In late June, I posted two items China’s present growth story is built on malinvestment and Chinese stock market bubble inflating, on the building bubble in Chinese lending and asset markets. The crux of the posts was that China, in its efforts to reflate the economy to meet very high growth short-term targets and start a new domestic demand dynamic, was creating a credit bubble. Much of the lending mandated by Chinese authorities was finding its way into housing and shares, inflating those markets in an unsustainable way.
Chinese authorities are onto this and have decided to act. The Financial Times reports.
Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming.
The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier.
Beijing’s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation.
The situation in much of Asia is very different from most Western economies, where governments have flooded the financial system with liquidity to encourage unwilling banks to lend more.
In China, regulators are now concerned that too much money is being lent by the state-controlled banks and the country’s tentative economic rebound could come at the cost of a stable financial system…
The flood of new lending also has implications for the quality of bank loans and the country’s overall growth.
“China’s economic recovery is being constructed on the back of a savaged banking system,” said Derek Scissors, a research fellow at the Heritage Foundation in Washington. “Tens of billions – and perhaps hundreds of billions – of dollars of loans will not be repaid.”
He points out that in recent years total loan growth of around 15 per cent has supported gross domestic product growth of higher than 10 per cent but in the first half of this year total loan growth of around 33 per cent supported GDP expansion of only 7 per cent.
“China’s economic policies have shifted from being unsustainable over the very long term to being unsustainable for any more than one year,” Mr Scissors said.
These accounts are not intended to malign the Chinese in any way. After all, the US led the way in the last decaderegarding reckless lending and unsustainable growth. And the Chinese have much greater savings with which to cushion a fall in assets prices. What’s more, whether we like it or not, an authoritarian central government in China is better able to handle economic shocks simply through coercion.
But these accounts should cause you some concern if you are invested in China’s asset markets and think the uptrend there can last indefinitely. To be sure, we should take heart that Chinese authorities are looking to step in and reduce the excess liquidity. Nevertheless, it sounds a lot more like jawboning than true regulation of the excesses. In my view, animal spirits are too high for this to have much effect. Authorities will have to take more draconian action.
The real question is whether the Chinese can foster more domestic demand before any ill effects from the present malinvestment become manifest. If so, we should expect growth to continue with only a little hiccup. My worry is that we are seeing the makings of a bust which could have wide-reaching consequences for China and the global economy.
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