led to a hairy situation last month where interbank lending rates began to soar (hitting as much as 30% for overnight loans that generally run around 2.5%) and cash began to dry up as banks began hoarding what they had on hand in case they couldn't secure more in the interbank market. Eventually the PBoC intervened with assurances of liquidity injections as needed to get cash circulating, but they made one hell of a point about the moral hazard of the banks that aren't prepared for the money spigot to start closing.
Fast forward to today and the country's banking system is still teetering on the edge. This week the PBoC stepped in with a fresh injection of cash to local money markets before the squeeze hit, but there are no indications that the speculative bubble that was blown with the PBoC's easy money is deflating on its own. What is a central bank to do?
Well, get the politicians to intervene, of course. And so we see some token gestures from Beijing that point to the long term plan for getting out of the current mess. The Chinese government is scrapping turnover tax and value-added tax payments for small businesses selling less than 20,000 Yuan of goods a month. The idea is that this is part of Beijing's “rebalancing” strategy to get the economy less dependent on fixed investment (which currently accounts for a record 46% of GDP) and more dependent on household consumption (which currently accounts for a record low 36% of GDP). Thus, rather than waiting for the bubble to deflate (or, more likely, pop), the government is hoping to grow the economy to fit the bubble.
That such a system will work in the long run seems exceedingly unlikely. In order to increase the share of GDP from consumer spending, fixed investment growth will have to level off. But that investment growth fuels much of the consumer spending that is taking place now, such as it is. The idea that a fundamental changeover in the economy can occur without dipping below a 6.5% GDP growth rate is almost unthinkable, and slashing of VAT taxes for some small businesses is not going to change that.
Unfortunately, now that China is the world's third largest economy, and now that trade with China has become an indispensable component of world trade, this problem is not just a Chinese one. It's global. The real question is whether the government in Beijing will have the fortitude to let some of the banks engaging in the dangerous ponzi lending schemes fail... when and if they go belly up, and whether they will be able to keep the cash flowing through the Chinese economy in such a situation. The world will be watching the moves the PBoC makes very carefully in the next few months, and so will we.