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China Radio: China’s Slowdown

February 21, 2012

Yesterday I was on China Radio International (CRI) talking about the latest figures and trends for the Chinese economy:  the drop in real estate, record bank profits, weak trade and PMI data, and persistent inflation.  The overarching question was whether the perceived slowdown in China’s economy is real, and how worried we should be about it.  You can listen to the discussion by clicking here.

Regarding the record annual profits being reported by Chinese banks, I don’t have too much to add to what I wrote on that subject last year (in my blog post on “Chinese Banks’ Illusory Earnings”), except to say that it would be comic, if it weren’t so tragic.  As I said on the air yesterday, banks have two costs of doing business:  the cost of funds (which they pay to depositors) and the cost of bad debts that aren’t repaid.  Since Chinese banks enjoy a regulated spread between their deposit and lending rates, the more they lend (and they’ve been lending a LOT these past few years) the more money they make.  But the more generously they lend, the greater the risk they won’t be paid back — a risk that should be realistically tabulated and deducted from the earnings spread.

That isn’t happening.  The notion that Chinese banks have 1% non-performing loan (NPL) ratios is patently ridiculous, and the claim that provisions for 2.5 times that amount are somehow “generous” (or remotely adequate) are equally absurd.  I don’t believe it, and neither do investors in Chinese bank stocks, based on their valuations.  Any company can report “profits” if it doesn’t recognize half its costs of doing business.  Any company can boost “revenues” by granted easy credit terms to customers who can’t pay it back.

Regarding inflation, the Wall Street Journal published an excellent editorial today that expresses my thoughts as well as I could.  You can read it here.  They do an excellent job describing the stresses facing China’s banks, and reconciling the apparent contradictions between a slowing economy and inflationary concerns:

It might seem odd to worry about inflation, capital outflows and tight liquidity at the same time, but that’s a consequence of China’s distorted financial system. Because allocation of capital remains politicized, a significant portion of the credit stimulus has gone into wasteful projects; since that money is not creating real growth or productivity gains, it chases too few goods at higher prices.

Meanwhile, those who need cash—including bankers and small and medium-sized businesses—can’t get it. Liquidity injections might help bankers with short-term funding. But absent broader reform, that cash will only follow earlier credit down the inflationary rabbit hole.

Usually economists consider slowing growth and inflation as polar opposites –you can have one or the other, but not both at the same time.  Over-rapid growth spurs inflation, but slowing growth reduces price pressure.  However, if you print (or in China’s case, import) money and spend it on projects with a zero or negative return, you will get an initial GDP boost (as long as you keep spending), but eventually you will get stagnant growth AND inflation: stagflation.  The Journal gets it.  Does anyone in China?

7 Comments leave one →
  1. Joy permalink
    February 21, 2012 5:44 pm

    I still do not understand why the central bank has to print RMB and purchase foreign currency with it to keep the exchange rate. Can’t they just “declare” the exchange rate? All the Chinese banks follow it anyhow.

    In addition, it was mentioned on this blog that the CB does not have in fact the 3 trillion (or whatever) foreign reserve because there’s already RMB printed and “linked” to it. I do not understand this as well, they have this “number” in their system and they can use it to take over assets abroad or whatever and keep the linked obligation in their system and do whatever they want with it.

    The RMB is already circulating in the system and being eroded via existing inflation and NPL. They can make up another number and stick it as a reserve somewhere. I’m not saying this will fix the problem or this is a correct economic way to resolve them, just that it “fits” into the current system.

  2. Joy permalink
    February 21, 2012 5:48 pm

    Sorry, another newbie question.

    If I am a sovereign country do I have any obligation to state to the outside world what is my current foreign reserve, inflows and outflows?

    That is, cant I just add a few trailing zeros left to the dot and increase my reserve? Is there some third party that keeps record of the world and controls such an event?

  3. Hua Qiao permalink
    February 22, 2012 8:42 am

    The other thing citd in the WSJ piece is liquidity issues at the banks. The explosion of trust business, the private lending sector, and exporters leaving their dollar revenues overseas all will stress bank liquidity.
    It will be interesting to watch money supply numbers, which I recall were slowing last year from the 20-30% annual rate reported in previous years. A reversal of that slowing would suggest that the pboc is monetizing the banks’ portfolio problems. As a bank you can always fudge profits and capital numbers but it is hard to hide liquidity problems. For that they will need pboc help in the form of lowering reserve requirements, direct lending, etc.

  4. Song Sia Wei permalink
    February 22, 2012 1:56 pm

    China Economy tragic but comical 😉

  5. Anon permalink
    February 22, 2012 7:08 pm

    I think your blog is blocked. I can’t access it without my VPN. Congratulations. You must be on to something…

  6. FrParlentAuxFr permalink
    March 8, 2012 8:36 pm

    The System suffers from Empire money, where the world mint is in the US. As long as the mint is reasonable ok, but the country controlling the equivalent of all Silver and Gold mines in the old days is minting tons of the world currency (USD). It results in permanent money shuffling exercise in the US to produce employment and significant unemployment. It forces manufacturing in other countries at repressed wages. It is smart for China to encourage the population to accumulate the monetary metal on which the central banks of the West have no control, (no not this one, the other one)…. Empire money started with a lack of competition and overvaluation of Gold (See Milton Friedman on that). China suffered both from a deterioration of the Mexican coinage and later demonetization of Silver and illegal drug overloads criminal British crown. Hong-Kong does not collect any seignorage on the hard peg, in a way very similar to the use of Spanish coins by the imperial China. A multiple peg of Hong-Kong dollar, where each nation would bring its own currency to be included in the pool and receive a seignorage free new HKD. The currency brought by foreign foreign central bank would be included in the peg, and in exchange teh HKD in circulation would expand to reflect the contribution to the pool, and the HKD would now reflect in the multiple peg some of the foreign currency. This would work wonders, it would accommodate any type of currency, fiat or metal based or even large private currencies. It would a fair system where no nation taxes the others. It would limit the seigniorage of a country to its own citizens not to others.
    We need an end to Empire money (USD), using the Yuan would another empire money and would hurt China in the long run the same way US is hurt now. A flexible peg seigniorage free that can reflect the world trade activity based on multiple flexible pool with no central bank printing like HKD is the solution.

  7. FrParlentAuxFr permalink
    March 8, 2012 8:45 pm

    I am a Westerner and I support China´s effort to end Empire money abuse. The Western population is suffering a lot from continuation of its politicians to maintain the empire status. As for criticism about rule of law, look at our own retroactive laws on taxes in the UK, look at the ability of the US president to arrest US citizens and detain them without trial. The West is very very deep in debt and is desperate to keep control on empire, so it wants to villify China. I fell for that rethoric for a while, did study a lot China. China is not perfect but at least it is managed by engineers not lawyers and economists which are good PR for the former and voodoo for the later. Now China has banking problems and property problems, BTW encouraging the population to buy some monetary metals is a very clever way to sterilize fiat overtime printing and preparing for a seizure of the monetary system of the West. I would take 10 times a bank crisis and property crunch over a currency crisis and sovereign crisis (EU) and currency vaporization (USA). Have a nice day, and please a bit measure and stop the spinning. We are following the historic idiocy cycle of pundits and policy makers of currency war, trade war now (latest bill in the US) and actual proxy war in Iran. I hope blogger are smart enough to cut their respective leaders from dragging us down in this misery.

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