At some point, investors might conclude that Chinese authorities are simply toying with global markets.
On Monday (August 21), People’s Bank of China Governor Pan Gongsheng knew full well that punters everywhere were braced for major easing. A bold step seemed warranted as the property slump deepens, consumer spending craters, credit growth tumbles and deflation takes hold.
Yet Pan surprised markets with more restraint. Though the PBOC trimmed its one-year lending rate, it left the more consequential five-year rate unchanged.
Such disappointments — and a widening gulf between market expectations and Beijing’s actions — are becoming a common theme. It speaks to a balancing act that President Xi Jinping seems determined to pull off.
The strategy: tightly targeted efforts to relieve tension in credit markets while avoiding stimulus explosions like those in 2009 and 2015. The response to both episodes led to new asset bubbles and boom-bust cycles.
Strategist Masayuki Kichikawa at Sumitomo Mitsui DS Asset Management speaks for many in concluding Xi’s government is too “concerned about downward pressure on the yuan” to greenlight a fresh stimulus boom.
The risk, of course, is that the “disappointing” size of Monday’s loan prime rate cut “wouldn’t help with building confidence” as Chinese authorities endeavor to stabilize sliding gross domestic product (GDP), says economist Maggie Wei at Goldman Sachs.
This abstemiousness, Wei worries, “can even backfire if market participants interpret these easing measures as policymakers’ unwillingness to deliver even moderate policy stimulus.”
Yet it’s a risk that Xi, Pan and Premier Li Qiang seem willing to take as the world’s top central bankers head to Jackson Hole, Wyoming for this week’s annual US Federal Reserve retreat.
Though nominally a Fed-centric exercise, the symposium in the Grand Teton mountains often serves as a brainstorming session in times of turmoil. This was the case in the late 1990s as Asia’s financial crisis and a Russian default shook the world.
It was true in 2008 and 2009 as the “Lehman shock” shook markets and in 2015 when China’s last displayed signs of financial stress panicked Wall Street. Jackson Hole served as a chance for leaders at the Fed, European Central Bank, Bank of Japan and others to spitball on ways to address Covid-19 fallout.
This weekend, chatter about the contours of the Fed’s inflation fight may be drowned out by China’s cracks. Deepening troubles in the world’s second-biggest economy are the last thing officials from Washington to Seoul need right now.
Xi, Pan and Li are grappling with much more than a Covid reopening that’s been more of a small pop than a boom. Global uncertainty is reducing demand for Chinese goods at the same time domestic fissures like record youth unemployment are complicating efforts to revive slumping property markets.
Fears that property giant Country Garden might default has global punters fretting about contagion risks in China. It’s the first time since 2021, when major developer China Evergrande Group missed bond payments, that global elites came to fear China’s frailty more than its strength.
Odds are such risks will have the PBOC lowering the one-year loan prime rate (LPR) again — on top of Monday’s cut to 3.45% from 3.55%. “We are penciling in a 10 basis-point cut in one-year LPR and 20 basis-point cut in five-year LPR to further shore up the property sector,” argue Citigroup analysts.
Carlos Casanova, economist at Union Bancaire Privée, adds that “looking forward, we expect that the PBOC will also follow through with additional 50 to 75 basis points in reserve-requirement ratio cuts and balance sheet expansion to mitigate risks in key sectors, such as local government financing vehicle (LGFV) debt and regional housing markets.”
Pawel Borowski, analyst at Fitch Ratings, says that “China’s macroeconomic activity indicators have deteriorated sharply in recent months, following a strong rebound earlier this year after Covid-19 pandemic restrictions were abandoned. Renewed deep falls in property starts and sales have led the downturn, but retail sales and consumer confidence have also weakened.”
Economists at JPMorgan write that “second-hand home prices remained low, with consistent declines both month-on-month and year-on-year across all tiers of the city. This further narrowed the price gap with new home prices. If second-hand house prices fall below new house prices, this could be a game-changer in that new house prices and second-hand house prices could become mutually reinforcing, helping to materialize the risk of Japanification.”
Caveats abound, of course. As Asia Times’ David Goldman observes, comparisons to 2015, when plunging Shanghai stocks spooked the globe, are belied by financial trends on the ground.
Despite extreme stress in mainland property, rates for five-year credit protection on the Chinese sovereign debt aren’t skyrocketing. Though the yuan is weakening – it’s down 5.6% this year – the trend is less remarkable than the yen’s decline.
All this could change, of course, if global investors decide that the PBOC under Pan – who only started the job on July 25 – is asleep at the wheel. That alone could accelerate the yuan’s decline, putting property developers with high ratios of dollar-denominated debt in harm’s way.
An even weaker yuan might put Beijing on Washington’s radar for currency manipulation, just as the 2024 election cycle heats up. It also could imperil Xi’s long-term vision for increasing the yuan’s role in global trade and finance.
It hardly helps that these fissures exist in a “world where America is determined to contain China’s rise but is no longer assured of its success,” says Diana Choyleva, chief economist at Enodo Economics. “A world where other countries and international businesses do not want to choose sides but will have to.”
But Xi’s balancing act is a tantalizing one. At the moment, Xi is resisting bailing out developers and other key sectors as China did in 2009 and 2015. Instead, his economic team is staying focused on Beijing’s bigger plans to squeeze extreme leverage out of the system and for China to grow better, not just faster.
