Andy Xie

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Too much debt permeates the country's economy, local governments and businesses. As I travel across the country, I mostly hear about local governments and businesses that are absorbed with managing solvency by resorting to ever fancier borrowing tricks. Many, if not most, local governments are borrowing to pay the interest on their debts. Businesses often cook up new projects to borrow more so they can manage their existing debt stock.

Debt and overcapacity form a vicious spiral. The latter diminishes cash flow for debt-laden projects. As local governments and businesses borrow more in the name of new projects to pay interest on existing debt, they exacerbate the overcapacity situation. China must stop the debt-capacity spiral. Continuing it provides no way out.


Investing in the Future
http://english.caixin.com/2014-06-03/100685451.html

http://english.caixin.com/2014-06-03/100685451.html?p2

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China must allow bad loans to fail for the good of its economy
http://www.scmp.com/comment/article/154 ... ts-economy

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China has a large trade surplus. It should have control of domestic liquidity. Hence, a periodic injection of liquidity, for whatever claimed purpose, is actually to prop up troubled financial institutions and their troubled borrowers. Capital and elite attention are all focused on rearranging the tables and chairs to keep a leaking boat afloat.
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Fiscal stimulus can stabilise the economy. Financial reforms must then follow. Too many financial institutions, even some large ones, are merely Ponzi schemes.


Reform, not monetary stimulus, is China's only choice to revive growth
http://www.scmp.com/comment/article/159 ... ive-growth


Andy Xie says to revive growth, China must step up market reforms to tap its inherent competitiveness, while shutting out calls from vested interests for more monetary stimulus

PUBLISHED : Tuesday, 23 September, 2014, 5:58pm

UPDATED : Wednesday, 24 September, 2014, 4:30am

China's economy continues on a downward trend. The main reason is the lack of significant reforms to implement the decision of the party Central Committee's third plenum. Sentiment, both at home and abroad, is at the lowest point in a quarter of a century. If reforms remain just talk, not action, the downward spiral could trigger a financial crisis.

To stabilise the economy, China must cut taxes by 1 trillion yuan (HK$1.26 trillion) or more. Value-added tax should be cut to 13 per cent, from 17 per cent, the top personal income tax rate slashed from 45 per cent to 25 per cent, and contributions to social funds halved for three years.

The central government should issue fiscal bonds to plug the resulting shortfall. To ensure the fiscal deficit is temporary, it should cap spending by local governments and the companies under their control.

Since the last quarter of 2011, China's economy has been deflating, a consequence of irresponsible, illogical and massive monetary stimulus in response to the 2008 global financial crisis. China has wasted tens of trillions of yuan on image projects and property speculation, all in the name of preserving its gross domestic product growth rate. The resulting bad assets are now weighing down the financial system.

The periodic injection of liquidity merely allows troubled financial institutions to delay reporting bad loans. They don't have the capital or ability to finance China's economic transformation.

International experiences of coping with numerous crises since 2008 show that injections of liquidity have a limited and diminishing effect. Fiscal stimulus is a much more potent tool to stabilise a declining economy. And, most of all, only structural reforms can revive a troubled economy on a sustainable basis.

China needs to cope with the consequences of the misguided stimulus in the past and restructure the economy to create another growth cycle. If attention is all focused on covering up past mistakes, it merely delays the inevitable, increases the bill for the eventual tidy up, and delays the beginning of a new growth cycle. As China's population profile ages, the delay may see the middle-income trap become a self-fulfilling prophecy.

There are three paths awaiting China within two years: stagnate, blow up, or break out. The current decisions of the leadership appear to be guiding the country towards the first scenario.

China has a large trade surplus. It should have control of domestic liquidity. Hence, a periodic injection of liquidity, for whatever claimed purpose, is actually to prop up troubled financial institutions and their troubled borrowers. Capital and elite attention are all focused on rearranging the tables and chairs to keep a leaking boat afloat.

The first scenario is similar to Japan's experience after its property bubble began to deflate in 1992. But, China isn't Japan. A trade surplus doesn't guarantee total control of domestic liquidity. The Japanese have an extremely strong domestic bias when it comes to storing their savings. Rich Chinese, by contrast, have a tendency to take their money offshore.

Another volatile element is the large share of wealth in China's deposit base. If the government was unable to prevent such money from leaving the country in a run, similar to what happened to Indonesia after 1997, a full-blown financial crisis could occur.

China is in a unique position to break out from the current paralysis and jump-start a new growth cycle to turn the country into a high-income economy before 2030. Chinese people remain highly competitive in the global economy. This is the most powerful engine for the economy.

Reforms are necessary to turn that competitiveness into world-beating products on the supply side and middle-class consumption on the demand side. All it takes is to shrink the size of government and give the market more room.

Fiscal stimulus can stabilise the economy. Financial reforms must then follow. Too many financial institutions, even some large ones, are merely Ponzi schemes.

A popular saying is that the financing chain must be kept intact. When a business goes bust, a break in the chain usually gets the blame. But that ignores the fact that such businesses were not solvent to begin with. To keep all the Ponzi schemes afloat, the central bank will be forced to inject liquidity again and again.

