Note:I have made a change in this piece from yesterday.I forgot that there was an increase in the minimum reserve requirement in April, which means that foreign exchange inflows were actually around $22 billion higher than the ridiculously high number I discussed.
An article just came out on Reuters claiming that inside sources have revealed that China’s foreign currency reserves at the end of April were $1.7567 trillion. If this is true that means that reserves grew in the month of April by $74.5 billion, the biggest one-month reserve jump in China’s history (and probably in the history of the world).
These Reuters reports have been correct in the past, but I am reluctant to believe the article because this number blows out anything I was expecting (although in retrospect China’s attempt to slow RMB appreciation in April may have had the effect of forcing even greater intervention). Had you asked me yesterday, I would have told you with some confidence that April’s reserve growth would have been alarmingly high, but that the rate of growth would – simply had to – be lower than the average monthly pace for the first quarter.
First quarter reserve growth of $154 billion was unbelievable.China has a number of regulations that limit money inflow, and these are usually set according to quotas for the calendar year, and so I had assumed that this would have boosted first quarter results relative to the rest of the year as investors filled their annual quotas immediately. But I would have been wrong.
To get a sense of scale, in 2006 reserves were up $247 billion for the whole year.This, at the time, was a number guaranteed to shock. No central bank in history has seen reserve growth at anywhere near this scale. Nonetheless in 2007, the growth in reported reserves nearly doubled over the previous year -- $462 billion – and more than doubled if we backed out a series of transactions that reduced headline reserve growth but had no net impact on the monetization of currency inflows.
But that wasn’t the end of record-busting reserves growth. In the first quarter of 2008 headline reserves grew by $154 billion, nearly one-third of last year’s total growth, and if you back out all the non-relevant transactions that reduced headline growth, it represented a significantly larger share of last year’s reserve growth.
But $74.5 billion in April is equal to 48% of the total reserve growth for the first three months of the year.
What is going on?I am reproducing a table I made in my April 12 entry (“So many questions about PBoC reserve growth”) in which I try to put these numbers in some sort of context so as to understand the true monetary impact on China’s domestic money supply, and more importantly to get some sense of the hot money problem. I have made one change to the table – Stone & McCarthy’s Logan Wright told me two weeks ago that around $20 billion of the PBoC transfer to the CIC may have been in the form of ownership of shares in Chinese securities companies, so I have removed $20 billion from the March “Transfer to CIC” column.
We can make some pretty good estimates of several components of this reserve growth. Logan Wright does a lot of the work already and I quote the following from his May 26 report:
The trade surplus in April was $16.7 billion, and foreign direct investment totaled $7.6 billion, so we can only account for $24.3 billion of this increase through these channels. Add in an estimated $6.6 billion in interest income, and that leaves a residual of $44.2 billion.
Even more surprisingly, under our working assumption that SAFE foreign exchange reserve figures are adjusted for currency movements, the dollar rebounded in April, meaning that the foreign exchange reserve figures were likely adjusted down, as the PBOC's non-dollar assets depreciated in dollar terms during the month. Assuming a portfolio of around 20% in euros and 7.5% in yen, this would mean that China's reserve totals should have been $11.6 billion higher during the month, leaving an astonishing residual of $55.2 billion in unexplained capital flows.
Adding these to my table shows the following:
January
February
March
April
Total
Headline reserve growth
62
57
35
75
229
Trade surplus
20
9
14
17
59
FDI
11
7
9
8
35
Currency gains
10
10
18
(12)
26
Interest
5
5
5
6
22
Unexplained amount
16
27
(11)
57
87
Reserve hike
22
-
24
22
68
Adjusted reserve growth
83
57
59
97
296
Unexplained amount
38
27
12
79
155
Transfer to CIC
-
-
75
-
75
Adjusted reserve growth
83
57
134
97
371
Unexplained amount
38
27
87
79
230
As the table indicates, headline reserve growth for the first four months of the year was $229 billion, or 49% of all of last year’s growth. When we add back the reduction in headline reserves caused by the redenomination of minimum reserve requirements, this rises to $296 billion – which means we are already running at well over 50% of last year’s adjusted growth in reserves.When we add back the transfer of PBoC reserves in 2007 and 2008 to China’s “other” central bank, the CIC, reserve growth for the year probably equals two-thirds or more of last year’s astonishing number (I am assuming that adjusting last year’s $464 billion to account for the redenomination of minimum reserves and the CIC transfer would have resulted in real reserve growth of around $550 billion).
It is really hard to know what more to say about all of this. Last week Brad Setser was marveling at the Chinese balance of payments and wondering if there was any definition of “sustainable” that could possibly accommodate this level of reserve growth – almost certainly not, he concluded, and it is hard to disagree.
