What did 5 Trillion RMB Buy?

I have been getting a wave of bullish sell side reports about how the stimulus program launched late last year is having an unexpectedly good impact on leading indicators in China.  Before we draw quick conclusions about how rosy everything will be, let’s step back and examine what these figures are actually telling us.  In essence, most of the benefits of pumping 5 trillion into the economy are temporary.  When this pace of lending slows, many benefits will reverse into major problems.

First of all, I am more or less repeating some points that Mike Pettis raised in earlier notes.  Also, unlike many sell side analysts, Stephen Green at Standard Chartered has issued several reports that give a more comprehensive view.  Let’s look at the latest figures.  In conjunction with the stimulus program, the banks issued nearly 5 trillion RMB in new loans in the first quarter, a historically high level.  Because there was basically no share issuance or new corporate bond issuance, the 5 trillion from the banks was really the main engine for 1Q 2009.   The 5 trillion is almost the size of the US fiscal stimulus package and basically 1/6 of China’s 2008 GDP.  As far as I know, this is the largest monetary easing in this period of time as a share of a country’s GDP (that didn’t go into writing off bad debt, that is).  Impressive indeed, but what did China get in return?

  1. To be sure, fixed asset investment grew by 25+%, which was one of the intended effects of monetary easing of this magnitude.
  2. Official PMI, which mainly reflects sentiment among SOEs or state corporation, went back into positive territory, but private sector PMI was still in negative territory at the end of March.
  3. There has been a pretty impressive stock market rebound in the A share.
  4. The housing market is showing some sign of life after a long winter.  Sales in many major cities are going up significantly, even driving up prices in some cases.

So far so good, BUT…

When we look at figures for non-investment economic activities, things do not look good at all.  In fact, it is down right disappointing after pumping 5 trillion into the economy.

  1. First of all, export and FDI continue to fall at a pretty fast pace, which can’t be helped.
  2. More alarming, inventory for many industrial goods continue to build UP! According to a recent note by Stephen Green’s team, refined oil inventory is up over 35% YoY as of the end of February.
  3. Coal inventory seems to have gone down, but that’s because many coal mines have ceased to operate.  The 21st Century Business Herald reported that 50-70% of mines are “resting” for the moment. Iron ore mines are facing the same problem as international iron ore now costs less than domestic ore.
  4. Electricity usage continues to be in negative territory.

Steel consumption has picked up somewhat from a collapse late last year.  However, I think the problem there is continual over-capacity.  The central government didn’t want any major steel firms to go under, so they are spending billions to “merge” a bunch of steel firms.  For example, Bao Steel based in Shanghai will buy up several steel producers in the Jiangsu/Zhejiang area.  This maintains the over-capacity in the sector and will put upward pressure on inventory.

In electricity generation, there is rumor of a ,CIC2, a mega company that will buy up distressed electricity producers and coal mines from across China, boosting the on-going consolidation financed by bank loans.  In the airline industry, billions have been injected into airlines to keep them afloat amidst disastrous bets on world oil prices.

There is then the widely cited figures of 12% increase in urban income at the end of 2008 and increase in car sales in first quarter.   In the first instance, I have no idea how the income figures were produced, but they almost always miss migrant workers, who are also urban residents.  On the car sales, China Economist already points to a recent FT article which questions whether sales of minivans will help car company profitability.  Finally, employment, which supposedly was the main point of the stimulus, was only marginally improved by the 5 trillion.  Most large projects haven’t gotten going yet as land still needs to be procured.  The biggest employment impact was that the 5 trillion prevented the mass bankruptcy of hundreds and perhaps thousands of firms. However, some firms are staying alive by laying off or furloughing workers, like the coal mines.

So, really, when it comes down to it, the 5 trillion bought:

  1. some psychological relief
  2. some more sales of real estate, thus delaying the bankruptcies of many developers
  3. an upbeat stock market, for a while
  4. prevented the bankruptcy of numerous state firms, especially in the airline, coal, electricity, and steel sector

The most alarming thing is that these “positive” effects of pumping money into the economy lasts only as long as the money keeps flowing.  If for whatever reason, the central government decides to slow down the pace of lending (and there are signs they are thinking of doing so), ALL of the above benefits will collapse relatively quickly.  Imagine; if the flow of funds slows significantly, the psychological relief will disappear quickly, as will short-term loans to developers; the upbeat market sentiment will follow as speculative funds withdraw suddenly from the market.  SOEs, which are building UP their capacity and inventory as we speak, will face growing losses from depreciation and deflationary pressure on output.  Without free flow of bank loans, they will begin to default on their previous loans.  Speculative demand for real estate will also collapse, given that inventory is expected to reach over 1 billion sqmtr some time in 2009 (again citing SCB report by Green et al.).