China's problems are mostly self- inflicted. The elite usually support monetary expansion, which powers asset inflation and fixed-asset investment that enrich insiders. This is why today's dominant opinion on curing the economic ills is still to increase the money supply.

China's internal debt load is already massive. If it continues to grow like before, people will be too frightened to hold more currency.

This is why a new theory on renminbi internalisation is gaining popularity. Instead of 1.4 billion people, some argue, 7 billion people in the world could hold up China's printing press, and, hence, there are no limits to how much yuan can be printed.

That such a fantastical theory is gaining popularity shows how wedded the vested interests are to monetary inflation.

It is puzzling and painful to see inaction on the reform front. Waiting won't bring a miracle. The prevailing theory is to maintain the growth rate with stimulus for the sake of social stability. When everyone throws in the towel for the future, there won't be any stability left to preserve.

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$60 oil will be norm for next 5 years: Economist
http://www.cnbc.com/id/102259827#.

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China economy suffering from government 'over investment'
http://www.bbc.com/news/30490554

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Policymakers' coddling of market failure exacerbates cycles of boom and bust

Andy Xie says market volatility is a feature of our boom-and-bust global economy today, and government policies that subsidise speculation by cushioning the downside are to blame

For two decades, markets have not been allowed to clear. Every downturn is met with stimulus policies to sustain the status quo.

Low interest rates have spawned numerous Ponzi schemes around the world. The time seems to be up, at least for some. The shocks in oil prices, the Swiss franc, internet concept stocks and China's A-share market are the harbingers of what is to come. For speculators, 2015 will be the year of living dangerously.

The rising US dollar and falling property prices in China are symptoms of an ageing global bubble. They symbolise global monetary tightening in the form of a slowing velocity of money, indicating that less buying and selling is taking place. Bubbles don't last forever, even with policy support.

When the US Federal Reserve began its quantitative easing policy after the 2008 financial crisis, it triggered a sharp fall in the dollar and inflationary pressure in emerging economies. The latter sparked a credit-cum-investment boom, in China first. The resulting surge in commodity prices triggered an investment boom in emerging economies in general. The boom justified the declining dollar. The declining dollar, rising velocity of money and surging growth in emerging economies formed a self-sustaining dynamic.

An investment boom is a kind of Ponzi scheme; factories make money by helping others to build more factories. The process goes on as speculators increase exponentially. At some point, though, there won't be enough new speculators joining the game and overcapacity then becomes widespread. Deflation ensues.

Since 2008, China has overinvested by more than US$6 trillion. That overspending was the reason for high commodity prices and the boom in emerging economies. As China slides into deflation to digest the overcapacity, the commodity market is heading into the ice age. The rising dollar is a consequence, not the cause, of the deflationary phase in emerging markets. The feedback loop takes deflation into the developed economies, too.

The emerging market boom has fuelled multinational companies' profits and, hence, the stock markets in developed economies. That lit a fire in the property markets of major financial centres.

Wherever there has been a surging trend in the world, the odds are that it was a byproduct of the emerging market boom.

The US economy is accelerating. Some say the Fed's policy is finally working. The reality is not so rosy. Deflation in emerging economies is making goods, oil in particular, cheap for American consumers who are famous for spending their last cent, and then some.

The growth driver is similar to what happened before 2008. But, the US supply side is weakening. The energy sector, such as shale gas and oil, has played a leading role in the US recovery after 2008. Now it has to contract. When the growth dynamic is rising consumption and weakening production, it is not sustainable.

The sorry state of the global economy, going from bubble to bust again and again, is a consequence of bad policies in major economies. For two decades, markets have not been allowed to clear. Every downturn is met with stimulus policies to sustain the status quo.

The global economy has become hopelessly out of balance. But the consequences of the rebalancing that is needed are so frightening that policymakers have buried their heads in the sand and go on talking about expedient measures to shore up the status quo.

This generation of policymakers, financiers and businessmen don't know what a normal market economy is. Their psychology is shaped by bubbles. Look at the current generation of internet entrepreneurs. They believe their own hype.

When push comes to shove, they make their own bubbles by announcing ever higher valuations in rounds of private financing. When this bubble pops, hundreds of billions of dollars in imaginary wealth will evaporate.

A bubble is, at best, a zero-sum game. Unfortunately, in the real world, bubbles tend to waste massive resources. Plummeting labour participation rates in the West and surging overcapacity in the East symbolise massive waste in the global economy.

The root cause of the global imbalance is government policies that subsidise speculation by cushioning the downside. More and more resources have been sucked into speculative activities.

In the East, governments tend to tax labour to support production. Hence, speculative activities occur mostly during the formation of new capacity. In the West, central banks view financial stability as the key to economic growth. Speculative activities there go into inflating the prices of existing assets. As these activities grow, policymakers literally think of how speculators will react when making policies. Hence, the global imbalance becomes larger and larger.

Rearranging the deck chairs on the Titanic is of little use. The bursting of the bubble may be happening in slow motion. Most policymakers would view it as a policy success. But, what next? Would inflating another bubble be the way to go?