What makes the process so worrying is that after we have backed out all the things we can easily explain, there is still $230 billion of inflows of which we cannot easily account. Stephen Green of Standard Chartered Bank argues that foreign currency lending and PBoC swaps may account for a portion of first quarter reserve growth, but even if we accept all his numbers, they still only account for a small share of this massive unexplained amount.What else can it be?
Clearly at least part of it must be hot money inflows.For most of the past few years it was China’s trade surplus that drove the astonishing growth in reserves. As I argued way back in 2004 and 2005, China had locked itself into a trap in which rising trade surpluses, the consequence of an undervalued and pegged currency, were causing too-rapid monetary expansion as the PBoC was forced to buy the foreign exchange inflows.
This monetary expansion was channeled by the banking system into higher and higher levels of fixed asset investment, and all this investment resulted in soaring industrial production which, since consumption could not keep up, resulted in ever growing trade surpluses (the trade surplus is the gap between production and consumption).It was hard to know how China could exit the trap without a much more rapid appreciation of the currency.
We have reached what I believe is the end stage of this trap in which the monetary system is forced to adjust through appreciation and inflation. The problem is that in such a case there is a huge risk that hot money inflows destabilize the adjustment process, and this seems to be exactly what is happening. Instead of reducing foreign exchange inflows, the appreciation of the RMB is causing massive hot money inflows (which is not at all surprising, but it has been made much worse by China’s bad luck of having to adjust in the middle of the sub-prime crisis) and so the adjustment must be much more dramatic and much more painful.No matter how quickly China tries to reduce monetary expansion by appreciating the currency, in other words, monetary expansion grows even faster.
Right now much of the attention in China is still focused on the results of the devastating May 12 earthquake. Two unfortunate consequences of the earthquake are likely to be reluctance from the authorities to deal aggressively with these out-of-control money inflows, and the granting of indulgences to the banks that will allow them to ignore lending quotas and to forgive debt a little too easily. An article from today’s China Economic Review explains:
China's banking regulator ordered banks to write off bad loans caused by the May 12 earthquake in order to reduce the debt burden on survivors and help overall reconstruction, state media reported. "If borrowers suffered huge losses that can't be covered by insurance ... the loans should be regarded as bad loans and written off in a timely manner," the China Banking Regulatory Commission (CBRC) said. The CBRC and the People's Bank of China previously urged banks to extend loan maturities and not to push for loan repayment if debtors in quake-hit regions fall behind in payments. Zhang Yun, vice president of Agricultural Bank of China, said the preliminary estimate for the bank's bad loans from the earthquake was US$863 million. Banks have agreed to lend US$11.9 billion to Sichuan province for relief and reconstruction.
This is not the right environment in which to deal with such worrying monetary numbers.By the way the stock market was down 3.13% today.
not a mistake in my view. $75b (really over $80b once you take into account valuation) is actually consistent with a continuation of q1 trends if april was a month with no increase in the reserve requirement (one way of holding fx reserve growth) and no transfers to the CIC (unlike q1). The thing was that until the April number leaked, I wasn't sure if the adjustments Logan and I were doing to the q1 numbers to account for what we thought was really going on (I should note that Wang Tao of UBS was making similar adjustments and also shouldn't be surprised) really made sense -- sense they implied over $200b in foreign asset growth in q1. After the April data, i am convinced.
Long-term US interest rates rose, pushing down the market value of reserves invested in long-term bonds that are marked to market (see Japan). If china marks to market its reserves should also have been marked down. i doubt reserve growth was even stronger than the leaked number implies, which calls into question whether mark to market gains on bonds are a major explanation for the q1 increase.
this cannot go on. but wow, is it spectacular. monthly reserve growth that, if annualized, is close to $1 trillion. who would have thunk ...
p.s. this also helps to explain the huge increase in the fed's custodial holdings. Only China could account for the $60b or so increase in April; Russia alone isn't close to big enough. Nor is Saudi.
By bsetser - 5/25/2008 10:53 PM
Yes, Brad, I spoke to Logan and he agrees that this number is certainly surprising but not at all unexpected. I guess my way-out-there alarmism is no longer as out-there as it used to be, and events are conspiring to push me into the middle of the pack. My quick-and-dirty suggests that in the first third of the year we are already above two-thirds of last year's reserve accumulation (when you add back the CIC transfers and the reserve redenominations). At this rate we are heading for a $1.1-1.2 trillion year growth in reserves unless something dramatic stops the process.
