China: A Deliberate “Snowball Effect”

By John Richardson

EARLIER this week we answered this question – “How bad will it get in China before it gets good?” – in this blog post and a follow-up post that looked at some the immense, long-term uncertainties.

Now it is the turn of the other two questions, posed by a senior chemicals industry executive, which are:

• To what extent can the current government allow it to get bad even if they know it is for the longer term good?
• Will the government blink too soon when it gets bad and pull back on some of the reforms?

“There’s already a lot of money in the pool, and we can’t rely on monetary stimulus to spur economic growth,” said China’s Premier Li Keqiang, in an opening speech at last month’s World Economic Forum in Tianjin, which prompted a walkout by overseas CEOs.

“Facing the New Normal state of the Chinese economy, we have remained level-headed and taken steps to tackle deep-seated challenges….in the latter half of the year and beyond, we will accelerate the transformation of the development model.”

There you have your answers – in a nutshell.

Here, in detail, are 10 of the reasons why Li’s comments are so significant:

1. The tone of statements like this by Li, and also by China’s president, Xi Jinping, indicate that as they would lose all their credibility, and thus their political legitimacy, if they changed course.
2. And even if they wanted to change course now, they could not because public perceptions have been deliberately changed by these statements – and by the overall direction of economic policy.
3. For us, the key economic policy decision remains a reduction in the growth of overall lending. When you take the air out of an economic bubble, it always deflates. Official bank lending was up by just 5% in January-August this year compared with the same period in 2014, as shadow banking was also reduced. This compares with the 12% credit growth needed to achieve real GDP growth similar to last year’s level.
4. There is a “snowball effect’ here. Not only has the supply of new lending been diminished, but so has the demand for lending as people realise that the old investment-led growth model is over. Banks are also now hoarding cash because of the same understanding.
5. In commenting on the latest basket of piecemeal measures designed to support the property market, the Wall Street Journal quite rightly wrote:  “‘[Property] prices have kept sliding even after dozens of local governments have lifted restrictions on property purchases. This suggests the correction is the natural result of a buyers’ strike. Ordinary Chinese seem to have been shaken out of their conviction that property can only appreciate over time, similar to the psychological turn seen in the US in 2007. A recent central bank survey of households found that only 19% of respondents expect prices to go up over the next three months, down from 36% a year ago.”
6. The blog detected this same change in sentiment during its recent trip to Shanghai, when it heard this from the owner of shops that sell mobile phone accessories:  “I can only see the credit situation getting tighter next year and growth slowing down even further. This means I am not going to expand my business. The boom was fantastic while it lasted, but I think a lot of us realised it couldn’t last forever as it was based on bubbles in real estate etc.”  The boom was certainly fantastic for this guy, as he went from owning only one store in 2005 to five shops today. But why should he risk all that he has achieved by taking on more risk?
7. This is exactly the type of change in thinking that Deng Xiaoping achieved when he launched China’s last big wave of economic reforms, based on investment and on mass, low-value manufacturing.
8. But Deng had to negotiate and sometimes compromise with the vested interests that opposed his reforms. As Singapore’s Lee Kuan Yew School of Public Policy wrote in this research paper on the 1978-1984 early reform period, “policy compromise occurred but [this was] only ever a short term tactical decision (see slide 28). This is the context in which we should place this week’s decision to relax restrictions on the property sector.
9. There was never any doubt about the headline policy direction, both during Deng’s early reform period and the post-1992 period –  after his famous “southern tour”.
10. Fast forward to today: History is repeating itself, even if not in quite the same way – as China pursues a new direction.