China’s Central Bank: Solve Debt Problem with Even More Debt

The Chinese government appear to be signaling desperation via policy flip-flopping 

Just a week ago, Central Bank Chief Zhou Xiaochuan reportedly said that the Chinese government “will not use any large-scale stimulus to boost its economy”

At the start of the week, China’s Shanghai index rocketed by about 2%. Why? In the contemporary central bank laced financial world...because of expectations of a central bank PUT and or government promise of support.

From Bloomberg: China’s stocks rose the most in a month, led by commodity producers and financial companies, on speculation the government will take steps to bolster equities… While Chinese President Xi Jinping said the nation needs to adapt to a “new normal” in the pace of economic growth, expectations are building among equity investors that the government will roll out market-boosting measures, according to Dragon Life Insurance Co… Policy makers are seeking to support the stock, bond and commodities markets as growth decelerates.

Yesterday in the face of reports where developers in housing starts have retrenched by 25% (based on estimates by Nomura) and home sales in April fell by a whopping 18% month-on month, the PBOC asked banks to liberalize credit issuance

From another Bloomberg report

China’s central bank called on the nation’s biggest lenders to accelerate the granting of mortgages, a sign that developers’ prices cuts and incentives alone won’t boost a slumping housing market and economy.

The People’s Bank of China told 15 banks yesterday to “improve efficiency of service, give timely approval and distribution of mortgages to qualified buyers,” according to a statement posted on its website. It also urged lenders to give priority to families buying their first homes and strengthen their monitoring of credit risks.

Premier Li Keqiang is seeking to put a floor under a slowdown in the world’s second-largest economy. The housing market has become a drag on growth as developers, facing a surplus of empty units and falling sales, put the brakes on new construction

And aside from easing of regulatory restrictions in parts of China, like in East Fujian Province, there are reports that developers in Guangzhou "zero down-­payments" to attract buyers (hat tip Zero Hedge)

With the PBoC asking banks to lend, which are most likely the state owned banks, such can be reckoned or deemed as implicit stimulus. As to the scale, this depends on the amount of banking sector loans issued. As for 'large scale', this also depends on what the PBoC defines as large.

As I noted in the past, the Chinese government’s financial repression policies of inflationism and bank deposit caps have led residents to chase for yields that has powered a colossal housing bubble.  A recent study says that 65% of Chinese household wealth have been tied to real estate. 90% of China’s population already owns homes. And that’s the perspective from the demand side.

Aside from infrastructure boom, subsidiaries of local governments have been a key proponent in providing the supply of properties which has been mainly financed by debt.

But the debt financed property bubble has been inflated into terrifyingly gigantic proportions.

Here’s from Telegraph’s Ambrose Evans Pritchard (bold mine)

Wei Yao, from Société Générale, said the property sector makes up 20pc of China’s economy directly, but the broader nexus is much larger. Financial links includes $2.5 trillion of bank mortgages and direct lending to developers; a further $1 trillion of shadow bank credit to builders; $2.3 trillion of corporate and local government borrowing “collateralised” on real estate or revenues from land use.

“The aggregate exposure of China’s financial system to the property market is as much as 80pc of GDP.

Such debt financed overbuilding has led to a massive glut. According to the Bloomberg, based on the estimates of CLSA’s Nicole Wong, more than 10 million homes sit empty in China, and the number could rise to 18 million within two to three years.

As you can see, the PBOC has already been trapped in a self made conundrum. In order to put a floor under the economic growth slowdown, the PBoC wants an economic system drowning in debt to absorb even more debt to increase demand for properties. 

The PBoC tacitly induces more debt financed building of properties to juice up the statistical economy where there has already been a mammoth oversupply. 

What they are really doing is to buy time from a devastating meltdown. Yet by doing so, they will increase the magnitude of a disorderly market clearing as resources continue to flow into speculative capital consuming ventures.

The decline in property prices has been manifested by a slowdown credit expansion. This simply means that the diversion of something for nothing bubble activities will materially decline. And a lot of the unproductive bubble projects will continue to surface as debt delinquent entities.

And demand that has emerged from the bubble boom will equally subside which should aggravate the surpluses.

And as the property sector slows, all other industries attached or that has emerged out of the bubble will also be significantly affected. There will be a contagion.

And feedback loop between problematic debt and the rapidly slowing economy enhances the risk of a credit event—a Black Swan moment.

If China’s bubbles has overwhelmed her residual real savings (which have been sunk into capital consuming speculative projects as embodied by vacant properties and ghost projects), then the policies to “kick the can down the road” will buy limited time. 

This also means that throwing money into the system will extrapolate to the law of diminishing marginal returns—more debt produces lesser growth, but on the other hand, amplifies systemic risks. 

And this is the reason why I have doubts in the political rhetoric by Chinese leaders for market based reforms. The fact that they cannot allow the markets to clear by blowing more bubbles runs contrary to their ballyhooed reform agenda.

And this is why we should continue to expect the Chinese government to intensify her bickering with her neighbors through territorial disputes in order to shift or divert her citizen's attention away from her rapidly deteriorating economy and for the latter to rally around the government through conflicts that evoke nationalism.

Yet policy vacillation in the face of a debt trap signify signs of escalating risks.