You are Either A Moron Or An Idiot If…10 November, 2011, 19:44. Posted by Zarathustra
Tags: Easing, Economy, Real Estate
Sure, inflation in China has slowed, and is set to go lower. There has been hope that there will be monetary easing: I get that. But be careful what you wish for.
No one could deny that if Chinese economy slows, the macroeconomic policy will be geared towards growth supportive. Yes, everyone gets that. There are two big questions with respect to the potential monetary and/or fiscal stimulus in China.
The first is the timing of it. Whenever Chinese officials sound slightly less hawkish with respect to inflation, people immediately think that easing is nigh. But just as the FT points out, Wen Jiabao has signalled some “fine-tuning” some weeks ago, but what has been done is nothing but some minor tweaks, or indeed, “fine-tuning”. Wen Jiabao is still hawkish in terms of property market curbs, for instance, and even as inflation slows, it is still nowhere near the 4% target, which should suggest that there should be no reason for massive easing. And one should also be concerned by the potential problems of easing too early, as Patrick Chovanec’s excellent article on Japan and China cited the book by Peter Hartcher explains:
The shifting of real estate speculation from Beijing and Shanghai, where “cooling measures” were mainly focused, to 2nd and 3rd tier cities is something I’ve been writing and talking about for over a year. The explosion in alternative forms of credit provision (so-called “shadow banking”) as an end-run around lending restrictions is a development that has really taken off this year. Hartcher continues:
The 1988 pause in Tokyo prices sent tremors through the ranks of speculators, whose whole approach was premised on ever-increasing prices. The liabilities of bankrupted real estate companies that year multiplied by 133 percent–from 196 billion yen ($1.96 billion) to 456 billion yen ($4.56 billion)–and virtually all of this amount was attributable to companies described as speculators. Such companies accounted for Japan’s two biggest corporate bankruptcies that year. Did this sober the banks and tame the recklessness of their lending? Not at all. Rather than reduce their exposure to speculators in difficulty, many banks increased it by lending the speculators more money so they could meet the interest payments due to the banks. Tokyo’s weak prices in 1988 turned out to be just a pause. In 1990 they zoomed to new heights, powered by yet more bank lending. The banks had learned nothing. Real estate prices broke new records … The Okurasho’s reflex response to the problem was to impose direct controls and bureaucratic directives.
Hartcher’s description of speculators’ difficulties is virtually identical to my analysis of the recent rash of bankruptcies in Wenzhou. And the response — the Chinese government’s instructions to local banks to expand lending and accept higher levels of non-performing loans, in order to prevent further failures — is strikingly similar.
So while everyone agrees on that the government will ease, I can’t agree on the timing of it. Indeed, Li Daokui, an advisor to the PBOC, thinks that there should not be any major monetary policy easing (not only in short-term, but in medium term).
Let’s say there will be more meaningful easing next year in forms of aggressive cuts in interest rates and reserve requirement ratios. The next question is how massive and how effective it is. Again, the “conventional wisdom” of the day believes that it will be massive, and it will surely work. This, as I have been saying, is a “this time is different” syndrome in China, which seems to believe that policymakers in China can engineer whatever they wish. This is just clearly absurd. As Patrick Chovanec’s excellent post reveals this in Peter Hartcher’s book:
Viewed through the distorting prism of the economic bubble, the skills of Japan’s bureaucrats seemed to be great indeed and their popular image of superior intellect and ability safe.
Isn’t this just exactly the same kind of sentiment majority of people have on China these days? “These policymakers could do no wrong”. It is as if policymakers in China have this God-like quality which makes them omnipotent, while they are not.
Realistically, if China does have to stimulate the economy very aggressively in the event of hard landing (which is judged here to be likely), surely China can offer unlimited quantitative easing. Surely China can print enormous amount of money to save everyone, and Chinese banks will all become zombie banks pretending that they are not zombie banks. Sure enough, perhaps they could still get its economic growth in Chinese Yuan terms at relatively fast rate if they pledge unlimited quantitative easing, but as explained for many times, the endgame for this has to be depreciation of Chinese Yuan. Indeed, even someone close to government’s policymaking has recently floated this contentious idea. If so, investors outside of China should think about whether they want to have any exposure to the currency.
And as written before, there could be cases where a government and/or a central bank just can’t stimulate the economy anymore. I am, for instance, concerned about the risks of a disorderly correction in the real estate market, which could potentially have a huge impact on the real economy. The “conventional wisdom” during the unstoppable bull-run has been that government policies will not stop the bull market. Bizarrely though, when it comes to stopping the market from falling, the “conventional wisdom” becomes that government can definitely stop the bear market. This asymmetry in expectation, again, is extremely absurd.
Could there be a sweet spot that China can ease at the right timing and right size of stimulus that could have no unintended nasty consequences? The “conventional wisdom” invariably thinks that the answer to this question is “Yes” that China can muddle through. But please, no one knows about it: Chinese policymakers will not know, investors will not know, and I don’t know. The point here is to present some alternative scenarios that could happen and are nasty. This is not a certainty game, but a probability game, and the probability I assign to the perfect scenario is very low, while the probabilities of nasty scenarios could be much higher. After all, the economic machine is very complex that no one really knows exactly what’s happening. You don’t know, nor do I, nor to policymakers.
Anyone who believes that he/she is 100% certain that Chinese policymakers can do no wrong is either a moron or an idiot (and the two words mean the same thing, essentially).