Last week’s report that China’s first quarter GDP slowed to 6.1 per cent has been widely analysed. The one figure that struck me at the time and still seems amazing was bank lending, nearly 5 trillion RMB, which is the equivalent to bank lending for the whole of 2008. An astonishing figure and one that shows when Beijing cracks the whip, it can still get people to jump as high as it wants. I’m sure Obama wishes he could do the same. The problem is, as the excellent Victor Shih of Northwestern University points out on his blog (and as he says, he is repeating points made by a number of others including Michael Pettis), all that cheap money has to stop sometime and, as I also noted in an earlier piece, unless exports have recovered by then, there could be a spectacularly messy comedown. Ironically of course, it was easy money that got the U.S. (and thence the rest of the world) into the current pickle in the first place. Anyway, Victor’s money grafs (tho the whole post is definitely worth reading):
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 (non-performing loans) 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.