The parallel universe of Yao Yang

Ever since she left FitchRatings, Charlene Chu’s research is available only to the clients of the new firm, Autonomous Research, that she works for. Bloomberg has a rare interview with her:

Question

How does China’s debt build-up compare to Japan’s previously?

Answer

Question

What’s your assessment of China’s capital flows?

Answer

“The party line is that outflows are all about offshore debt repayment, but that accounts for a minority of the flows we are seeing. We think most of the money is leaving through trade mis-invoicing, which is very hard to shut down. Although capital outflows have quieted down, the underlying motivations for people to move their money out of the country are still there. This problem has not gone away.” [Link]

This one on ‘denial’ in China is important:

Question

Is a financial crisis or a very dramatic economic slowdown now inevitable?

Answer

“Not yet, but we’re getting there because the problem is getting so big. We’re still adding 10 to 20 percentage points to the ratio of credit to GDP every year — that has not changed despite the fact that credit growth has decelerated. If the government was to come out with a very aggressive — and it would have to be incredibly aggressive — bailout package for corporates, as well as financial institutions, it would do a lot in terms of dealing with some of this debt overhang and getting rid of the black cloud that’s hanging over the country. However, the idea that China needs a massive bailout in the trillions of U.S. dollars isn’t something I think the authorities are on board with or accept yet. They still believe they can grow out of it.” [Link]

The Parallel Universe of Yao Yang

It is not just the authorities who believe that they can grow their way out of trouble. Yesterday (10th June), I attended a presentation by Yao Yang, Dean, National School of Development (NSD) & Director, China Center for Economic Research, Peking University, Beijing, at the LKY School of Public Policy of the NUS in Singapore. He too was blase about the problems in China. The words ‘debt’ and ‘deleveraging’ appeared in his presentations much later.

In his world, China does not have an excess capacity problem but a demand deficiency problem. Very original, indeed. Therefore, there is nothing that cannot be solved by a good old-fashioned fiscal stimulus. At the same time, China’s potential growth rate is between 6.5% and 7.5% and it is growing at potential so much so that China’s aggregate GDP would exceed the aggregate US GDP by 2023, at the latest. Then, where is the demand shortfall and the need for stimulus? A big contradiction here.

There was no mention of the extent of bad debt that has been accumulated by the banks, even though the problem was supposedly due to reliance on banks for credit creation. Sure. But, that is as much a political choice as it is one of a market underdevelopment issue.

The Bloomberg interview with Charlene Chu cites SocGen Research and puts the estimate at 12% of GDP. But, there are much larger estimates too. I think Charlene Chu’s firm estimates the bad debt ratio at 20% of GDP.

The need for the government to recapitalise banks was acknowledged but since the estimated amount was left out, there was no difficulty in assuming the problem away  – Chinese government can address demand shortfall and recapitalise banks and there would not be any problem with fiscal deficit, with credit rating, etc.

The notion that there is room for China to grow because there are vast areas of poverty and underdevelopment is a bit trite. Levels of absolute poverty and underdevelopment have never come in the way of countries suffering periodically from excess credit, malinvestment, overinvestment, bad debts and other overheating issues except that, in the case of China, these magnitudes are far larger.

Finally, on China deleveraging, her answer needs to be etched in people’s minds since they forget the basic meaning of ‘deleveraging’. IT is not a slowdown in the second derivative of credit (it is not a slowdown in credit growth) but it is contraction in credit (credit contraction instead of growth):

The word deleveraging should not be used when discussing China. Deleveraging means negative credit growth, or a contraction in the ratio of credit to GDP. China is nowhere close to deleveraging. [Link]

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