By Michael Pettis - 5/26/2008 2:27 PM
At the present growth rate, China's reserves will amount to three trillion dollars by this time next year, mostly in U.S. government debt. How can the American dollar possibly withstand such an enormous fortune's dominance? Isn't an American devaluation of the dollar increasingly becoming just as likely as a Chinese revaluation of the RMB? Aren't BOTH economies becoming 'trapped' by their disproportionate interdependence? Isn't an economic sneeze in China now an economic heart attack in the U.S.? How is China to diversify its reserves without flushing the American economy down the toilet? Isn't the likely answer: China buys America, using its immense dollar holdings? Isn't the petro-dollar migration of capital in the 1970's from the West to OPEC small change compared to what is about to take place in China? How can China's official socialism survive in such wealth?
Isn't the greatest test yet of capitalism now imminent?
The total amount of US treasuries outstanding is about $5.3 trillion and China and Middle East purchases are going to hit that limit pretty soon. What is interesting is to look at the balance sheet of the Federal Reserve, and it's stock of US Treasuries is started to run down quite dramatically.
It's going to be interesting to see what happens next.
China will shift to agencies and start working through the agency stock long before it runs out of treasuries to buy. that and the US will start issuing more treasuries.
duoist -- if china slows, it likely will run a bigger not smaller current account surplus, so i don't think that is a risk to the us. but the extent of us-chinese financial interdependence does worry me enormously
By bsetser - 5/26/2008 7:28 PM
One fun website to look at is the Federal Reserve Statistical Release
Duoist, I think this is a little dramatic: "Isn't an economic sneeze in China now an economic heart attack in the U.S.?" From where I sit, I would have argued the opposite, and in fact I think Chinese authorities would agree with me, or at least they are acting like they agree. They seem far more worried about the implications to China of a sharp slowdown in the US, and among Peking Univeristy professors I know there is some serious gloominess. It strikes me that the view of China from abroad is radically different than the view of China from inside.
By Michael Pettis - 5/26/2008 7:44 PM
For therir to be such substantial intervention they would struggle to sterilse it. The 7 day repo rate has in fact been increasing .... Hard to see how this could mechanically be true.
By Cameron - 5/26/2008 11:55 PM
i will write something quite controversial, but just a thought. to me, the only thing which is known for sure to grow as fast as China's reserves, is China's commodity bill. think about it. iron ore, copper, oil, and now even coal are imported with quantities much larger than last year at prices sometimes 100% higher than a year ago. and what is it that China export? steel exports are actually half of what they were ago. compared to last year China's trade balance is not doing anything heroic. think about it. China is consuming 1/3rd to half of world's resources (depending on category) each year to produce 8% of its GDP! (and when it comes to resources, I only use nominal GDP). that country wastes 100 million tons of coal every year on inefficient distribution networks, burns twice the electricity for aircons and heating... what is the angle? how can they AFFORD all this stuff? i would not be surprised if all this FX lending and FX reserves growth is actually a red herring and in fact is a reflection of enormous pain China is going through now to deliver those GDP growth numbers. maybe PBoC is using USD receivables from the Sinopec/Petrochina as reserves? I would not be surprised, China has done this before - look at how they "solved" the NPL problem. PBoC just issued notes to the banks at par, and that was it!
By chegewara - 5/27/2008 2:55 AM
chegewara: what is the angle? how can they AFFORD all this stuff? i
Commodities are cheap, and even a badly run inefficient factory generates more wealth than agriculture.
chegewara: China has done this before - look at how they "solved" the NPL problem. PBoC just issued notes to the banks at par, and that was it!
Actually no. Once the banks did a debt-equity swap then there was a massive restructuring of the state-owned enterprise sector so that the bankrupt ones were closed and the good ones were reorganized into quite profitable corporations. The problem with NPL's weren't the existing NPL's, but rather the prevention of new NPL's.
twofish: what do you call wealth? kickbacks for provincial government? does anybody know anything about the true profitability of chinese steel, cement, aluminium plants when all these industries are subsidized? (i suggest you take a look here http://www.americanmanufacturing.org/wordpress/wp-content/uploads/2008/01/energy-subsidies-in-china-jan-8-08.pdf) furthermore, what is the capital return of building 15,000 bridges every year for the past 10 years (and people used to laugh about japan!). i bet building the great wall boosted Qin China's GDP for sure, but at least it didn't require copper :)
twofish: what are your sources on so-called "SOE restructuring"? how many SOEs were actually bankrupted. how many unproductive plants and refineries shut? my npl estimation is loosely based on the scandalous EY NPL report from 2006. if you read it, there's nothing erroneous about it. npls at unbailed institutions (like agri bank, and until recently, CBD) + undisposed-of assets of the four AMCs + npls at the big 4 came to about $900bn in 2006. what is your response to that?
and to be sure, new npls are created evrey day. outherwise 75% of loans wouldn't be given to soes accounting for only 25% value added. thing is, you can trust most of the chinese numbers just as you can trust the announced budget of the PLA. but even so, why do you think of all the BRICs, China is the only country where credit grew MORE IN ABSOLUTE TERMS than GDP for the past decade?
