By Jayati Ghosh, Professor of Economics and Chairperson at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Cross posted from Triple Crisis
The recent rout in the Chinese stock market – and the Chinese authorities’ increasingly panicky responses to it that temporarily halted the decline – may not seem all that important to some observers. Indeed, there are analysts who have said that this is just the typical behaviour of a still immature stock market that is still “froth” in the wider scheme of things, and not so significant for real economic processes in China. After all, the Chinese economy is still much more state-controlled than most, the main banks are still state-owned and stock market capitalization relative to GDP is still small compared to most western countries, with less than 15 per cent of household savings invested in stocks. Most of all, there is the perception that a state sitting on around nearly $4 trillion in foreign exchange reserves should be rich enough to handle any such exigency without feeling the pain or letting others feel it.
But this relatively benign approach misses some crucial points about how the Chinese economy has changed over the past few years, as well as the dynamics of this meltdown and its impact in the wider Asian region. Since the Global Recession, which China weathered rather well, there have been changes in the orientation of the Chinese government and further moves towards financial liberalization, which were rather muted before then. And these resulted in big changes in borrowing patterns as well greater exposure to the still nascent stock market, in what have turned out to be clearly unsustainable rates.
Some of this has to do with real economic processes. The export-led strategy that had proved so successful over two decades received a big shock in 2008 and pointed to the need to generate more domestic sources of demand. But instead of focussing on stimulating consumption through rising wage shares of national income (which could eventually have threatened the export-driven model) the Chinese authorities chose to put their faith in even more accumulation to keep growth rates buoyant. So the “recovery package” that the Chinese government out in place in the wake of the Great Recession of 2008-09 was essentially one that encouraged more investment, in an economy in which investment rates already accounted for close to half of GDP. The stimulus measures encouraged provincial governments and public sector enterprises to borrow heavily and invest in infrastructure, in construction as well as in more productive capacities even though it was becoming evident that there had clearly been excessive capacity creation in the previous period. They also encouraged much more active interest in the real estate sector, which became the driver of China’s growth in the recent period.
Much of this investment was on the basis of money borrowed from the public sector banks that had dominated the financial landscape in China. But as the real estate sector started showing signs of a major bubble, banks were restricted from putting much more money into such loans, and there were also caps on their deposit and lending rates. This encouraged the growth of a “shadow banking” sector that emerged as a form of regulatory arbitrage, as various trusts and non-bank financial institutions created “wealth management products” to offer higher returns to savers and provided financing for real estate and construction, fuelling the property boom. Surprisingly, the authorities turned a blind eye to such developments – and even implicitly encouraged them, allowing banks to lend money to such financial institutions and thereby get indirectly implicated in this process.
The result has been a dramatic explosion of debt in just a few years. Between 2007 and 2014, total debt in China (in absolute Renminbi terms) went up four times, and the debt- GDP ratio nearly doubled. At around 282 per cent of GDP, this makes debt in China relatively much larger than in, say, the United States. Corporate debt increased to reach 125 per cent 2 of GDP; provincial governments are also highly leveraged for infrastructure investment; and debt held by households has gone up nearly threefold to a hefty 65 per cent of GDP. Fully half of the debt (much of it coming from the unregulated shadow banking institutions that were allowed to flourish) was oriented directly or indirectly towards the real estate market and housing finance, fuelling property bubbles in major Chinese cities that began to burst around a year ago.
We know what happens when the value of the underlying asset falls: this affects the capacity to repay, as the US housing market in 2006-08 vividly illustrated. The housing bubble began to subside from early 2014: total property sales fell by nearly 8 per cent in that year, and new land purchases by developers have fallen by nearly one-third in the first quarter of 2015 compared to the same period the previous year. The index of housing prices for 70 cities shows that average new home prices dropped nearly 10 percent by May 2015 compared to the beginning of 2014.
