By John Richardson
WHEN all you care about is making money on the next chemicals cargo, or on a recovery in financial markets, then the current “will they, won’t they?” question over whether China will launch a new round of economic stimulus makes every bit of sense.
The debate grew more intense on Monday after the HSBC Flash Purchasing Managers’ Index for March fell to an eight-month low (sorry to have to repeat this, but not enough people seem to be listening! It is total lending growth that is a much more important measure than manufacturing sentiment. Any sentiment index depends on what time of day you ask the questions, and, of course, who asks and answers the questions, whereas excessive credit creation is the main fuel that has driven the Chinese economy, particularly since 2008).
Anyway, back to the main point. There is nothing wrong, of course, with making money out of the next chemicals cargo or from a rally in financial markets. The problem arises when people conflate short with long-term analysis.
In the past, this didn’t really matter as what happened in the short term was, in fact, the same as the long term – meaning, the more stimulus that China pumped into the economy, the better both the short and long-term growth rates.
But everything has now changed as “kicking the can down the road” will only make China’s eventual economic reckoning even harder.
We have seen more evidence, during our travels over the last two weeks, of the “conflation” problem confronting chemicals companies. They still assume that all that China has to do is throw more money at the problem and everything will go back to normal. This is not the sound basis for a long-term corporate plan.
Where do we start? How about here?
We also came across this excellent blog post from Michael Pettis, the Peking University finance professor, who makes these four important points:
1. Leverage boosts growth and deleveraging reduces it. By now nearly everyone understands that China is over-reliant on credit to generate growth.
2. Hidden transfers will be reduced. The investment-led model encourages investment by transfers – hidden or explicit – from the household sector to subsidise investment. Because these transfers no longer create net value on the investment side, the proposed reforms will act to reverse the mechanisms that goosed growth by transferring resources from the household sector to subsidise manufacturing, infrastructure building, and real estate development. It should be clear that as Beijing reverses policies that once acted to increase growth, the result must be slower growth.
3. Excess capacity will be resolved. Beijing recognises that cheap credit and limited accountability have created excess capacity in industry and real estate. As Beijing acts to wring out excess capacity, we will inevitably see a reversal of the earlier growth impact.
4. Losses will be recognised. Because many years of overinvestment have left a large amount of unrecognised bad debt on bank balance sheets, China’s GDP growth has been overstated by the amount of the unrecognised losses. Over the next decade as Beijing cleans up its financial system, this bad debt will either be explicitly recognised or, more likely, implicitly written off over the remaining life of the loan. Either way, as the losses are recognised, growth over the next several years will automatically be understated by the amount previously overstated.