By chegewara - 5/27/2008 5:14 AM
chgewara: does anybody know anything about the true profitability of chinese steel, cement, aluminium plants when all these industries are subsidized?
Subsidies have to come from somewhere. To what extent SOE profitability is "real" and to what extent it was accounting trickery was a major topic of debate around 2003-2005. See Louis Kuijs for one side of the debate, and you can see pointers to people on the other side. The trouble with accounting trickery is that it doesn't last for very long, and I think that the general belief is that SOE profitability has been too high for it all to be due to accounting.
chegewara: what are your sources on so-called "SOE restructuring"? how many SOEs were actually bankrupted. how many unproductive plants and refineries shut?
Again you can start with Kuijs and go from there. The number of SOE's have been drastically reduced from several thousand to several hundreds, mostly through consolidation. Also the main problem wasn't with unproductive plants and refineries. The basic problem was that most SOE's were social welfare societies that weren't producing anything at all. One interesting thing is that a lot of SOE's turned out to have nothing, except urban prime real estate, which is now worth quite a bit.
chegewara: EY NPL report from 2006. if you read it, there's nothing erroneous about it. npls at unbailed institutions (like agri bank, and until recently, CBD) + undisposed-of assets of the four AMCs + npls at the big 4 came to about $900bn in 2006. what is your response to that?
My response is that Ernst and Young can't add. The reason they withdrew the report was that to get $900 billion, they double counted about $300 billion in NPL's. If you have a copy of the original report, I can show you exactly page and the line that they did that. Without that double counting the number goes down to $600 billion of which about $300 billion has been paid off.
chegewara: and to be sure, new npls are created evrey day. outherwise 75% of loans wouldn't be given to soes accounting for only 25% value added
Explain. Also most SOE financing doesn't happen though bank loans, they happen through internal investment of corporate profits. Also, the thing that most people are worried about isn't the big 4 banks, but rather the joint stock commercial banks.
chegewara: thing is, you can trust most of the chinese numbers just as you can trust the announced budget of the PLA
If you can't trust the numbers then why do you think the situation is bad? What people do, which is wrong, is to assume that there are some super secret numbers that the all seeing Politburo has, and take the announced numbers and assume everything is worse. This is silly. If you want to understand what is going on, you really have to dig into the numbers to figure out what they mean.
chegewara: why do you think of all the BRICs, China is the only country where credit grew MORE IN ABSOLUTE TERMS than GDP for the past decade?
I don't know. Why do you think this is the case? I should point out that the money supply has outpaced GDP growth since 1978, one interpretation of this is that the velocity of money has vastly increased over the course of the last thirty years.
Speaking of which, for the past thirty years, you have lots of people saying that the growth in the Chinese economy has been a mirage. Eventually those people will be right. If you predict the end of the world, eventually you will be right. I only ask two things from the doom-sayers:
1) explain why people before got it wrong, and what you are doing that is different
2) give me a time frame. Saying that the Chinese economy will collapse tells me nothing. Eventually the Chinese government *will* make a mistake and the Chinese economy *will* collapse. It makes a big difference though whether that happens next year or a 100 years from now. If you argue that the Chinese economy is a statistical fluke due to bad accounting, then its easy to come up with a date on which the economy will collapse. Estimate the total wealth available, and the burn rate. If it's a year or two and it doesn't happen, then you will have to explain why. If it turns out to be ten years before the bottom falls out, then there is plenty of time to do something.
Now as far as my model of the Chinese economy. Chinese economic growth is being driven by moving people from low productivity farm to less low productivity service industries. It's possible to have extremely high rates of growth in this situation even with a highly broken, inefficient economy (witness the Soviet Union in the 1950's). This growth phase will end around 2020-2030 when you start having lots of old people and when all of the people have already moved to factories, so the goal now is to developed an economic infrastructure so that you can continue to have growth, once China is completely urbanized and in which it is very old. It's important to do things now, because it takes about a decade or two to figure out what to do and do it.
One other thing, you can do the same estimation game with Treasuries. If Chinese reserves are growing at current rates, it can't be more than a year or two before China owns every single treasury bill issued by the US government. Since this can't happen, something interesting is going to happen in the next few months. The other interesting number is the decreasing stock of treasuries that the Fed has on hand. It's only about six months before the Fed runs out of treasuries.