The subsiding of the froth in the housing market led to investor focus on the stock market, which then began to sizzle. The past year showed how irrational such markets can be, as stock market indices went up by more than one and a half times in around a year, reaching a peak in early June. For some stocks, the price-equity values crossed 200. This was clearly crazy and begged for a correction, which was bound to happen. But that correction was untidy in the extreme. Since 12 June, stocks have plummeted, and on the worst day in early July they were trading on average at nearly 50 per cent lower than the peak. Worse still, at first various emergency measures of the government – from suspending trading in stocks of nearly 800 companies, through forcing brokers not to sell their shares, to indirectly buying shares on a mass scale through the China Securities Finance Corporation and sovereign wealth funds–did not work in stemming the downslide and may even have backfired by adding to the sense of panic.
Thereafter, there has been some stabilisation, although this is clearly artificially created and the market is likely to remain jittery for some time. In any case, the inflated stock prices have still not come down to what could otherwise be called reasonable levels given the crazy increases during the bubble phase, and so there may be more “correction” required. This has created a problem for the Chinese state, whose aura of economic omnipotence has taken a severe battering, because it is no longer clear how exactly they should best deal with this situation. Having talked up the stock market, extolled it as a sign of China’s growing economic strength and encouraged much greater participation in it by relatively small retail investors who are now suffering, they will find it difficult to allow it to decline any further, yet may be powerless to prevent it in the medium term.
This will have impact beyond the obvious problems for stockbrokers and some of China’s rich. In the period of the boom – and particularly in its later stages – tens of millions of small retail investors were enticed to enter the market, sometimes betting their entire savings in the hope of making amazing gains. As is the case in most such cycles, they are the ones who will be most badly hit by the bust. The political fallout of their losses is likely to be unpleasant at the least, and potentially more dangerous.
More significantly, this asset deflation hitting both real estate and stocks comes in the context of an overall slowdown in GDP growth driven by poor export performance in the past year, which is already having negative multiplier effects across the economy. The Chinese government has cut interest rates four times since November and launched a slew of stimulus efforts to shore up economic growth. Few of them seem to have worked as intended, bringing to mind the desperate but unproductive efforts of Japan’s government nearly three decades ago. Manufacturing activity – the mainstay of the economy – is falling and jobs are being shed in this sector.
This has already begun to infect other economies across the world. China’s imports fell by 17 per cent in the first quarter of the year compared to the previous year – and analysts say this is just the beginning. The resulting pain is being felt by commodity producers and intermediate manufacturers from Brazil to Nigeria to Thailand. The worst impacts are in Asia where China had become the hub of an export-oriented production network catering mostly to the West. Many of these Asian economies are already into or about to begin their own asset deflation processes, as the highly leveraged property bubbles in those countries have started to collapse. Contagion will spread both through trade and through finance, with negative feedback loops widely in evidence.
With such an integrated world economy, such severe headwinds cannot go unnoticed in any region. And the febrile behaviour of finance is only likely to make things worse. So those who are looking only at Greece and the crazy behaviour of the European Union may well be looking in the wrong direction to identify the next big crisis as it comes.
But there is a bigger lesson in this, beyond that of concern for the immediate future. The lesson is that unregulated finance is not just a terrible master – it can also never be a servant (that is, under the control) of society and the real economy once it is unleashed. If an economy as strong and apparently state-directed as that of China can be so badly hit by these crazy moves in asset markets with only partial deregulation of financial activities, the clear dangers of such deregulation should then be apparent to everyone.
Originally published in the Frontline.
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They are gonna round up all the short sellers and send ’em to Tiananmen Square.
Also – Chinese market cap hit $10 trillion on June 15th. Not so small. GDP around $10 trillion USD, they say.
China has $21 trillion domestic deposits, compared to $11-12 trillion in the U.S. The death of Chinese economy is greatly exaggerated.
China also has I believe some $3-4 trillion of foreign currency reserves. In addition a huge amount of gold. Much larger than what she is officially declaring. The Western central banks fraudulent manipulation of the paper gold price is allowing China to buy ever more gold at very low prices.
