While investors have cheered China's latest Q2 GDP growth of 7.9% as evidence of the country's policy success, they may be missing a hugely destabilizing spiral in monetary policy that is generating it. The country looks set this year to generate new bank lending equivalent to over 30% of GDP, or twice official targets, while money supply is growing at an annualized 26%. That's enough to make even Alan Greenspan in his bubble blowing heyday blush, and bubbles are blowing aplenty in China. The quality of most of these rapid fire loans dictated by Beijing is surely abysmal. About $170 billion of Chinese bank loans are estimated to have been funneled into the Shanghai stock market in the first five months of 2009, or 20% of the total new loans banks made in that time period. Is it any surprise that China has just surpassed Japan to become the world's second largest equity market, and the best performing this year?
I suspect another large chunk of that lending has found its way into speculative commodity stockpiling, as well as the real estate market. It's a bit rich that Chinese officials are criticizing US economic policy when they are are essentially following the easy money credit boom model in order to forestall a cyclical economic recession. China suffered a record yoy fall in exports of 26.4% in May, and Beijing has ramped up money supply growth partly to prevent the US dollar from falling below 6.80 Yuan, to sustain the country's comparative advantage amid weak global demand. China can certainly achieve its talismanic 8% growth target by throwing vast resources into mechanical short-term growth objectives, but the question is whether these policies are sustainable or simply delay the necessary re-balancing of the economy away from manufacturing and infrastructure investment toward domestic consumption.
Investment productivity is appalling, and has been declining for a decade ; it is very likely much of the stimulus spending will be a total waste. Far from 'leading' a global recovery (unlikely anyway as it only comprises 8% of global GDP), China will be among the last countries to escape from the effects of the global crisis, being trapped in a deflationary trap of chronic export overcapacity as its foreign consumers deleverage over the next few years. It seems doomed to repeat Japanese policies of the early 1990's, which left that country carpeted in concrete but still mired in recession. Meanwhile, foreign reserves surged to a record US$2.13 trillion at the end of June, making it likely that speculative capital is flooding in to bet on rising asset prices and a quick economic recovery (and even an eventual Yuan revaluation). Most of the increase was driven by the very large trade surplus and declining but still high net FDI inflows, plus of course returns on the existing overseas portfolio, but speculative capital betting on a Yuan revaluation is back for the first time since last Summer, evading strict controls on the capital account.
Despite often confused media commentary on the dollar and China's role in its fate, China doesn't fund the US fiscal deficit; it funds the US current account deficit, and it has no choice but to fund it because of the dollars generated by its trade surplus with the US. Simplistically, if the US wants China to buy, say $500bn of new bonds, all it has to do is ensure that the US runs a $500bn trade deficit with China that year. Reserves rose US$178 billion in the second quarter, the biggest quarterly increase on record and up from the US$1.95 trillion Yuan at the end of March.
So called 'hot money' flows, notably via Singapore and Taiwan (via falsified trade passing through the current account), intensify Chinese growth in the short term, even as they complicate the PboC's job. The PBoC must recycle the net surplus on the current account and the capital account, and with the very high current account surplus, China is creating a huge amount of domestic money from that source alone. Many commentators rightly worry about the Fed's exit strategy from current policies, but China's future policy options are even more ominous. The Chinese economy right now is enjoying a huge sugar high created the combined effects of a lending boom, money supply growth, and speculative capital inflows, as well as nearly $600bn in fiscal spending, and the asset bubbles all these are helping to generate. However, as the consequences of current policies come home to roost in 2010 and beyond, from soaring bank write-offs to inflation, China will likely become the problem, not the hoped for solution.
