Can Governments Stop an Economic Slowdown?
How strong is China's economy? CNN Money says Jim Chanos believes it is about to go into meltdown. Chanos has warned in the past that China was pumping billions into a property bubble that would ultimately burst, but now he may now be proven right. "China's top auditor said that loose lending standards and a sharp rise in local government borrowing (for building projects, of course) may have created a mountain of debt that cannot be repaid ... All it will take is a fall in housing, or some sort of economic slowdown, to reveal an untold number of bad loans."
The New York Times says "Liu Jiayi, the top auditor in China, said on Monday that at the end of last year local government debt had reached $1.7 trillion, or about 27 percent of the nation’s gross domestic product. He said better regulation was needed to manage the debt risks." The prosperity was built on a mountain of government debt, acquired by the Chinese government itself.
The auditor’s report on Monday was similar to a warning earlier this month by the Chinese central bank. The bank said that at the end of last year, local government liabilities were as high as 30 percent of gross domestic product, or about $2.2 trillion — far higher than previous estimates.
That survey said local governments had created 10,000 investment companies to borrow money from banks, mostly to finance ambitious infrastructure projects. (China does not allow local governments to issue bonds to finance projects.) ...
Mr. Shih and other analysts say local governments create their own investment companies to borrow from state banks to finance infrastructure projects. And because much of that borrowing is done off official balance sheets, often using government land or assets as collateral, the debt can be hard to track and assess.
And often the projects, which include roads, bridges, tunnels and subway systems, do not generate enough earnings to repay the loans.
In its report Monday, the national audit office said it had found many irregular activities. For instance, many local governments were using “unreal” or illegal collateral to secure the loans, the report said, and some of the money they borrowed was funneled into the stock and property markets. At other times, the auditor said, the local governments were “overestimating the value of the collateral” — which was often tied to land values.
Now that Chinese property prices are beginning to decline, leading analysts to worry that the meltdown has started. Experts who were once bullish on China are now very much afraid. The Wall Street Journal asks, "what changed? A growing realization that much of China's massive stimulus spending and lending of 2009 and 2010 ended up in land purchases, driving up prices in an unsustainable fashion." Because the Chinese people used savings, rather than debt to invest in some of these schemes analysts expect the effects will not be as bad as the subprime mortgage meltdown in the West. All the same, a bursting bubble would wipe out an enormous amount of wealth.
The government keeps bank deposit rates well below the rate of inflation to benefit state-owned banks and other firms, which have the political power to defend the status quo. With few financial alternatives to beat inflation, Chinese savers buy real estate, even if supply soars ahead of demand.
Chinese savings wound up in these black holes, which recycled rising consumer incomes and may now have wasted them.
It's no secret that China and its people have done an amazing job stimulating its economy by investing and attempting to drive the wealth machine, encouraging its citizens to save, save, save! From 1982 to 2007, China and its citizens jumped aboard the savings bandwagon as national savings as a percentage of gross domestic product jumped from approximately 34% to 54%. This period also witnessed one of the most precipitous drops in personal consumption ever witnessed. In 1982, personal consumption as a percentage of GDP stood at 52%; by 2007 this figure would drop to just 35%.
Under normal circumstances, in a healthy economy, we would expect the personal consumption to rise along with GDP, but we simply aren't seeing that with China. One reason could be that the wealth effect seen in China is simply artificial. Investment rather than consumption is what's driving growth, and this usually proves to be unsustainable in the long term. Real wealth appears to be tied up in the banking system and not with the general public. Personal consumption's disconnect with GDP is a major red flag that Chinese consumers may not be able to sustain this economy any longer.
If the population's savings are wiped out in a crash, there will be a great deal of anger in the population to go with sudden bankruptcy. If the China bubble is real and actually bursts, it could wipe out the Recovery Summer that the President hoped his stimulus would provide. All over the world the efficacy of public-sector led stimuli is being tested. The global results so far don't look all that good.