China's August scare is a false alarm as fiscal crunch fades
The recession in China has been and gone. The housing market is picking up as stimulus revives, putting off the day reckoning again
By Ambrose Evans-Pritchard
The situation in China is desperate but not serious, to borrow an old Viennese saying.
Given the sanctions and given that China has a trade surplus of $600bn or 6pc of GDP - and is therefore accumulating foreign exchange at blistering pace, ceteris paribus - there is no chance whatsoever that reserve losses will spin out of control.
Jens Nordvig from Nomura says China has $3.65 trillion reserves to cover foreign currency debts of $1.135 trillion, a ratio of 322pc.
This a far cry from the East Asia Crisis in 1997-1998 when the ratio was 59pc in Malaysia, 33pc in Thailand, 27pc in Indonesia, and 22pc in Korea. All these countries had current account deficits. China most emphatically does not.
"We think the authorities will remain in control of the situation. This may mean that the worst shock effect is behind us, although ultimately the economic data will provide the final verdict," he said.
On cue, the economy is already coming back to life after hitting a brick wall over the winter. Credit growth jumped to a 31-month high in July. The monetary base has grown at a 20pc rate over the last three months, implying an economic spike later this year.
It is worth remembering what has just happened in China. The country is recovering from a ferocious monetary and fiscal shock. The authorities refused to react as falling inflation caused one-year lending rates to ratchet up to 5pc in real terms from zero in late 2011.
This was deliberate, of course. Premier Li Keqiang intended to break the back of the property bubble and wean the country off its $26 trillion credit dependency. But pricking bubbles is no easy task. The authorities overshot.
The crunch came just as fiscal policy went awry. Budget spending contracted in the first quarter. This was certainly not intended.
While details remain murky, it appears that banks refused to roll over short-term loans used by local governments to finance a raft of existing projects. They feared that these loans were no longer covered by a state guarantee under new rules. "It caused huge disruption," said Capital Economics.
At the same time, the regions saw a sudden-stop in lending for new projects as well. Local governments were prohibited from fresh bank borrowing in January. Under the so-called "debt swap" plan there was supposed to be a seamless transition from loans to bond issuance, but the bond market was not up and running until May. This is why China crashed into a recession in the first half of the year.
Wisely or not - depending on your economic religion - the Communist Party has now reverted to stimulus as usual. The local governments issued almost $200bn of bonds over the two months of July and August. Beijing coyly describes its fiscal spending as "proactive". Turbo-charged would be another way of putting it.
The property crash is already a memory. House prices have risen for three months. Sales were up 18.9pc in July. This matters more than anything happening on the Shanghai stock market. Moody's says real estate in all its forms makes up a quarter of Chinese GDP.
The 'Tier I' cities led by Beijing have risen 6.5pc over the last year, and Shenzhen is up by 25pc.
"The authorities may soon be forced to cool the property market again. Otherwise they risk another destabilising asset bubble," said Oxford Economics.
It is no mystery why property is picking up. The government has abandoned its assault on speculation. It slashed the minimum downpayment from 60pc to 40pc in March for second homes. Interest rates have been cut four times.
Housing in the smaller cities has bottomed out but is still deeply depressed. The International Monetary Fund warned in its latest Article IV report that inventories for the 'Tier 3 & 4' cities have risen to three years' supply, and these account for half of all construction. "Working off the excess will require a multiyear adjustment," it said.
At the risk of sticking my neck out, I think that Gothic warnings of a Chinese collapse this year will look silly by Christmas. The reckoning has been delayed again.
The "devaluation" saga this month is a red herring. The PBOC has switched from a dollar peg to a 'managed float' to protect itself from any further surge in the US dollar as the Fed tightens policy.
This is not a devaluation. It is an insurance policy against at further rise after a 22pc jump in the trade-weighted exchange rate since mid-2012. There is a fashionable suspicion that the PBOC is hiding behind a "market-led" exchange rate to disguise what is really a beggar-thy-neighbour policy to hold onto export share, but it is far from clear whether China has anything to gain from doing so.
It would risk setting off the very capital flight most feared. It would send a deflationary shock through a fragile global economy, and risk a further escalation in Asia's simmering currency wars. It would invite an iron-fist response from Washington. The costs are high: the benefits scant.
True, Chinese exports are languishing, though over half of the 8.3pc fall in exports in July was due to base effects. Yet the "trade intensity" of China's economy is plummeting as the country moves beyond export-led catch-up growth. World bank data shows that exports peaked in 2006 at 36pc of GDP. They fell to 22.6pc last year.
Exports as a share of GDP
China is becoming a fortress economy like the US, moving to its own internal rythm. This is unpleasant for countries like Brazil that make a living supplying China with raw materials, but not for China itself. As Stephen Jen from SLJ Macro Partners puts it, the Chinese downturn is "soft on the inside and hard on the outside."
Nor is there any need to risk a currency war. The economy has been generating 1.2m jobs a month this year. There are still more vacancies than candidates.
The offers-to-seekers ratio has risen from 0.65pc in the early 2000s to 1.06pc. It has come down sharply this year - and needs watching - but the flood of migrant workers from the countryide has dried up as China's passes the "Lewis Point". The wages of migrant workers are still rising at a rate of 10pc. The labour market is tight.
None of this is to say that China's economy is healthy. Credit still rising by seven percentage points of GDP each year, pushing the debt ratio ever further into the danger zone. It will be 270pc by next year. This will end badly.
But China is not in immediate crisis. The Reserve Requirement Ratio (RRR) for banks is still 18.5pc. The PBOC can slash this to 6pc - as did in the late 1990s - flooding the system with $3 trillion of liquidity. It can even go to zero in extremis.
The time to worry is when China has exhausted this last buffer. This August scare of 2015 is a false alarm.