She has also dumped a large amount of US treasuries over the last few years, and is buying fixed assets like land/farms, harbours, airports , gold and silver and copper mines, and prime real estate. When Trump announced his campaign for President he boasted he had just sold a property to a Chinese man for $15 million. I wonder if the Chinease Man paid in US paper $s or treasury bills?
China has huge problems, but it is still growing at an amazing rate. I think the U.S. now has about 350 military bases surrounding China. China is getting ready to dump the $, and all hell is going to break out when it does.
Buying land/farms.
Regarding land, there is no country located entirely on water surface. A country must be on land (and then, afterwards, makes claims on areas of water).
Another observation: A country can exist without financial derivatives, but financial derivatives can’t exist without being inside a country.
One more: A country and her people can exist without paper money, but paper money can’t exist without a country and her people, though a country can’t exist without land, and land can exist without a country.
As usual Trump exaggerates, but rarely to the down side! No self-respecting Chinese Man would bother with a property worth only a paltry 15 million. What probably happened was that the real sale price was 50 million, and the difference was laundered through one of Trump’s Panama front corporations to avoid paying US taxes.
That’s the way any normal successful businessman would do it. Like Mitt Romney funneled the “management fees” “earned” by Bain Capital into his accounts in the Cayman Islands. Or Steve Jobs’ widow, now living comfortably on her 300′ yacht in the Caribbean with over 200 billion Appledollars laundered through multiple offshore accounts and safely hidden forever from the IRS. Think IPhones are built by FoxCon in China only because labor is cheaper? Think again.
Anyone who has had experience negotiating with a Fortune Cookie 400 businessman will tell you that they are certainly no less sophisticated than their American counterparts! For every yuan that went to building the hollow shell towers of a Chinese ghost city at least one more found its way to a blind trust account in Panama or real estate in London, Vancouver or New York. If the recently bankrupted ex-middle class takes up their pitchforks and have to be slaughtered it won’t really affect the Sons of the Long March because they already have theirs.
*Sigh*
China can’t “dump” its US dollar holdings. Your scenario is like that of the sheriff in Blazing Saddles threatening to shoot himself in the head.
If China were to dump Treasuries, the US dollar would go down and the renminbi would go to the moon. China would lose its trade surplus because all of its products would become vastly more expensive to foreign buyers. That would kill a large portion of its economy, causing a big increase in unemployment and social unrest.
Moreover, dumping its Treasuries would guarantee large losses. That would also go over badly in China.
China accumulates dollars by virtue of running trade surpluses with us. It most assuredly does not want that to stop. It then decides to hold those dollars mainly as Treasuries to get a return on those holdings while not sacrificing liquidity or safety.
So the Chinese people owe the Chinese people, lets say 200 Billion RMB, aAnd owe the rest of the world nothing
Write it off. Who gets hurt? The Banks? They become state owned entities.
Perhaps China need its equivalent of the $1 Trillion Coin.
Same principle, lessor extent, applies to the US. The bulk of the national debt is owed…to ourselves, thus it doesn’t really exist. You simply cannot REALLY borrow money from yourself and if you say you did then it is just a rhetorical device with no objective basis. The bulk of US debt is not real and can be as easily written off as that of China’s without any harm to real people (only a few banksters who falsely believe they are as sovereign as a country).
By financial liberalization I figure they mean deregulation? Also, quadrupled total debt since ’07 means what in real terms in regard to their sovereign currency? Would not the consumer portion be the most problematic? Curious about these details, I don’t doubt it’s excessive… another question is in regard to the command/control economy that I’ve heard china is, and that i’ve heard described as if it were an advantage china has over the us It’s easy to see how greece is bound and gagged, china has more flexibility but I’ve got no context this am…
I am interested in such developments in China, as our own economy is, I think, more entwined with it than many realize. I am wondering about the ripple effect, for ex, on the current housing bubble in CA, which in part has been driven by a glut of homes purchased mostly for ca$h by Chinese and other Asians.
Thanks for the update.