What does this mean?  The central government cannot stop or even significantly slow this pace of lending until export picks up in a significant way, else the bubble will burst.  This is a race against time.  At some point, this pace of lending will lead to a serious NPL problem or inflation, or both.  If by that point, export and domestic household consumption remain anemic, I am not sure what options the central government will have.

6 Responses to "What did 5 Trillion RMB Buy?"

  1. gregorylent   April 23, 2009 at 1:51 am

    same with the usa, the money is only for mental comfort, to manage expectations and avoid riots and bank runs ..

  2. serialsaver   April 23, 2009 at 4:01 am

    Central governments/banks are quickly running out of bullets. Quantitative easing, buying of debt, etc cannot go on forever. What is ignored by all central governments is tangible stimulus for the economic engines that aren’t temporary or market/financial/credit driven but rather enable workforces and individuals. The upside-down incentives leading to over-concentration of top-heavy wealth/power finally excluded too many and short circuited their revenue streams.Time for new paradigms, thinking and disincentives for the political forces supplied by oligarchs wealth on the world stage.Human nature is predictable, when threatened people will protect themselves financially and otherwise. The question now is if there are sober adults who will enable populations in garnering tangible wealth, ownership of property and rewards. Secure paths which are clearly visible towards economic security and prosperity is required but will necessarily radically trim the entitlement, wealth and power of those who perpetrated this grand scheme. Time will tell if there are any realists, heroes or bravery in the ranks of those with the power to turn the current crisis into a sustainable positive for the vast populations or if political and self-interest will continue to rule.

  3. Anonymous   April 24, 2009 at 2:32 am

    Are those StanChart reports you mention available on link? Would like to have a closer read of them

  4. Wilson Siu   April 24, 2009 at 10:44 am

    Dear Victor, nicely written and rather introspective. I agree about the phenomenon, but got a kindergarten solution which is used in the US. If we run out of candies, just ask the fairy to print them!The problem can be solved of course, just like everywhere else in the world. Just print money! This is a one stone hit two birds approach. If they will, this is the wisdom from ancient China, which will work in the 21st century for the following reasons:1. As the federal reserve continues to print money, which according to Milton Friedman’s Quantity Theory of Money, it will lead to a lower value of the dollar. When the dollar goes down in value, if China does not buy the dollar in order to have a stable currency, they are called currency manipulaotr. (Note: if the federal reserve does not print money in the first place to lower than valuation of the dollar, the Rmb would not have fundamentally been stronger.So the argument is, if we engineer a lower value of our currency and you do not let you currency rise, you are a currency manipulator. ????????? Would it not have been a problem in the first place at if the federal reserve does not manipulate its currency?)So the solution is, in order to keep a stable currency, China instead of buying up US dollar can also print as much RMB as possible or at the same speed as the US, as such the fundamental value of the RMB would have depreciated as fast as the US dollar.Here is the one stone hit two birds part:1. By printing as fast as the fed, China can have a relatively more stable currency while not having to buy the US dollar, thus no blame game for the US anymore.2. Money printed can be pumped into the system to stimulate the economy.One stone hits two birds, I hope China does that.So it can put a full-stop to the following arguments:1. We got too fat because you are willing to provide us with Donuts. ( We are in debt because you provide us with credit)2. If the board of directors have decided to issue new shares thereby diluting the value of the stock’s net asset value per share, and if any major shareholders does buy back of the stock in the market in orede to stabalize the stock price, you are a stock price manipulator. ( If the fed does not print money in the first place, the US$ would not weakened in the first place. If the company does not issue new shares, earnings per share would not have decreased in the first place).Let’s end the hypocrasy show in economics.

  5. Victor   April 24, 2009 at 11:08 pm

    Dear Wilson, I agree in theory with what you say (though if there is real appreciation due to inflation, then it’s harder for China to export….). However, one key assumption is that “Money printed can be pumped into the system to stimulate the economy.” My piece is saying that the money is NOT being used for that purpose, but mainly to continue to build excess capacity and bail out bankrupt SOEs and state entities. If the money is used as direct transfer to the people of China and if the government can credibly guarantee that the transfer would continue, I would then say that the stimulus may work.

  6. Anonymous   May 6, 2009 at 1:30 pm

    Dear Dr. Shih, Your posts here come very few and far between. And are very welcome. No doubt there are many who read them. Just a suggestion, but you might think about spending more time to write even more of your thoughts about China with greater frequency. Even though no one can expect to be an authority on China, or even expect to get anything right, still, please spend more time to put your best foot forward and definitely not be bashful about expressing your views.Some vociferous readers may try to shout you down. But, pls dont listen to them. Just pls write your real views. So that we can read them. And pls try to post your thoughts, twice a week. If you can find the time. Tks!Thank you and hope you will write more often.