China Bubble: Diminishing Returns of Credit

Here is an example why asset bubbles are being blown in China.

From the Bloomberg:

China’s economy is proving less responsive to credit, escalating pressure on Premier Li Keqiang to strengthen the role of private enterprise.

The government’s broadest measure of credit rose 58 percent to a record 6.16 trillion yuan ($1 trillion) in January-to-March, when gross domestic product gained 7.7 percent, compared with 8.1 percent a year earlier. Each $1 in credit firepower added the equivalent of 17 cents in GDP, down from 29 cents last year and 83 cents in 2007, when global money markets began to freeze, according to data compiled by Bloomberg.

The diminishing returns to lending heighten focus on the need for what the International Monetary Fund said yesterday are “decisive” policy changes in the world’s second-largest economy. Without a refocus away from state-approved projects, Li and President Xi Jinping risk overseeing both a further slowdown in growth and an increase in non-performing loans.

The article reveals of the Chinese government’s entrenched adaption of Keynesian policies which views credit as an indispensable macro tool used to attain economic growth. 

The Zero Hedge has great on charts representing the above dynamics:

China’s credit boom…

…amidst languishing economic growth

Policymakers hardly distinguish on the character of credit. For them, credit growth of any kind presupposes increased consumption or “aggregate demand”.

And the above report only validates my suspicion that the Chinese government’s covert stimulus has been channeled via state owned enterprises (SOE) since late last year.

In order to avoid controversies from the peering eyes of world, the Chinese government uses the SOEs, which remains a substantial force in her economy, as principal conduits for the transmission of social policies

Yet as explained yesterday much of the credit expansion has only been channeled into yield chasing speculations which has been evident by the ballooning property bubbles and massive expansion of the shadow banking system. 

The existence of ghost communities (towns or shopping malls) are manifestations of wanton misallocation of resources or capital wastage, thus the clueless media and policymakers scratch on their heads on the so-called ‘diminishing returns’ from credit in producing “economic growth”. 

In contrast to the mainstream impression and as shown above, inflationist and interventionist policies reduce aggregate demand over the long run. Thus, macro tools will hardly solve on real micro problems.

To add, the 58% jump in credit growth in the first quarter only means that much of the 7.7% “growth” represents a statistical artifice or a mirage.

The call to focus on private enterprises via economic freedom should signify a policy imperative. This means that the Chinese political economy should further decentralize and that the Chinese government must relinquish political power to the marketplace. This also suggest that people should be allowed to keep their savings from the stealth predations enabled by financial repression policies (e.g. negative interest rates)

But it is doubtful if officials will sacrifice political privileges.

Nonetheless real "private enterprise" based reforms will constitute real growth over the longer term.

Unfortunately there will be short to medium term consequences from all the intensive accumulation of malinvestments. 

Where every action has an attendant consequence, markets must be allowed to clear these imbalances. Otherwise these will continue to mount, until it snaps with greater intensity.

Bottom line: In a recast of Newton's 3rd law: for every bubble boom, there will be a corresponding bubble bust.