China urgently needs a stimulus of shock-and-awe proportions, backed by a deep cleansing of its broken banks along the lines of America’s “Tarp” (Troubled Asset Relief Program) rescue in 2008. The latest package announced today falls far short.
The drumbeat for radical action is by now deafening. It dominated the weekend’s China Macroeconomy Forum in Hong Kong, where a chorus of influential voices called for a fiscal blast of up to $1.4 trillion (£1.1 trillion) to pull the country out of debt deflation and cosmic gloom.
Liu Shijin, a former rate-setter at the People’s Bank of China (PBOC), said the government should issue special bonds worth 8pc of GDP to boost social spending, pensions and health care. And to convert the galactic glut of unsold flats into homes for the 180m-strong army of migrant workers caught in the no-man’s land of the semi-feudal Hukou system.
Mao Zhenhua, co-director of the Renmin Institute of Economic Research, wants a similar package of $1.4 trillion – or 10 trillion yuan – proposing direct cash transfers to citizens akin to Covid cheques in the West.
The authorities have been dribbling out stimulus for months, but it has been too half-hearted to arrest the slide into a Keynesian liquidity trap. Disappointing data over recent weeks have finally caused the dam to break. The PBOC cut the reserve requirement ratio by 50 points on Tuesday. There were targeted measures to prop up the crumbling housing market.
Raymond Yeung, China strategist at Australia’s ANZ bank, said the measures will inject a trillion yuan into the banking system but do not add up to a genuine bazooka. “We question whether today’s package can lift China from the deflationary spiral. Massive easing and a complete change in mindset is required,” he said.
“We won’t rush to upgrade our growth forecasts just yet,” said Capital Economics. “The big picture is that monetary policy has lost much of its effectiveness in China.”
Yi Gang, the PBOC’s venerable ex-governor, warned earlier this month that it would take a double-barrelled shot of combined fiscal and monetary stimulus to right the ship, saying it was becoming urgent to “fight deflationary pressure”.
He stopped short of proposing quantitative easing (QE), a remedy still viewed as Western snake oil by the Communist Party. But QE is where China may eventually end up. The GDP deflator has been stuck in negative territory for the last five quarters.
Freya Beamish and Rory Green from TS Lombard said the monetary transmission mechanism is broken, and the Chinese economy is heading for an outright contraction of nominal GDP early next year, although Beijing will massage the figures to disguise this devastating indictment of Xi Jinping’s strategy.
“We’ve both covered the economy for our entire careers and we’ve never been more worried about Chinese growth. Policymakers have chosen demand deflation and that is what they are getting,” they said.
“The mass attempt to deleverage by saving is killing profits and crushing wages. Things could get bad enough to force a bank recapitalisation,” they said.
Official stress tests published last week showed that over half of China’s 4,000 mid-sized and small banks would fail a moderate shock, and 10 of the 19 systemic banks would fail a serious shock. The true situation is probably worse.
TS Lombard said a US-style Tarp programme would lift China off the reefs but the Xi regime is more likely to repeat the mistakes of Japan and Europe, papering over problems with mergers that contaminate stronger banks without resolving the debt problem.
Chinese banks are clearly in trouble. Minsheng Bank is halving wages to stay afloat after lending heavily to the bankrupt developer Evergrande. Global Times reports that China International Capital Corporation (CICC) has cut salaries by 65pc since the peak four years ago.
Hence the fate of Zheng Wenlu, a 30-year-old investment banker who threw herself off a CICC building in Shanghai. She had a mortgage debt of $1.5m and monthly payments of over $8,000. The property crash had wiped out her 40pc down payment and left her in negative equity. Pay cuts pushed her into insolvency.
This is an extreme case, but it has touched a nerve among netizens caught in the deflationary pincers of falling pay and falling home equity. Centaline’s property price index for Tier 1 cities has fallen 28pc over three years. The estimated paper loss for all homes across China is $18 trillion. This is causing a contractionary snowball effect through the wealth effect.
Robin Xing, from Morgan Stanley, said the economy is entering a second stage of entrenched deflation driven by a negative “wage price spiral” and surging urban unemployment that could be very hard to reverse.
The De Tocqueville theory of revolutions is that regimes are most vulnerable when a long period of rising living standards is interrupted by a depression. If so, it is a mystery why Xi Jinping is allowing this slow-motion train crash to happen.
His response at the Third Plenum in July was to double down on extreme over-investment in industry rather than taking steps to lift consumption. It is a bet that China can export its way out of its slump while at the same time achieving global clean-tech hegemony.
This is not a remotely plausible strategy. The world will not tolerate a state of affairs where China produces 31pc of total manufactured goods but – due to the forced savings of its Leninist structure – accounts for 13pc of total consumption.
The country has already built solar and lithium battery capacity that exceeds total global demand twice over. It is playing the same game with EVs, electrolysers, heat pumps, air conditioners, etc. Does the Politburo really think that China can get away with dumping its unemployment on our societies and demolishing our industries by means of predatory mercantilism?
But there may be another reason for China’s reluctance to stimulate demand. Xu Gao, the chief economist at Bank of China, says much of the policy elite in Beijing has fallen under the spell of Friedrich Hayek and the Austrian business cycle.
Hayek is neglected in the West – few still read Prices and Production or The Fatal Conceit: The Errors of Socialism – but his market fundamentalism is perversely fashionable in Communist China.
Any attempt to alleviate China’s post-bubble pain is decried as “drinking poison to quench one’s thirst”. Excess credit must be purged by liquidation, with no interference in the self-correction process. Hardliners say that curing a debt crisis by pushing the augmented fiscal deficit to 14pc or 15pc of GDP is pure hemlock.
This economic ideology is fully aligned with Xi Jinping’s views on social discipline and moral fibre. “Welfarism” is a dirty word in Xi Thought. It fosters “lazy people who get something for nothing,” as he puts it.
Yet China’s leader may conclude that the punishment beatings have gone too far and that the survival of the Communist Party is better served by letting the Chinese people consume more of their own hard labour, and by retreating from trade wars with Europe, America and India.
Xi abandoned the Maoist lunacy of “dynamic zero Covid” suddenly and without explanation. It is not impossible that he will listen seriously to those now calling for a drastic change of course and Roosevelt policies. Should he do so, it will change the global economic landscape overnight and set asset markets on fire.
Investors need to watch China very closely over the next six months.
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