Congratulations Dr. Jayati Ghosh !!
Welcome to NakedCapitalism…
Hi
Excellent piece of analysis.
Yves, I don’t want to suggest anything that would add to your already excessive workload but have you thought about writing a page or two on the similarities between China today and the Japan you saw first-hand 20-odd years ago? Or if you’ve seen a piece by someone else that you think is well done and can be reposted to NC, that would be great as well.
From where I’m sitting, I think China may be lucky to do as well as Japan did post-bubble. There is so much hot money, hidden players, shadow banks, etc, I think China could give us our “CreditAnstalt” moment.
Best,
P
I’d second that – I think the Chinese have always been very aware of what happened in Japan and have gone to great lengths to avoid it happening – but sometimes hubris is just more powerful than rational analysis. The comparisons between 1980’s Japan and China today are very obvious – massive property and stock market bubbles, investments in crazy infrastructure projects, a refusal to face up to the implications of demographic trends, a banking system controlled by cronies with zero transparency. They’ve even replicated some of the identical idiotic real estate ventures, such as fake Dutch cities in the middle of nowhere. I would be surprised though if there wasn’t a file tucked away somewhere in Beijing marked ‘what to do in a Japan style crash’. It might have some sensible advice, or it might just say ‘grab everything and take a flight to San Francisco’.
Another similarity – China has lots of foreign reserves, as did Japan in 1980 (and still does now).
And if Japan can drag it out and keep the nation more or less in one piece for at least 20 plus years, can’t China out-do those territory-robbers?
Michael Pettis has often mentioned the precedent/parallel.
Yes, Pettis has some of the best analysis from an historical perspective out there – he really is required reading for anyone interested in the Chinese economy. He is unusually optimistic though, he repeatedly maintains that a long term crash and stagnation is avoidable, although I wonder to what extents he believes this or whether his job in China requires him to temper pessimism only he can answer.
The ‘Fistful of Euros’ and the ‘Ice’ blogs both discuss (following I think an FT story) about one area of real concern – that Chinese banks may have followed the example of Icelandic banks in allowing shareholder insiders to borrow against those shares. If so, it could result in a horrible dance of death once things go into reverse. While there is no evidence one way or another, anyone who knows the way China works wouldn’t be surprised at all if this was the case.
I personally suspect that one reason why the response to the stock market collapse was so clumsy was that a lot of policy insiders were personally caught out. Its the only explanation I can think of why they have suddenly turned so inept and obvious in their manipulation.
It’s astonishing–no matter what label the rulers operate under, they still stick with the time-honored dogma that any crazy trick, any nutty scheme, is better than giving the workers money so they spend it and stimulate the economy. “Wealth effects”, asset bubbles, supply-side economics, ZIRP, QE: you name it, they’ll try it, so long as it does not include giving the people who make stuff more money to buy stuff. Incredible.
I agree totally with this comment James. Steve Keen on a Max interview today says much the same thing. I got a better understanding of Keen’s bedrock criticism of modern markets – that everybody thinks money doesn’t matter – which then throws everything askew. Minsky style. They talked about floating exchange rates not working to stabilize currencies, leading to the insane diagnosis for austerity. But my takeaway was that Keen was saying we can’t have both floating exchange rates and deregulated finance. Because money becomes an absurdity that the banksters can create. Instead of some symbol of a sound economy. And the bubbles take off in all directions. It would certainly be interesting to see China simply forgive debt as Keen prescribes. And maybe peg the yuan to full employment. Hey, they’re communist, right?
I think Joe Guinan, a Senior Fellow at The Democracy Collaborative and Executive Director of the Next System Project, has a good article on this. (and includes an impressive set of references)
“Since 15 August 1971, when Richard Nixon unilaterally terminated the convertibility of the US dollar to gold, bringing to an end the Bretton Woods regime of fixed exchange rates, countries issuing their own sovereign currency have had in place something approximating to the democratic monetary system for which the nineteenth-century Populists struggled. The difficulty lies in the fact that we have yet to comprehend this fully – and to demand that it is used properly.”
