Carnegie Endowment for International Peace
In the first half of this two-part blog post, I discussed the problems affecting four rural banks in Henan and the subsequent mortgage boycott in parts of China. In the second half, I argue that these crises need to be seen not as isolated events but rather as signs of systemic problems that reveal a great deal about China’s finances and balance sheet.
There is increasingly a consensus in Beijing that China’s excessive reliance on surging debt in recent years has made the country’s growth model unsustainable. Aside from the economy’s current path, there are only four other paths China can follow, each with its own requirements and constraints.
Most economists have trouble understanding why too much debt may harm an economy, let alone how much debt counts as too much. To make matters worse, the common practice of comparing vastly different countries’ debt-to-GDP levels is not a useful tool for gauging how a particular economy is likely to manage its debt burden.
The debate about whether it is U.S. consumers or Chinese businesses that pay for American tariffs on Chinese-produced goods reveals absolutely nothing about whether the tariffs harm or benefit the U.S. economy.
There are conditions under which governments can create money—or debt—without fear of inflation or excessive debt burdens. There are other conditions under which debt or money creation can lead to inflation and balance sheet problems.
Facebook seems to think its new digital currency Libra will be used mainly for purchasing goods and services and for current account transactions. But it will probably be used mainly for capital account transactions. Do we really want to eliminate frictional costs on the capital account?
Most of the discussions among economists about the impacts of tariffs and trade intervention are more ideological than logical. While tariffs may cause households to pay more for tradable goods, there are many other ways households, and the overall economy, are affected, positively and negatively. What matters are the conditions under which trade intervention policies are made.
If local governments and state-owned enterprises in China systematically invest in projects that are not economically justified, to the extent that these projects are not correctly marked to market, China’s reported GDP will be overstated by that amount, as will its total wealth.
A number of Chinese companies are trying to shore up their stock prices with programs that encourage employees to buy shares and ensuring them against losses. These programs have implications about leverage in China and about the way losses may be distributed within the banking system.
The Chinese development model is an old one and can trace its roots at least as far back as the infant industry protection, internal improvements, and system of national finance of the American System of the 1820s and 1830s. Understanding why the many precedents for its growth model have succeeded in some few cases and failed in others will help us enormously in understanding China’s prospects.
While it is difficult to predict the nature and timing of the shocks buffeting China’s economy, China’s difficult economic situation makes such crises inevitable.
Some analysts contend that the RMB is no longer undervalued but is in fact overvalued. However, a more careful analysis suggests that the yuan is still undervalued, but perhaps not by much.
The structure of investment strategies in the Chinese stock markets had always guaranteed that this would be a brutally volatile market that trades almost exclusively on “the consensus about the consensus”, and therefore prices will reflect very rapid shifts in this consensus.
An “efficient” market is one that has an efficient mix of investment strategies. Without this efficient mix, the market itself fails in its ability to allocate capital productively at reasonable costs.