It’s a risky approach, particularly as the PBOC attempts to wean the economy off Japan-like ultra-easy monetary policies.
“Protecting banks’ net interest margins is the main motivation behind the smaller-than-expected cuts to LPR in our view,” Goldman’s Wei says. “Having said that, confidence remains key to an economic recovery, and the disappointing cut to LPR would not help with building confidence.”
What would build trust is for Xi and Li to make clear and tangible progress in recalibrating growth engines, incentivizing private-sector investment, increasing innovation and productivity and creating broader social safety nets. Instilling confidence that this is indeed happening is key to offsetting efforts to choke off property speculation and related lending.
At the moment, China confronts an “expectations recession,” as Bert Hofman, former China country director at the World Bank, told Bloomberg. “Once everybody believes that growth will be slower going forward, this will be self-fulfilling.”
Hence the intensifying chatter about Japanification risks for China. As former US Treasury Secretary Lawrence Summers writes in the Washington Post: “There can now be little doubt that just as the conventional wisdom way overstated the economic prospects of Russia in 1960 and Japan in 1990, so have China’s prospects been greatly exaggerated in this decade.”
Yet missing from such takes from the West is the other half of Xi’s calculation. Along with squeezing out speculation and leverage, Team Xi is working to prepare the ground for more efficient and productive investment.
For years now, the World Bank, International Monetary Fund and US Treasury – including during Summers’ day – implored Beijing to improve the quality of economic growth. That means disincentivizing prefectural leaders from engaging in an infrastructure arms race.
Since the Lehman Brothers crisis, metropolises around the most populous nation raced to build skyscrapers, six-lane highways, international airports and hotels, white-elephant stadiums, sprawling shopping districts, amusement parks and vied for museum projects from the likes of Guggenheim to impart a “Bilbao effect” in the Chinese hinterland.
After the 2008-2009 subprime crisis, this strategy shifted into overdrive. At the time, Xi’s predecessor Hu Jintao relied on local government public works projects as a key engine to avoid the worst of the global financial crisis. The same with Xi’s men when financial turmoil hit Shanghai in 2015.
Xi’s remedy to the challenges of 2023 stands in sharp contrast. Rather than take a throwing-the-kitchen-sink approach to this year’s turmoil, Beijing is prioritizing reform over indiscriminate stimulus. A same-old-same-old approach might just reward bad behavior, enabling a new wave of re-leveraging that leads to bigger and more numerous boom-bust cycles.
The good news is that thought leaders like economist and former politician Jiang Xiaojuan are intensifying the argument that the key is bolder efforts to build a more vibrant private sector.
Jiang, who’s with the University of Chinese Academy of Social Sciences, argues that private entrepreneurship, not the state sector, must be China’s future. Not the newest idea, but her gravitas carries weight in policymaking circles.
As William Hurst, a China development expert at the University of Cambridge, puts it: “Massive new spending and/or lending now would make those asset price bubbles even worse. It would continue to crowd out consumption and more productive investments. And it would make it more difficult and costly down the road – maybe even prohibitively so – to do this again.”
Ultimately, Hurst adds, “inflection points and critical junctures can only be clearly spotted in hindsight. But what we’re seeing in China is not the start of something new and probably not the very end of an unwinding of export-led growth that began 15 years ago.”
“We’ll likely see serious debate – or at least evidence that it’s happening behind the scenes – and possibly a meaningful shift in at least short-term economic policy in China over the coming days and weeks. But any really big macro-level change will be slower in coming and harder to see in real-time.”
Economist Michael Pettis, a Carnegie Endowment senior fellow, observes that the “costs of maintaining high GDP growth rates have become so obvious in recent years, not least in the extent of the debt burden they have created, that it’s no longer possible to ignore the extent and severity of the underlying imbalances.”
But, Pettis explains, “while most analysts now recognize that China must urgently raise the role of consumption in generating demand, and an increasing number recognize the institutional constraints in doing so, the real shocking imbalance” is “China’s extraordinarily high investment share of GDP – now 44% of GDP.”
Pettis says “there is no remotely comparable historical precedent. Among other things, this means that China can deliver high GDP ‘growth’ only as long as it maintains impossibly high investment rates.”
All the more reason for Xi and Li to push ahead with policies to reduce the amplitude of bullish-to-bearish financial swings. It’s a pivot for which the Jackson Hole set has urged for years.
The PBOC focusing more on the big picture than achieving this year’s 5% growth rate – and showing a poker face in global markets – speaks volumes about how China is prioritizing building economic capacity at home.
The same goes for China’s outlier status in Jackson Hole. Unlike the PBOC, Fitch analyst Borowski notes, major central banks have continued hiking rates.
The Fed raised its benchmark to 5.5% in July, while the ECB raised its key refinancing operations rate to 4.25%. The Bank of England recently raised rates to 5.25%.
The PBOC is going the other way, though not nearly as fast or as drastically as the doctrinarians in Wyoming this weekend might have expected. But then, Team Xi seems to be making confounding the conventional wisdom on China’s economy its brand – and not a moment too soon.
Follow William Pesek on X, formerly known as Twitter, at @WilliamPesek