“Modern monetary theory destroys the intellectual basis for austerity but needs a more robust political economy.”
Escape from Austerity
I thought this was the seminal article on the subject. Careful, though…NC is an MMT site.
http://bawerk.net/2015/07/27/chinas-unfortunate-dependence-on-the-eurodollar-expansion/
:) I think as Jayati Ghosh and James Levy point out, China has misused its ‘MMT potential’:
“The stimulus measures encouraged provincial governments and public sector enterprises to borrow heavily and invest in infrastructure, in construction as well as in more productive capacities even though it was becoming evident that there had clearly been excessive capacity creation in the previous period. They also encouraged much more active interest in the real estate sector, which became the driver of China’s growth in the recent period.”
But they are also heavily investing in solar energy.
I think Ingham brings some useful insights to MMT by emphasizing the social and political networks that have an impact on economic decisions and how it is important for these decisions to have a level of political and social trust. As Ghosh points out above:
“This has created a problem for the Chinese state, whose aura of economic omnipotence has taken a severe battering, because it is no longer clear how exactly they should best deal with this situation. Having talked up the stock market, extolled it as a sign of China’s growing economic strength and encouraged much greater participation in it by relatively small retail investors who are now suffering, they will find it difficult to allow it to decline any further, yet may be powerless to prevent it in the medium term.
This will have impact beyond the obvious problems for stockbrokers and some of China’s rich. In the period of the boom – and particularly in its later stages – tens of millions of small retail investors were enticed to enter the market, sometimes betting their entire savings in the hope of making amazing gains. As is the case in most such cycles, they are the ones who will be most badly hit by the bust. The political fallout of their losses is likely to be unpleasant at the least, and potentially more dangerous.”
All bubbles need bagholders. Otherwise they’re no fun for anyone in the end.
Not that China won’t try and make bubbles a “store of wealth” – same as we try to in the Western World. (and Japan)
Back to James Levy’s original point that it’s important in implementing MMT that money be given to the people to spend (I assume directly and exclusively, that is, to the people, and not the government).
Can’t have that. Not enough Beijing Bucks to go around. What China needs to do is find a prominent biz mag editor (Ste Fo, maybe ?) and have him make up a list of potential Billionaires. The Fortune Cookie 400. These 400 people can then be in charge of spending all the money because they know better what to spend it on. The Little People would probably just do something irresponsible with it.
The Chinese government has come a long way since 1288, when they had to operate restaurants, taverns and the you-know-whats to generate revenue to fight the Mongols.
Now, it can just print.
That’s too bad, because, I think, a lot of people will want to check out those government run pleasure places.
And I certainly like to see a government that will run the private sector, growing wheat and rice, making cars, etc. , with the people doing the public sector inspecting. Trading places, you might say. And if the government is producing to much, the people can tax the government to slow it down (another role reversal). And because the people no longer have to compete to survive, but with the government providing everything, the society will be a more harmonious one.
Yes, things would work better if we could all just print our own money and pay government to grow and make all our stuff, clean up our crap, and entertain us properly. I’ve always felt I was on the wrong side of that deal.
And in fact, China tried that almost 1,000 years ago.
Again, from The Economic History of China, Pg 153 by E. Stuart Kirby, about an important aspect of the failure of the Song, the great inflation in that period
There you have it – plenty of good stuff.
1 Soldiers not regime-changing in Parthia, but growing food
2. resisting exploitation with this mercenary soldier-farmer scheme.
3. More pay and less work when it comes to soldier-farmers
4. retirement money for public officials
5. Unlike ZIRP, one generates inflation under this arrangement
Makes sense. If you’re a soldier worker, you can hold up your wimpy boss for a raise!
You might say it’s literally turning swords into plowshares.
“Join the People’s Liberation Army to serve your country. You will be growing rice along the New Silk Road, or fishing in the South China Sea. It’s not just a job. It’s an adventure.”
