China’s Bubbles are Unintended Consequences of Financial Repression Policies

This article tries to pin the blame on underdeveloped markets as culprit for China’s runaway property bubbles.

From Bloomberg:

The willingness of people like Zhou to shun other investments in favor of property shows why residential prices have defied a more than three-yearlong government campaign to rein them in and is among the forces crippling efforts by the central government to deal with an expanding housing bubble. New home prices in major cities, including Beijing and Shanghai, rose more than 10 percent in July from a year earlier, compared with a more than 10 percent drop in the benchmark Shanghai Composite Index (SHCOMP) during that period.

“Prices have been rising because China doesn’t have developed financial markets,” Yao Wei, a China economist at Societe Generale SA, said in an interview in Hong Kong. “Now, with the economy slowing, that has worsened as other investments don’t yield good returns compared with property.”

This essentially mistakes effects for the cause.

The same article says that the incumbent leadership will not tolerate a growth lower than a self-imposed target

Li, who signaled in July he won’t tolerate a slowdown beyond a 7 percent bottom line, has come up with no new measures to rein in property prices since his predecessor in March, underscoring the role real estate plays in the world’s fastest-growing major economy. Property, construction and related industries account for about 20 percent of gross domestic product, according to Societe Generale.

So basically we have a Chinese version of ECB’s Draghi of "do whatever it takes" to push up statistical growth” for political goals.

Yet this one wrongly blames it on the lack of welfare state...

Traditionally, because of social welfare and pension systems that aren’t as advanced as in developed countries, the Chinese have felt safer buying real estate, said Liu Yuan, a Shanghai-based researcher at Centaline Property Agency Ltd., the country’s biggest real-estate brokerage.

The reality is that underdeveloped markets have not been ‘market failures’ as portrayed, but have been part of the political institutional architecture for the political class to wangle money out of their constituents. This is called Financial repression

From Carmen Reinhart and Kenneth Rogoff [This Time Is Different (p. 143)] (bold emphasis mine) I previously quoted them here.

Under financial repression, banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payment system. Governments force local residents to save in banks by giving them few, if any, other options. They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form of taxation. Citizens put money into banks because there are few other safe places for their savings. Governments, in turn, pass regulations and restrictions to force the banks to relend the money to fund public debt. Of course, in cases in which the banks are run by the government, the central government simply directs the banks to make loans on it.

Governments frequently can and do make the financial repression tax even larger by maintaining interest rate caps while creating inflation.

As one would note, underdeveloped markets exist BY DESIGN and has not emerged out of a vacuum.

 

For instance, the Chinese government has promised to liberalize interest rates.

From China Daily: (bold mine)

China is actively developing rules to establish a deposit-insurance system and to manage financial institutions' bankruptcies - two steps widely believed to herald the final interest rate liberalization, a senior official said on Saturday…

China's government has long maintained controls over banks' lending and deposit rates. It has placed a ceiling on what banks can pay on deposits and a floor on what they can charge on loans.

Exactly how financial repression works. So China's political class has deliberately kept the status quo and has delayed reforms because it has benefited them. But the risks of imploding bubbles jeopardizes their political tenure and privileges which is why the promised measures of reforms.

Finally skyrocketing prices will also not exist if these has been financed only by savings. 

This means that credit is ultimate fuel for runaway markets. And which entity is responsible for the origination of credit? 

Well the PBOC and their agents the China’s banking and financial industry.

The PBOC’s assets has shot to the moon with an explosive growth from about USD $.3 trillion in 2002 to about $5 trillion today or 15.7 times in 11 years (chart from Yardeni.com)

Such explosion in PBOC assets has also been reflected on China’s formal banking system where loan exposure has exploded from 90% of the GDP to 240% and counting.(chart from Zero Hedge)

With a growth quota in mind of the leadership, the already precarious debt level conditions will deteriorate further with the government owned banks dispensing more loans as part of the stealth stimulus to prop up the statistical economy.

So the runaway bubbles we are seeing today in China represents unintended consequences from deliberate policies implemented.