Suppose you want to make someone stop buying something, you decrease its value. The trouble with Treasuries is that they can't pay less than zero percent interest. To get negative interest, you have to have inflation which is what is happening in the world.
The end of Bretton Woods II is looking a lot like the end of Bretton Woods I.
Scary thought: I wonder if the fact that the Fed opened the discount window to broker-dealers ended up creating a tidal wave of hot money that ended up in China. As long as the discount window is open only to commercial banks, then there is a limit to the flow of hot money. Once the Fed opened the discount window, you now have a straight path to China.
Can't help wondering if NPLs from way beyond are still lingering around, perhaps not in the top 4 banks but perhaps in the smaller regional or functional banks? But do agree that in the present climate the greatest problem where NPL s are concerned are how to prevent loose monetary atiitudes from spawning NPLs the next generation.
Thing is with the informal banking system is loose monetary system a matter of fact?
One thing I 've always wondered about, what makes them so sure (the people directing those lava flows) they have a water-tight exit option and they can enforce it before everyone else?
I've seen Kuijs' report, and there is also a confronting point of view that a lot of these SOEs simply re-classified into JVs. if you look at who is really running these companies there would be no difference between before the NPL clean-up and after. I can provide some of the sources i'm basing this on later.
I agree that a lot of NPLs turned out to be "non-assets" at all. if you keep on giving loans to the company that literally burns money (buy commodities - produce an unnecessary bridge), eventually you are just paying for the losses - that benefits only people that receive salaries (esp management, which often happens to sit on the board of the banks - see the steel industry report from above for examples) and suppliers.
RE the NPL estimate - yes I do have the copy - whch line? I also happen to have presentations from PwC which explained the PBoC note swap and S&P report with estimates on NPLs at unbailed institutions. NPL disposal in China has always been a super shady process. tender offers announced at random local newspapers at random times and then transacted upon with connected parties. look at companies like Silver Grant, that have been feeding on NPL disposals and run by the same people that issued the original loans, then grouped them into NPLs at the AMCs and then moved the best of them into the private sector at 5c on a dollar.
RE credit allocation: a few papers (McKinsey global institute had a report on this back in 2006) looked at what percentage of outstanding loans corresponds to specific segments of economy by value added. Private sector was close to 2/3ds of GDP (ok, not 3/4ths) with 1/4 of loans oustanding. also, there are numerous papers from WB/IMF that looked at whether interest rates charged by banks differ by segment (yes, they do, SOEs always pay the minimum), or by provinces (the biggest lagging provinces are getting outsized loans). do you want to say that in a situation where prices are subsidized and inflation is still 8% charging negative interest rates results in effective allocation of resources? i know that statistically SOEs finance themselves mostly through retained earnings (if these are real) - this is the most disturbing part of it. PRC is raping its citizens through financial repression (ceiling on deposits and no alternatives for savings, few papers about it out there), not requiring SOEs to provide return on the capital through dividends, money that could be spent on basic healthcare, education and/or implementing the rule of law (you have to BRIBE to actually get these and judiciary system is directly controlled by the CCP, isn't it?)
RE trustworthiness of the Chinese stats - so do you think PLA budget is not understated by the factor of, say 3-5x? thing is, i'm sure there is some statistics that only the politburo sees, but mostly numbers are not reliable because the country is at its present political state (with local authorities doing essentially what they please) the whole country is just, well, mathematically unmanageable. silly as it might sound to you, if you dig into some of the numbers, you DO see major inconsistencies (i personally enjoy inclusion wholesale sector in the retail sales, that leaves a lot of foreign retailers wondering why they don't sell much to Chinese middle class). and you DO see corruption at the highest levels of political hierarchy (as a percentage of population China now has more bureaucrats than in Qing days). how about that SAFE director that jumped off the building back in 2003 being suspected in surprise >fx reserves embezzlement<? Chen Liangyu anyone?
about the credit to gdp. this is really easy and is same as USA that "borrowed" growth by allowing banks to print money. i suggest you get a copy of jim walker's "off the rails" reports from the asianomics.
i'm not a doomsayer, by the way. i just think China will have to completely revamp its financial system and also massively upgrade the rule of law - unfortunately this will require a crisis - which is coming in the form of the global slowdown. once it does that, there will be a replication of Deng Xiaoping's reforms in wider sectors of the economy and a subsequent boom in growth.
