One of the things I always tell my smarter students is that the best time for them to be in government is during a crisis, when there is a lot of pressure to give power to the technically proficient rather than the politically connected.Given the increasing anxiety in the leadership about the accelerating economy and inflationary pressures, this may be such a time.Perhaps because policy conflicts seem so deep, there are now rumors that Wang Qishan may be appointed governor of the PBoC and Vice Premier.I am not by any means a political insider and have no idea if these rumors are good ones, but it is worth pointing out that Wang, a protégé of hard man and uber-reformer Zhu Rongji, is reputed to be a smart, tough, problem solver.
December’s trade surplus came out on the low side -- $22.7 billion, instead of the $24-5 billion most were expecting, and less than the $26.2 billion recorded in November.This brings the annual surplus to $262.2 billion, 48% higher than last year’s surplus.
Export growth has slowed a little – 25.7% in 2007 relative to 27.3% in 2006 – while import growth speeded up – to 20.8% in 2007 relative to 21.7% in 2006. These figures underestimate the slowdown in export growth because much of it happened at the end of the year.In December export growth was “only” 21.7%, compared with last month’s 22.8%.Import growth however rose slightly from 25.3% in November to 25.7% in December.
Many analysts are suggesting that we may have seen a cresting of export growth and perhaps even the trade surplus. I am skeptical.I think recent export-related cooling measures, plus the surge in oil prices, may have brought the trade surplus down temporarily, but the figures are still very high and money growth is still excessive.Once the initial cooling measures on exports wear off (not to mention when the anti-inflationary cooling measures on consumption kick in) we will get back to the old dynamics of an expanding money supply leading to expanding industrial production leading to expanding exports.Remember, even if the trade surplus begins to grow less quickly, and most economists expect it to grow by at least another 20% this year, it is still extremely high and hot money inflows will probably be substantial, and so the expansionary pressure on the domestic money supply will remain unabated. Brad Setser has a very interesting, not-yet-published piece that suggests hot money inflows are picking up, which does not really surprise me given the huge yield pick-up in holding RMB relative to dollars.
Of course if we really do see a real and persistent fall in export growth, perhaps because of a US slowdown, the corresponding counter-entry won’t be a surge in domestic consumption so much as a surge in inventory, since after so much monetary expansion it will be quite a while before industrial production can slow down to accommodate Chinese consumption growth.This is, to me, the danger scenario and the typical end of a 19th Century-style overinvestment cycle.
In a conference today, Shang Fulin, chairman of the China Securities Regulatory Commission (CSRC), said the country will encourage companies to sell more shares domestically.The securities regulator plans to “expand the scale of fundraising in the capital market, increase the amount of tradable shares and push forward the listing of large companies and high-quality medium-sized companies.”
For a while we have been hearing that one of the best ways the country can deflate the stock market bubble is by increasing the supply of shares. This will allow it soak up some of the flood of money looking for a place to go, and will reduce the need for heavy-handed measures that the government now employs to knock down the market every few months.
This is almost certainly true. China suffers from too much money looking at too few investment opportunities, and not surprisingly the result has been credit bubbles, real estate bubbles, stock market bubbles and much else. The government’s main way of managing down the stock market – various administrative measures – is not only very inefficient but, as I argued in an entry last week, actually retards the development of a well-functioning stock market by undermining fundamental investment strategies and strengthening speculative strategies based on predicting government behavior. But, as an indication of the quandary in which the government has found itself because of its slowness to address the currency regime, if the CSRC is really serious about increasing the selling of shares in the domestic markets it will seriously undermine attempts by the PBoC to control inflation and overheating by reining in lending.
The PBoC hopes that by imposing caps on loan growth it can reduce China’s torrid pace of investment, which is seen as key to the overheating problem facing the country.As I have argued earlier, we need to be skeptical about the effectiveness of these caps on loan growth because there are too many reasons why banks, corporations, and provincial leaders are going to resist.In fact last week at the end of its two-day conference, for the first time in years, the PBoC was not able to announce loan growth targets for the year – probably because the policy was too controversial to resolve.
But even if it does succeed in reining in loan growth it won’t matter. One of my recurring arguments is that if China’s lack of a domestic monetary policy is the real culprit, which I believe it to be, administrative measures such as capping loan growth will simply force money to flow through other channels into overinvestment.Here, it seems, the CSRC is going to help prove my point.By encouraging companies to sell more shares, they will take money away from the banks – who presumably aren’t able to lend it anyway – and pass it on directly to corporations who will then spend it on new investments.The only difference is the structure of the corporate and banking balance sheets, but the money will still end up invested.
However this difference is not negligible, and this is a very important consideration. If China is anyway going to suffer from an overinvestment crisis, it will be much better for China if corporate funding is raised in the form of equity rather than debt. This reduces the financial distress costs to corporations after the crisis, speeds up their recovery, and perhaps most importantly of all, reduces the future growth of non-performing loans in China’s already shaky banking system.
So I agree wholeheartedly with the CSRC’s plan to encourage share sales, but not because it will help soak up liquidity and so reduce the consequences of China’s out-of-control monetary policy. I think it will have no such effect, and only policies that directly address the accumulation of capital inflows can ever do that.I think this is a good policy because it will significantly ease China’s recovery if it is forced into an ugly adjustment.
China is still trying to figure out what policies will help prevent a crisis. I think it is just as important to figure out what policies will minimize the economic impact of a crisis if and when it occurs.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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January, 2008
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