Thank you FM for that link. I just finished it. Way good. It is just a matter of getting rid of an old entrenched idea about money. I can’t help thinking that since money is an artifact of human society it should be directly linked to the well-being of society. A Social Standard. So I always see private banking as a means to undermine the economy. Unless they printed their own money.
Let’s be honest here.
When Marie Antoinette was over eating her brioche, she was stimulating the French economy. What a bunch of ungrateful bakers.
More luxury chateaux on the Rhone Valley? Government stimulus projects. How could the masons not prostrate themselves before her?
Re James’ point: Let’s go at this from the standpoint of writers like Brenner, who argue that bubble-based credit creation mechanisms like overvalued stock or housing markets were needed to replace demand lost as working/MC class wages were crushed. It’s interesting to consider how wage-based demand is in some ways more constrained than credit-based demand. Perhaps this is simply Minsky’s point, but once bubbles become in a sense institutionalized, doesn’t that mean that sources of credit — and I’m really at a loss when it comes to covering the range of them anymore — are prone to jump into action the moment a bubble possibility portends? Credit is generated, commodity purchases are made, the created credit is thereby nominally validated and then enters into a period in which the bubble commodity owners pray for profitable sale with a terminal TBTFish state validation on the horizon. And then it’s off to the next bubble, an idea which Krugman and Summers have recently conceded. Utterly different from investment decisions based on consumer market demand calculation and leading to a very different political order, especially at the elite level.
I think you could map this on to Streeck’s argument in Buying Time that we’ve gone through a progression of tax state >>> debt state >>> consolidation state, with each phase involving a declining tax base and more dependence of the state on financial markets to manage debt. It’s in the consolidation phase, that the stage is set politically for policies that render the banks more and more autonomous vis a vis that state in terms of credit generation.
Another reading and it looks alot like the us reaction to the GFC, foam the runway with small timers…the difference being that the Chinese gov’t has alot of money but that may or may not matter, what am i missing. How are the 17% of imports impacted by low commodity prices?
Yes. And even resorting to long term trickle-down to avoid any wage-price spiral. God forbid anything should interfere with asset appreciation and strong currencies.
imf economic wars…
how convenient for the imf that russia, brazil and china have dust ups when they start letting the ink dry on alterbanque corp…
maybe dsk had a download he was not authorized to walk out of the room with…
either way…the usa did not roll up into a fetal position when the nasdaq market reacted to mccain and bradley being forced out of contention by blocking mechanisms of the duopoly party on march 9 2000
who is going to rise up and “take” china…???
they have a few things that go boom very loudly when dropped on people…
this is just a wwf pay per view special event…beer heeyah…get ya beer heeyah…one or two mac…that’ll be ten bucks…beeyah heeyah…get ya beeyah heeyah..
Ah yes, the ‘stimulating consumption’ argument :-)
Wage growth can only happen if wage-earners bargaining position is strengthened and given the current and expected future amount of surplus labour (at current amount of hours worked per labourer) then wage growth is only to be had for two categories:
-people with extremely rare and valuable skills (always going to be a tiny portion of the population, never more)
-rentseekers who are using positional power (although they claim to have rare and valuable skills, sociopathy as a skill…)
Neo-liberals claim to want to increase consumption by reducing taxes but in the end what happens instead is that social security nets will be dismantled.
Workaholics will claim there are unlimited amount of jobs already today which pay a living wage so vacations can’t get longer, retirement can’t be had earlier etc etc. Sometimes I wish I wore those rose-tinted glasses…
Old-fashioned reactionaries prefer the old fashioned killing off of people through wars, they’ll get the spoils of war and as a side-effect the survivors will often have found solidarity with each other and will use their bargaining position to increase wages as share of the economy.
So, will there be solidarity or will capitalism eat itself?
