Mike “Mish” Shedlock
Business Insider
4/4/2011
In his latest Email review, Michael Pettis at China Financial Markets discusses financial reform (actually the lack thereof in China), as well as an observation on China’s Growth.
Pettis writes ….
Three months ago during their 2010 Q4 conference, the PBoC said that they believed that the global economic recovery would continue in 2011, although they acknowledged a great deal of uncertainty. The PBoC also said that stabilizing the price level was their top priority, and the central bank planned to control the “main gate” of liquidity inflows and to bring credit growth to “normal” levels.
Chen Long at SWS notified me yesterday of a change in tone. In their 2011 Q1 conference earlier this week the PBoC said that the fundamental basis of the global recovery is not very solid. The central bank still acknowledges that stabilizing price levels is an important task, but they only refer to “managing liquidity efficiently”.
What does this imply? I suspect it means that policymakers are becoming a little more concerned with slowing growth and a little less concerned about domestic overheating. As I argued in the past few newsletters, growth may be slowing more quickly than Beijing would like, and combined with the very volatile external environment, I suspect they are going to be cautious about too much more tightening. We will see how many more interest rate hikes and reserve requirement hikes we are likely to get in the next quarter.
Whether or not we have reached the point in China in which investment is misallocated and debt levels rising is clearly a matter for heated debate – I think we have already passed that point – but clearly we are tending in that direction.
In the last ten years the combination of socialized credit risk, very low interest rates, state-directed lending and tremendous pressure on the part of SOEs and local and municipal governments to generate employment and growth in the short term has increased the probability that the Chinese financial system may be misallocating capital on a dangerous scale.
Aside from the many studies I’ve cited showing that profitability in many of China’s largest companies is substantially less than the value of the financing and other subsidies, and anecdotal evidence of unnecessary real estate and infrastructure projects, just imagine what would happen to banking deposits and stock prices if the government credibly removed all guarantees on loans extended by the banks, and furthermore removed interest rate controls. I suspect most investors and depositors would assume, correctly in my opinion, a surge in non-performing loans that would wipe out the banks’ capital base, and so would sell their stocks and withdraw their deposits…
The article continues at Business Insider.