i will also have to say at this point that too many people get fixated on two numbers. first is 1.3bn people (this is Satyajit Das' ironic "armpit theory" - 2.6bn armpits in China, all needing deo sticks that can be sold to them). another one is 10% growth; for the naive, headline is all that matters so while people understand that there are externalities of the growth that perhaps make it all look rather less glorious, this is not reflected in investment decisions.
finally your comments on treasuries. i remember reading something similar in greenspan's memoir, where "maestro" basically mentions how they were "concerned" that market would "run out" of treasuries because low and behold, budget was in surplus in the late 90s. of course we all know what happened - budget was very very unbalanced after the dot-com bubble burst and it remained very unbalanced ever since. trust me - there will be no lack of issuance out of treasury. lump-sum the agency and FHLB debt to the outstanding securities (oh they will get bailed out) and China can have all the fun it wants (seriously THIS is silly, not sure when/if ever China "collapses", bu know for sure that China's TB >WILL COLLAPSE SOONER< than US runs out of treasuries). on the other hand, would not be surprised if "geniuses" from the IBs are flogging into RMB, this is my second favorite explanation. RMB NDFs were forecasting 12% appreciation back in April - must have taken a lot of fools to move it that far.
By chegewara - 5/27/2008 7:31 PM
chegewara: I've seen Kuijs' report, and there is also a confronting point of view that a lot of these SOEs simply re-classified into JVs. if you look at who is really running these companies there would be no difference between before the NPL clean-up and after
Not JV's. Listed companies. Probably about 50% of the companies were simply converted to listed companies. The reason that this fixed things was that they were viable companies which just had too much in the way of social security commitments. If you look at *why* companies were losing money, the reason wasn't bad management. It was that they were put in situations which were fundamentally economically unviable. If you can't fire workers, then the money you are using to pay them can't go into investment of new plant. Now *someone* has to take care of social welfare, but you can't make it the job of the SOE's.
Also you have other things like creating a central capital budget and creating SASAC.
chegewara: that benefits only people that receive salaries (esp management, which often happens to sit on the board of the banks - see the steel industry report from above for examples) and suppliers.
Salaries, healthcare, housing, education, pensions etc. etc. SOE's were responsible for all of that, and what's more in 1990, there were no alternative channels to provide these social services. Also, managers of the SOE's didn't sit on bank boards, and they weren't the primary beneficaries of the bank loans. Also if you look at managers in SOE's, they didn't make that much money.
chegewara: yes I do have the copy - whch line? I also happen to have presentations from PwC which explained the PBoC note swap and S&P report with estimates on NPLs at unbailed institutions
This is from memory, but if you look at the numbers in the E&Y report, and look carefully at the NPLs already existing, you'll see that they add those into the total NPL's twice. You will note that E&Y gives larger numbers that PwC and S&P. One problem with economic estimates is the echo chamber effect. If you are pessimistic about the Chinese economy, then you take the worst number and pass it on. The trouble is that someone else takes the worst number adds a fudge factor and passes it on, and so forth until finally you are completely out of touch with reality.
Also, the general tone of the E&Y report makes it pretty clear that they were just promoting their NPL business and that it's marketing literature.
chegewara: look at companies like Silver Grant, that have been feeding on NPL disposals and run by the same people that issued the original loans, then grouped them into NPLs at the AMCs and then moved the best of them into the private sector at 5c on a dollar.
As with a lot of other things, it's not clear to me if this is a good or bad thing. Asset striping a viable company is a bad thing. But if someone takes a company that has been pronounced dead, moves it into the private sector and then makes a huge amount of money from this, I'm not sure that this is economically a bad thing. You do end up leaving for the government the cost of social welfare liabilities, but separating those from commercial activities was the whole point of the process.
Just because someone personally benefits from something doesn't make it wrong (which was Deng Xiaopings whole point).
chegewara: do you want to say that in a situation where prices are subsidized and inflation is still 8% charging negative interest rates results in effective allocation of resources?
Prices of raw materials are stabilized which means that sometimes (like now) they are below market prices and sometimes they are above market prices. This does reduce the consequences of price shocks. As far as effective allocation or resources, you can calculate the deadweight loss due to resource misallocation, and I don't think that it is killing growth.
chegewara: so do you think PLA budget is not understated by the factor of, say 3-5x?
There is the official PLA budget which is an accurate reflection of amount that is transferred to the PLA from the central treasury. Then there is the amount that the PLA gets from subsidized factories and other budget transfers. The big factor in trying to guess PLA budgets is how you adjust for differences in PPP and personnel costs.
chegewara: but mostly numbers are not reliable because the country is at its present political state (with local authorities doing essentially what they please) the whole country is just, well, mathematically unmanageable. silly as it might sound to you, if you dig into some of the numbers, you DO see major inconsistencies
Yup, but nothing that suggests to me that China is about to collapse or that economic growth isn't real.
chegewara: you DO see corruption at the highest levels of political hierarchy (as a percentage of population China now has more bureaucrats than in Qing days).
