Commentary on Political Economy

Wednesday 3 March 2021

 Friends will recall how recently we followed Professor Michael Pettis in warning that China’s growing inflow of Western finance will expose it inevitably to the collapse of its own credit pyramid. In this article,  Stephen Bartholomew has cleverly detected how the Butchers of Beijing are now softening up their own people to the impending blaming the actions of Western monetary authorities !  Hahaha....

‘There will be problems’: China fears the blowback from global financial bubbles

Global markets are awash with liquidity, with the risk of financial “bubbles” rising as central banks continue to pour monetary stimulus into their economies in response to the COVID-19 pandemic. That has China’s authorities worried.

In unusual, and unusually blunt, comments on Tuesday, the head of China’s Banking and Insurance Regulatory Commission, Guo Shuqing, said China was very worried that foreign asset bubbles would burst soon and identified the US markets as representing the greatest risk to the global economy.

Sombre warnings from Guo Shuqing, the chairman of the China Securities Regulatory Commission.

Sombre warnings from Guo Shuqing, the chairman of the China Securities Regulatory Commission.CREDIT:BLOOMBERG

The massive injections of liquidity into the US and European financial markets from their stimulus measures in response to the pandemic had pushed asset valuations above levels justified by economic fundamentals, risking a “serious run in the opposite direction,” Guo said.

“If financial markets diverge too much from the real economy, there will be problems,” he said.

While it might appear unusual, even odd, that a senior Chinese regulator would be commenting on the monetary policies and markets in the US and Europe, there’s an explanation that lies closer to his home.

China is clearly concerned that, having opened some of its markets to foreign capital, the ultra-loose conditions elsewhere – which will be exacerbated if the Biden administration is able to add its latest $US1.9 trillion ($2.4 trillion) stimulus package to the $US4 trillion US pandemic response last year -- will lead to destabilising inflows of speculative capital into its own system.

China was trying to deleverage and shrink some of the vulnerabilities in its own financial system when the pandemic struck, forcing it into its own very large stimulus program. As it brought the pandemic under control, it began removing liquidity and tightening access to credit.

De-risking the economy

It has put a ceiling on bank lending for property, cracked down on shadow banking and, controversially, embarked on a brutal assault on the unregulated but fast-growing peer-to-peer lending sector, with billionaire Jack Ma’s planned $US35 billion initial public offering of the Ant Group an early and very high-profile casualty. The float, which would have been the biggest IPO in history, was aborted only days ahead of its planned listing.

The reasons for China’s pre-pandemic efforts to de-risk its financial system were obvious. Its response to the global financial system crisis in 2008 was arguably the largest of any major economy’s, and left a legacy of dangerously high corporate debt levels at about 150 per cent of GDP and massive levels of unproductive investment.

The authorities were trying to address that leverage, and the inefficiency with which China’s corporate sector has deployed its capital, particularly within the state-owned sector, when the pandemic hit and they had to reverse course.

They are also trying to deflate what appears to be another property bubble within its own economy, a bubble inflated by last year’s stimulus and China’s strong and early economic recovery from the pandemic. It was the only major economy to post positive growth last year.

“If financial markets diverge too much from the real economy, there will be problems.”

Guo Shuqing

The subsequent tightening of conditions resulted in a slew of Chinese company defaults last year on bonds they had issued in both the domestic and offshore markets. About 40 Chinese entities, including state-owned enterprises, defaulted on about $US30 billion of bonds they had issued, including defaults on bonds issued offshore.

There have been more than $US8 billion of new defaults already this year, about a third of them on bonds issued offshore - including disturbing missed payments by a big property developer, China Fortune, whose biggest shareholder is China’s largest insurance company, Ping An. China Fortune has $US4.6 billion of dollar-denominated debt.

No bail-outs

The absence of bail-outs for state-owned enterprises signals the greater willingness of China’s authorities to allow even state-backed companies to fail or be forced into restructuring. It is a sign of their commitment to financial and economic reforms – and an indicator of the severity of the perceived challenges within their corporate sector.

Guo’s concern about liquidity and bubbles elsewhere probably relates to what has been happening to that excess liquidity churning through global markets.

In their efforts to deleverage and reform their corporate sector and improve the quality of lending by banks and shadow banks – and under pressure from the Americans and Europeans – China’s authorities have been carefully opening up segments of their financial system to foreign capital and firms.

Higher interest rates in China, particularly for bonds issued by riskier issuers, are seeing big inflows of foreign capital. China’s more lowly-rated bonds trade at a massive premium – as much as five percentage points -- to the “high-yield” or “junk” bonds in the US.

Not surprisingly, in a world where investors have been prepared to take ever-increasing risks to chase yields, the returns on offer in China – the yield differentials -- are attracting capital and exposing China to the risks in other financial systems.

Given that it’s in the midst of a difficult and delicate attempt to deleverage its own system and reform its industrial base and financial sector while still trying to maintain a reasonable level of economic growth, China is exposed and vulnerable to external shocks.

While Guo’s comments were unusual, they aren’t particularly controversial. It’s inevitable that the gushers of liquidity unleashed by central banks will produce unintended consequences and stretch financial asset valuations to levels that could result in messy, disruptive and probably destructive outcomes somewhere down the track.

For the moment the sole focus of the central banks and their governments in developed economies is on their real economies and their recovery from the economic fallout from the pandemic, with the risks of asset price bubbles and/or adverse impacts on others’ economies and financial systems acknowledged but regarded as second-order issues.

China, clearly, isn’t as sanguine about pumping all that liquidity into the global financial system without sufficient regard for the consequences.

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