Kicking the can down the road simply incurs higher and higher costs. One day, the problem will be so big that the world just slides into chaos, revolution and armed conflict.

We have been there before. Will we repeat the tragedy?

Andy Xie is an independent economist

http://www.scmp.com/comment/insight-opi ... ycles-boom

Source: South China Morning Post

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Iron Ore Seen Below $40 by Andy Xie on China Steel Slowdown

http://www.bloomberg.com/news/articles/ ... mand-drops

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Economist Xie on China's Economy, Government Policy
http://www.bloomberg.com/news/videos/20 ... ent-policy

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China's surging stocks: why the bull-run days are numbered
http://www.scmp.com/comment/insight-opi ... e-numbered

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Monetary easing won't resolve China's economic imbalance

Andy Xie says China can no longer monetise away its bad credit decisions, as it did when the economy was smaller and simpler. Quantitative easing only delays the inevitable: painful reform

Quantitative easing cannot revive credit growth.

China may have already begun its own version of quantitative easing, putting local government debts directly or indirectly onto the central bank's balance sheet. Corporate and financial-sector debts could eventually make their way there, too. As quantitative easing in the US, Japan and the euro zone has led to currency devaluation in those places, stability of the renminbi could soon become a challenge.

Since 2008, China's M2 money supply has tripled and debt has quadrupled, while nominal gross domestic product has doubled. The massive leveraging in such a short time span reflects the rise of a gigantic property bubble. As China's credit system functions on collaterals, when land prices are surging, credit and money supply accelerate too, which further inflates land prices. The spiral is the reason for so much debt in such a short period.

China's domestic debt is likely to reach 300 per cent of GDP, with 230 per cent of it in the real economy and 70 per cent financial sector debt. The mountain of debt is primarily with local governments and property developers.

The land market is pretty much dead in most cities. If appraised realistically, over 90 per cent of developers may already be effectively bankrupt. But, in China's government-controlled financial system, they have merely become zombies.

As property developers have become zombies, so too have the local governments they finance. Some local governments, even among the rich coastal provinces, have trouble paying their employees and are resorting to squeezing businesses to prepay their taxes to stay afloat.

Obviously, something has to be done about liquidity for local governments. But, should it be just about money? If the debts are merely forgiven, the same would surely happen again, as it has many times before.

Further, if sound reforms are not undertaken, the quantitative easing is likely to lead to a devaluation of the renminbi, as has happened to the dollar, euro and yen. In the case of China, currency devaluation has unpredictable consequences for domestic stability. In the past, every significant devaluation has been followed by some social instability.

China's economic success between 1994 and 2002 had much to do with its hard currency policy: depreciation pressure was alleviated through structural reforms to boost competitiveness. But, the depreciating dollar after 2002 gave China the opportunity to become more inefficient without worrying about the exchange rate. As the dollar reverses its trend, the consequences of the poor policy decisions of the past are all beginning to bite.

Before 1994, China monetised bad credit decisions and accepted devaluation. Will it revert to this habit?

There are two differences between now and pre-1994. First, the amount of debt is much bigger. Before 1994, China's financial system was very shallow. Devaluation would trigger goods inflation quickly, with limited long-term financial implications.

The large financial system today means that a substantial devaluation would have a big impact on household wealth. Many who have made it into the middle class could be pulled back.

Second, China is now the largest export economy in the world. Two decades ago, exports were a fraction of today's level. Devaluation today would surely trigger a tsunami in the global financial market. A political backlash in major trading partners like the US would be likely. A potential trade war would be very bad for China.

Further, without structural reforms, quantitative easing cannot revive credit growth, as experience in the US, the euro zone and Japan show. It merely stops the credit system from contracting.

As local governments and property developers become zombies, their suppliers, such as construction companies and equipment manufacturers, will become zombies, too. Quantitative easing would merely bring stability by destroying growth.

A zombie economy cannot support further expansion. The stock market bubble is filling the gap temporarily; inflated stock prices could be pledged as collateral to support credit creation. This continuing credit growth means that dealing with the consequences of a property bubble burst can be postponed.

But, the stock market bubble is likely to burst this year. What then?

China's economic tasks are: one, to deal with the consequences of the property bubble; and, two, to reach a sustainable balance between investment and consumption. The numerous micro problems that many analysts like to point out stem from these two macro challenges.

When the macros are healthy, most micro problems will just go away. It is sad to see that the government loves to talk about micro problems and takes no action to deal with their macro origins.

China still has potential. The current per capita income, merely a fifth of the level of advanced economies' and 20 per cent below the global average, is far less than Chinese workers can achieve. A good economic system could quickly bring China's per capita income to half the OECD level.

To get there, China must increase household consumption from one third to 60 per cent of GDP and reduce fixed asset investment from half to 30 per cent of GDP.

Playing with money, such as through quantitative easing, merely postpones the day of reckoning. Without structural reforms to boost investors' willingness to pay for the future, the hidden non-performing loans will bring down the financial system. Being clever is just not enough. China must accept the pain that comes with real reforms.

Source: South China Morning Post

http://www.scmp.com/comment/insight-opi ... -imbalance