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February
06
2016
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China’s $6.6 Trillion Toxic Loan Problem
Rotting Vegetables “As long as you’re green, you’re growing. As soon as you’re ripe, you start to rot,” once remarked Ray Kroc, mastermind of the McDonald’s franchise empire. At the moment, no truer words can be spoken for China’s ripe economy. The Middle Kingdom’s 30-year economic boom is being overcome with the unpleasant odor that befalls rotting vegetables. What’s more, there’s no way to reverse it. Economic activity in China is stalling out. All of the sudden, the mistakes that were hidden by a growing economy are surfacing en masse. Excess capacity is turning up in all corners of the economy and no one knows what to do about it. Each day, it seems, new rot comes to bear upon Beijing’s central planners. Somehow the miracle workers have lost their hot hand. A slowing economy, falling stock market, exodus of wealth, and weakening currency are not conforming to the graphs and statistics reported in the latest blueprint for the planned economy. How could it be that the professional politicians, who’d sparkled with genius all these years, so grossly missed their targets? Aren’t the talented men, who’d lorded over a contrived capitalism all these years, capable of fixing this? Perhaps these are the wrong questions to be asking.
China’s Politburo – from left to right, Zhang Gaoli, Liu Yunshan, Zhang Dejiang, president Xi Jinping, prime minister Li Keqiang, Yu Zhengsheng, Wang Qishan (Wang is running Xi’s anti-corruption effort. If you want to find him, go to Zhongnanhai and ask for Wang’s wing). Photo credit: Carlos Barria / Reuters Individual Preferences Simply put, an economy cannot be executed by a central government to fulfill the objectives of a five year plan. At times this may appear to be so. But these instances are mere coincidence…not the result of an erudite centralized mastery. Time and time again, the effects of government intervention into an economy and markets have proven to cause more harm than good. Price controls, minimum wage laws, tariffs, taxes, subsidies, corn ethanol, federal medical insurance…you name it. The greater the intervention that takes place the greater the harm. Certainly, a central government can coerce its population to act in certain ways to a point. But it cannot make discrete choices for each individual. Trying to do so is futile.
In 1945 F.A. Hayek published his famous essay “The Use of Knowledge in Society”. The argument had ripened in the course of the debates he and Lionel Robbins had with representatives of “market socialism” and “trial and error socialism” like Oskar Lange, Henry Dickinson and Fred Taylor in the 1930s. As Hayek argued, the knowledge of individual actors in the economy is widely dispersed, highly situational and local, and often tacit (i.e., non-verbal). It is simply impossible for a central planning body to even acquire this knowledge. Mises in turn had shown that even if it were possible for the planners to acquire this knowledge, they would not know what to do with it. The central problem of socialism was already made clear by Mises in his essay on the calculation problem: once prices for the factors of production no longer exist, economic calculation becomes impossible. What central planners of all stripes discount is that an economy is made up of individuals, with individual preferences. In China’s case, the economy is made up of over a billion individuals. On any given day, these billion individuals will make thousands of discrete choices. For example, some people like to sprinkle salt on their rice. Others like to rain soy sauce all over it. Some like their rice plain. Others like it dry and sticky. Some like it fried with chopped vegetables. Others think rice is disgusting and don’t eat it at all. Choices like these, and countless others, must be made by each individual. Planners cannot make these choices for their entire population. They can attempt to declare the price of rice, salt, soy sauce, and vegetables by edict. But they will always be utterly wrong. Supply gluts and shortages will quickly result from their efforts. The wisdom of bureaucrats is no substitute for market pricing. China’s $6.6 Trillion Toxic Loan Problem The addition of government intervention into money and credit markets opens a whole new can of worms. Like in the United States, but on a much greater scale, Beijing’s attempts to stimulate growth through cheap credit and massive government spending programs have had the ill effect of misleading the Chinese countrymen in ways that could have never been imagined. Debt, backed by debt, has been piled up to heights beyond comprehension for purposes that don’t pencil out. According to Darlene Chu, of Autonomous Research Asia, Chinese banking assets increased from $9 trillion in 2008 to $30 trillion at the end of 2015. Chu estimates that 22 percent – or $6.6 trillion – of these assets are nonperforming.
Various estimates of the percentage of non-performing loans in China’s banking system. To the left, the utterly useless official NPL ratio. Thereafter, NPLs including loans that are also NPLs but are allowed to masquerade as something else, followed by CLSA’s overly generous “minimum” estimate, BNP’s estimate and lastly Ms. Chu’s estimate. “The world has never seen credit growth of this magnitude over a such short time,” said Chu. “We believe it has directly or indirectly impacted nearly every asset price in the world, which is why the market is so jittery about the idea that credit problems in China could unravel.” Despite the government’s driving impetus to keep the bubble inflating, there are natural limits to policies of perpetual debt expansion. If you can believe it, Chinese banks tapered back on their lending in December. They’ve crested the credit peak and are now entering the downside. In other words, Chinese banks are exiting from a period of mass credit expansion and entering a period of mass credit contraction.
The Chinese yuan (or renminbi) – here in the onshore version – has entered a downtrend in late 2014 – incidentally, precisely at the point in time when the US stock market’s internals peaked, along with the Dow Transportation Average. This is not a coincidence. Decades of green growth have ripened. Now, just like Kroc said it would, the growth is rotting. A yuan devaluation of 30 percent – or more – could transpire over the next six months. If the central planners try to resist the downside like we think they will, it’ll take a generation – or two – to purge the rot from the system. Charts by: Bloomberg, BigCharts Chart and image captions by PT
M N. Gordon is the editor and publisher of the Economic Prism.
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