True, but the failure of the Qing dynasty was that the country was massively under-governed. Also corruption is the markets way of telling you that you aren't paying your officials enough. Also, you had massive amounts of corruption in South Korea, Taiwan, and Hong Kong during their growth phases. Corruption isn't a good thing, but there is nothing that I've seen that suggests that it is killing the economy.
chegewara: about the credit to gdp. this is really easy and is same as USA that "borrowed" growth by allowing banks to print money. i suggest you get a copy of jim walker's "off the rails" reports from the asianomics.
Except if there is real wealth creation going on, then you really do need to print money.
chegewara: i'm not a doomsayer, by the way. i just think China will have to completely revamp its financial system and also massively upgrade the rule of law - unfortunately this will require a crisis - which is coming in the form of the global slowdown. once it does that, there will be a replication of Deng Xiaoping's reforms in wider sectors of the economy and a subsequent boom in growth.
The financial system has massively changed in the last few years. Also, China is in the "mid Soviet" phase of development where the productivity gains that result from urbanization overwhelm any financial or industrial system inefficiencies. The thing about financial systems and legal systems is that "wait for a crisis and change everything" seldom gives you good results since you don't often know what to change the system to. Deng Xiaoping genius was to ditch ideology and just move the system through one step at a time.
chegewara: headline is all that matters so while people understand that there are externalities of the growth that perhaps make it all look rather less glorious, this is not reflected in investment decisions.
If you know of a better path of economic development, I'm interested. Economic development is fundamentally a very messy process, and the tradeoffs that China is making (i.e. wrecking the environment) are not unusual for similar societies. Also, people will make mistakes. If someone went back in a time machine to 1985, then the process of industrial restructuring would have been done differently and someone could have paid more addition to health care. However, we don't have complete knowledge of what is going on, and I fundamentally distrust people that think that they do, and that don't realize that we are probably doing about five or six things now that we will regret later.
chegewara: budget was very very unbalanced after the dot-com bubble burst and it remained very unbalanced ever since. trust me - there will be no lack of issuance out of treasury.
Yes, but if you increase government borrowing this creates fiscal stimulus that increases inflation. The Federal budget has actually moved back into balance over the last few years. Also exponential growth curves are unsustainable so that you can put the limits of Federal lending where ever you want and if trends continue, those limits will be breached. So those trends can't continue.
chegewara: this is the most disturbing part of it. PRC is raping its citizens through financial repression (ceiling on deposits and no alternatives for savings, few papers about it out there
Trouble with not having depositor interest caps is that then you end up with the US S&L problem. Unless you have a system of financial regulation, then people will invest their money on whose lies the most.
chegewara: not requiring SOEs to provide return on the capital through dividends
Except that if you aren't careful with dividend policy then you end up punishing well run companies and rewarding badly run ones. One general problem with SOE's is that the second they make a profit, the state takes all of the money. What then is the point of making a profit? The understanding that SOE's could make profits and the state wouldn't take them except through taxation was made in the early 1980's and it is something that you really don't want to change without a lot of thought.
chegewara: money that coulde spent on basic healthcare, education and/or implementing the rule of law (you have to BRIBE to actually get these and judiciary system is directly controlled by the CCP, isn't it?)
The problems in healthcare, education or judicial systems aren't due to a lack of total wealth available. It's getting the money to the right people which is much harder than it sounds. In order to fund social services, you have to have a decent tax system, and much of the 1990's was trying to get together a decent taxation system.
As far as the judicial system, for economic cases in major population centers, the courts are pretty good. The big problems are less political interference than a lack of qualified judges.
There is something odd here. First you are complaining that state is extracting too much wealth from the citizens by using interest rate ceilings, and then you complain that the state is extracting not enough since social spending on health and education is insufficient. One second, bureaucrats are evil and corrupt, and then next second you rely on them for health and education purposes. One second, its a bad thing that someone makes a lot of money, and then next second, its a bad thing that someone isn't allowed to make a lot of money.
There are a lot of tradeoffs in getting a functioning economic system and one of the difficulties is that you just can't impose a new system on people, you have to work through existing people and shape incentives. People *will* act in their self-interest, and the trick is to set up self-interest so that you get social good. There is a school of thought that the best thing to do is to have a crisis, which gives you a blank slate in which you can do whatever you need to do to come up with a perfect system.
