China’s difficult choice between stimulating the economy and not5 September, 2012, 12:55. Posted by Zarathustra
This is part 5 of 7 in the series China Economy: Hard Landing and Beyond
Original version appeared on 27 August
Quite a number of commentators (particularly those within China) believe that there is no money for the government to spend to offset the current slowdown. Many points to some statistics showing that local governments obviously do not have enough tax revenue to support any large-scale investment projects (as we have mentioned some of the figures here), not to mention that many local governments have also become quite overstretched after the massive credit expansion post-financial crisis.
The numbers about local government revenue and spending are accurate, yet we believe that the idea that the Chinese government can actually run out of money is not correct. The idea that a country can possibly run out of the money which they print is absurd. This applies to countries like the United States, but not for countries like Greece, which has surrendered their ability to create money to the European Central Bank. We think the same should hold for China just as well. With the Chinese banking system dominated by state-owned banks, and with the most powerful tool to control credit growth being state-directed bank lending, there should not be any actual funding constraints for stimulus programme in the forms of investments into infrastructure and productive capacity. The only way that China can really run out of money is when the government decides that “enough is enough” and imposes spending constraints deliberately.
Even so, the choice between stimulating the Chinese economy aggressively or not is not a straight forward one. We have noted for quite a long time that the massive stimulus after the 2008 financial crisis has been widely regarded as a big mistake by commentators and economists within China, and we believe that some inside the government’s decision making body share that view (a recent presentation made by a State Council economist confirm our view). This has very likely contributed to the delay of (much anticipated) stimulus, and the stimulus (if any) will not be as massive as the previous one. Some economists and commentators within China also believe structural reform should be the top priority. After all, the economy urgently needs rebalancing, and more investments into overcapacity will only delay the process of rebalancing. On top of that, some also believe that the involvement of the state should be minimised, thus government deficit spending will not be at odd with such an idea. The biggest critics of China’s economic policies for the past few years are anyone from the West, but many economists and commentators within China.
If we have read the social mood correctly that China might be more pro-austerity than pro-Keynesian, and if policymakers indeed share that view, then the consequence in the near term could be rather grim. The delay in stimulus as well as the small size of it so far has already done damage, if you like. The economy is already on course to hard landing. The combination of high leverage, slowing sales, falling asset prices, etc, are all pretty consistent with the idea of debt deflation. If there is zero government intervention and minimal central bank monetary easing, the outlook will be almost apocalyptic.
There is another choice, of course. Given a stimulus which is large enough (let say RMB4 trillion to be spent every year, to exaggerate things a bit), the government can create GDP simply by spending money into investments in infrastructure and productive capacity. The private sector might be deleveraging and destroying jobs, but government spending could offset that as long as it is large enough, and asset prices would probably fall in an orderly way.
The longer term consequences will be different of course. If austerity is the choice, it will be very painful in the short-term. We will not be talking about a sub-7% or so GDP growth. In fact, we might be looking at a downright economic contraction. Longer term, however, after unprofitable businesses are closed and investments into new excess capacity are stopped, those who survive might have a chance to see their returns on investment enhance over the medium term. And although consumption will be hard hit in the short-run, with investments grind to a halt, the economy will probably rebalance rather quickly regardless. The economy will no longer be growing at 7-8% after the recovery, but that is hardly an important consideration. The short-term outlook will become almost apocalyptic, yet without doubt, there will come a life-time opportunity to invest.
In the “economy on steroid” option, the economy can keep growing at whatever rate the government sees appropriate. The government and state-owned enterprises can invest in ever more infrastructures and productive capacity despite already absurdly low capacity utilisation. While private sector shrinks, the state-owned sector increases to pick up to slack. Meanwhile, PBOC can perform quantitative easing to ease liquidity, while banks are instructed to keep lending to whoever needed credit. For the sake of maintaining jobs, state-owned companies can be instructed to maintain production even though it will not make any profit. The long term consequence is that growth will slow down, yet you are not going to see any dramatic contraction of economic output, massive deflation, banks failures, or anything like that. However, economic growth cannot be possibly maintained if government withdraws its support one day. In other words, the economy will need permanent government support, and the support required will probably be growing as government stimulus (we suspect) will decrease in effectiveness.
These two extreme scenarios are, of course, exaggerated and imaginative on purpose to illustrate the two ends of the spectrum, namely, “do nothing policy” and “whatever it takes policy”. The actual scenario to be played out will most likely be something in between, although our current judgment is that the choices being made leans towards do nothing. If our judgment about what the government will likely be doing, the economy will continue to perform disappointingly, particularly for those who have been hoping for massive stimulus. Of course, our judgment will definitely change if the government becomes more proactive.
Before proceeding, there is one thing that we must make clear: advising the government what to do is the last thing we are interested in. Although we occasionally have views on what the “right” thing should be, we are not making any judgment on which policy choice will be the “right” one. We really do not care. As someone interested in investing in China, the only thing we really care is the likely policy path, the consequence of that, and how we might position ourselves to take advantage of the economic consequence.
- China Economy: Hard Landing and Beyond
- China’s overinvestment: the problem of having too much
- China’s “little” debt problem
- Chinese central bank’s ability to ease monetary policy is constrained by outflow
- Effectiveness of PBOC’s monetary easing will be limited by deleveraging
- China’s difficult choice between stimulating the economy and not
- China’s hard landing is not the end of the world