My guess is that the ruling-class of workaholics will, due to their lack of empathy with the rest of us, steer capitalism into eating itself and the depression will get worse :-(
No. Labor strength can be built into the fabric of the law by requiring corporations, whether private or public, to pay its highest compensated executive NO MORE than 60x its average worker pay (including temps in real US dollars so there’s no way to game the system by only using temps or off-shoring and claiming that the real $5/day paid to a worker in BFE is “equivalent” to $50/hr in the US. No. That $5/day counts as $5/day, period, so the best the top exec can hope for is 60x $5/day).
It’s not like the “right” of incorporation is written into the Constitution or even recognized as a universal human right. Incorporation is a privilege extended by governments and the rules of incorporation can be (and have been) changed to make corporations act in any way the government sees as most beneficial. In Revolutionary America, corporations were very untrusted and banned from ANY political activities, could only exist for a fairly short time period, were directly culpable, as were all its officers, for violations of law or harm to people (no such thing as LLC back then…you do something as a “corporation” you are directly responsible and punished for wrongdoing). We need to go back towards the “original intent” of the Founders on this.
Make incorporation predicated upon, among other things, the pay limit/scale mentioned above, eliminate LLCs, change the “prime directive” from “maximizing shareholder value” to serving in the public/societal interest FIRST, then worrying about shareholders. It’s as easy as using white-out on a printed page, as using on a keyboard and entering new text. This stuff isn’t written in stone, nor did it come down from “on High”.
If an economy as strong and apparently state-directed as that of China can be so badly hit by these crazy moves in asset markets with only partial deregulation of financial activities, the clear dangers of such deregulation should then be apparent to everyone.
I see. Blaming partial deregulation of financial activities as the culprit in this disaster, while in the same sentence the cause of the disaster is forgotten.
The recent rout in the Chinese stock market – and the Chinese authorities’ increasingly panicky responses. . . After all, the Chinese economy is still much more state-controlled than most, the main banks are still state-owned
It is a state led disaster and deregulation has little to do with it. All these decisions made by the Chinese government are political, and as evidence, cite the tens of millions of empty new dwellings, rotting in place.
Some of this has to do with real economic processes. The export-led strategy that had proved so successful over two decades received a big shock in 2008 and pointed to the need to generate more domestic sources of demand. But instead of focussing on stimulating consumption through rising wage shares of national income (which could eventually have threatened the export-driven model) the Chinese authorities chose to put their faith in even more accumulation to keep growth rates buoyant. So the “recovery package” that the Chinese government put in place in the wake of the Great Recession of 2008-09 was essentially one that encouraged more investment, in an economy in which investment rates already accounted for close to half of GDP. The stimulus measures encouraged provincial governments and public sector enterprises to borrow heavily and invest in infrastructure, in construction as well as in more productive capacities even though it was becoming evident that there had clearly been excessive capacity creation in the previous period. They also encouraged much more active interest in the real estate sector, which became the driver of China’s growth in the recent period.
That’s how the princelings get the money to buy up San Francisco and Vancouver.
This encouraged the growth of a “shadow banking” sector that emerged as a form of regulatory arbitrage, as various trusts and non-bank financial institutions created “wealth management products” to offer higher returns to savers and provided financing for real estate and construction, fuelling the property boom. Surprisingly, the authorities turned a blind eye to such developments – and even implicitly encouraged them, allowing banks to lend money to such financial institutions and thereby get indirectly implicated in this process.
I’m not surprised. In China, nothing is what it seems.
We know what happens when the value of the underlying asset falls: this affects the capacity to repay, as the US housing market in 2006-08 vividly illustrated.
Nonsense. An asset such as housing is sold on the ability of the buyer to pay the mortgage and the market price fluctuates up or down. That does not change the capacity of the buyer to repay. The US housing market was fueled by fraud.
. . . The worst impacts are in Asia where China had become the hub of an export-oriented production network catering mostly to the West.
The West, has too much stuff. Stuffed to the gills with stuff. Cheap stuff. From China. We don’t need any more, we have enough. I think China is getting the memo. Please keep your stuff. Especially the drywall. You are going to need it.
The fraud was generated by the banks, not the buyer.