Given the experience with the Great Leap Forward, the Cultural Revolution, and shock therapy in Russia. I don't think this is a particularly good thing to do.
twofish: There is something odd here. First you are complaining that state is extracting too much wealth from the citizens by using interest rate ceilings, and then you complain that the state is extracting not enough since social spending on health and education is insufficient.
i am not complaining about state doing or not doing anything here. you are totally missing the point. to make things work the state has to let the markets operate more freely. THE MARKET has to decide what is an adequate return on capital or not. THE MARKET has to decide what is an adequate interest rate (and, by the way, the exchange rate as well).
Saying smth like "if the CCP allowed freedom in this part of the market or that it would result in an S&L crisis" is a very tall order. the types of institutions that seek entry into China are HSBCs, BoAs etc of this world, not Countrywide Financials. yet CCP made it IMPOSSIBLE (because these banks care about the return on capital) to do anything, except take passive stakes. I very much doubt that China would have steel mills in EVERY province if it was not for the fact that people from provincial government were involved simultaneously on the lending, subcontracting, managing and reaping benefits side of the deal (btw to say that Chinese bureaucrats/SOE managers are underpaid is myopic, obviously if you control supply of refined products at $60/bbl you CAN make money).
I think we are too ideologically different: you think that it is possible to "manufacture" GDP by purely building inefficient plants. the fact that they are inefficient is only better. the more inefficient, the more coal fired plants have to be built (which are in turn inefficient too). the more coal fired plants, the more railways. growth is great, right? well, so is breaking your arm, or just breaking a glass (lest you think it's a personal attack :)) - it is GOOD for growth. Sichuan earthquake will make GDP growt, i'm sure. But is it really what you call "wealth creation"? and you are wrong that there are no alternatives to the command and control (directed if not by the central govt technocrats, then by the local economic warlords) growth that China is undergoing. in fact, there are more failures of command and control than successes. you may say "China and Korea" did the same thing. to some degree yes - and you had big crises there as a consequence of the investment booms to be sure. both the Chaebol and the Keiretsu system were FAILURES ultimately. it will take a crisis of the similar kind in SOEs (I must admit I miss your point on Listed companies in its entirety, since they are 80-90% controlled by the government) to reshape the system (sell the govt stakes in SOEs and banks - have you thought about it?).
there are plenty other points you wrote about (you must be an academic!) - unfortunately i work in the industry so my further replies might take a while.
By chegewara - 5/27/2008 11:09 PM
twofish: Yes, but if you increase government borrowing this creates fiscal stimulus that increases inflation. The Federal budget has actually moved back into balance over the last few years. Also exponential growth curves are unsustainable so that you can put the limits of Federal lending where ever you want and if trends continue, those limits will be breached. So those trends can't continue.
ok, now that i got a minute - that's interesting. fed budget has been in red since 2002. even with record receipts from housing bubble it never moved into surplus. my question to you: what do you think the budget will look like this year? will the deficit be bigger than 400bn in 2004?
for an example where government spending does not lead to a stimulus look at the bail-out of bear sterns. in general, look at how fiscal spending did not result in inflation in Japan in the 90s. this is an argument which is completely wrong. fiscal stimulus will not work in US same way as in 2001, because we are in the different stage of the credit cycle - people will use the money for the victuals (i.e. food) or paying back debt.
By chegewara - 5/28/2008 12:03 AM
chegewara: i am not complaining about state doing or not doing anything here. you are totally missing the point. to make things work the state has to let the markets operate more freely. THE MARKET has to decide what is an adequate return on capital or not. THE MARKET has to decide what is an adequate interest rate (and, by the way, the exchange rate as well).
And I'm saying that macro-economically that just isn't going to work. States are horrifically bad at distributing capital between different industries, but to have a functioning market, you have to have pretty massive state intervention. That intervention is indirect (i.e. selling or buying treasuries), but it has to be there. Interest rates are largely determined by governmental fiscal and monetary policy.
chegewara: Saying smth like "if the CCP allowed freedom in this part of the market or that it would result in an S&L crisis" is a very tall order.
It's basically what happened in the United States in 1980 after the Federal Reserve abolished Regulation Q which capped interest rates. The problem is that to boost return, you have to boost risk, and without regulation financial institutions are pressured to make extremely risky investments, which then proceed to blow up. I do think China would be better off with more flexible interest rates, but flexibility and regulation have to move in lock step with each other.
There are many ways in which the Chinese financial system
was marveling at the Chinese balance of payments and wondering if there was any definition of “sustainable” that could possibly accommodate this level of reserve growth – almost certainly not, he concluded, and it is hard to disagree. 
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