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Goldman Warns Additional Chinese Stimulus Risks Global Financial Stability
The soft July data have once again generated expectations of monetary easing from China. Goldman however thinks further monetary easing would have incrementally less of an impact and would come at the cost of financial stability. This diminishing impact, they argue, would result as overcapacity/oversupply restricts long-term borrowing demand and due to interest rate deregulation, which tends to move the long-term risk-free interest rate to a higher equilibrium, as seen in recent data. As the tradable sector continues to recover on the back of an improved global outlook, Goldman believes that a combination of sectoral policies aimed at easing financial stress and structural adjustment would be a better policy option. They do not expect broad macro easing or an interest rate cut in what remains of this year.
Goldman's Li Cui Explains...
Better global growth has supported recovery, while domestic demand is still soft
Recent data show that the impact of earlier policy easing was short-lived, and domestic demand has remained soft. For July, in particular, most indicators related to domestic demand – including investment, financing and imports – decelerated notably from the previous month. Industrial production held up but this was most likely a reflection of stronger exports rather than domestic momentum. While one monthly data point does not signify a trend, the underlying picture is clear: Chinese exports have seen a visible recovery since last year, cushioning the impact of the domestic slowdown, in line with our expectation.
Given soft domestic momentum, market attention has again turned towards the potential for further monetary easing, including liquidity easing and a cut in interest rates. However, recent experience suggests that monetary easing is likely to have a limited impact on the growth recovery, as we have argued elsewhere. The credit rebound in May-June and the decline in July were entirely driven by short-term borrowing. Long-term borrowing corresponding to corporate capex and infrastructure construction has been muted, and stands at 15.5%yoy, compared with 17.3% at the end of 2013. Thus, long-term investment has continued to decelerate despite monetary easing. Along with the elevated long-term borrowing costs discussed below, this suggests that monetary easing has yet to produce a lasting impact on economic demand. The relief through higher short-term loans has mostly benefited enterprises with working capital needs, in particular companies in sectors with overcapacity.
Monetary easing is likely to have incrementally less of an impact on growth, but a higher cost in terms of financial stability
Monetary conditions have eased since Q1. The 7 day repo has declined by over 200 bps from its peak in late 2013, The domestic component of our FCI index also eased, although the majority of the FCI easing still came through the weaker exchange rate from last year.
There are reasons to question the impact of monetary easing (liquidity easing or interest rate cuts, as some observers have recently proposed), not least given their limited impact on growth so far.
First, long-term interest rates have shifted towards a new 'equilibrium' level. This is a powerful counterforce to near-term liquidity easing. Monetary policy affects the economy mostly through its effect on long-term borrowing costs. Despite the significant decline in front-end rates, the long-term risk-free rate has remained well above 4%, more than 100bp higher than in 2013, pointing to a rise in the term premium. (We calculate the term premium for 5-year government bond yields as the difference between the actual rate and the implied 5-year rate from the short-term rate forecast. See Exhibit 1, see Asia Economics Analyst: China: Higher term premium challenging monetary easing, May 16, 2014).
In turn, bank lending rates have held up as banks faced higher funding costs. Lending rates on general loans rose from 7.0% to 7.3% between December and June (the latest data available).
Higher long-term interest rates mostly reflect interest rate deregulation, in our view. As the government pursues incremental steps towards interest rate liberalisation and reduces financial repression, savers start to enjoy higher returns on their savings. This means increased funding costs for banks, and for the economy as a whole. Long-term interest rates thus show limited downward flexibility, despite the liquidity easing. This means that interest rate liberalisation tightens financial conditions, and hence a more supportive fiscal stance and exchange rate, as well as regulatory adjustments, are likely needed to compensate for the effect.
Exhibit 1: The increase in term premium* offsets the impact of liquidity easing on long-term borrowing costs
* The term premium is estimated as the difference between actual 5-year government bond yields and the yield implied by the short-term rate outlook estimated on the basis of Consensus Economics forecasts. For a detailed discussion, see Asia Economics Analyst: China: Higher term premium challenging monetary easing.
Second, the cost of monetary easing for financial stability is higher. A steeper yield curve tends to encourage interbank risk-taking (although such activities have declined due to the recent regulations). A cut in the benchmark deposit rate, which is already below the market rate, risks deposit outflows to higher-yield products (as observed most recently at end-June). This could increase liquidity and disintermediation risks for the banking system, without clear evidence that such a rate cut would help to bring down borrowing costs in the economy.
Third, long-term investment demand is constrained for reasons unrelated to funding costs. Domestic cyclical sectors (heavy industrials and property sectors) are still weighed down by overcapacity/oversupply, and fiscal measures have been selective and measured in general. The fiscal stance turned more supportive from May to June after the unusually contractionary stance in the January-to-April period, but the overall fiscal deficit is largely on par with the budget – there has been limited incremental expansion overall.
Policy balancing act has stayed on track, in part thanks to the higher cost of funding that has cooled leverage growth
We wrote at the start of the year that the macro policy agenda is unusually complex this year, and that the government needs to maintain stable growth, control credit expansion and curb tail risks, while at the same time pursuing structural reforms. On the positive side, the government has a large set of policy tools that allow it to address various policy priorities at the same time.
So far, the score-card for this balancing act has generally been positive:
- Leverage growth has continued to come down, while economic growth has held up (Exhibit 2). Higher long-term rates help to contain leverage growth and reduce inefficient investment. Growth in the non-leveraged sector – in particular, exports – has helped to support the economic recovery.
- Financial stress has declined, even though interest rate deregulation has continued. Financial tail risks as perceived by the market have come down substantially, measured using our financial stress indicators, which are compiled on the basis of financial market prices and spreads. Such declines reflected the more dovish central bank signals and the new regulations aimed at limiting risk-taking in the interbank market (Exhibit 3).
Exhibit 2: Total Social Financing (TSF) decelerates, while growth has remained stable
Exhibit 3: Market perception of tail risks** has declined sharply on the back of improved regulation
** These indices are combined on the basis of financial market prices and spreads, adjusting for economic cyclical positions. In particular, the interest rate risk index is the weighted average of the deposit rate and the 7-day repo rate. The credit risk index is the average of the yield spread for longer-term financing costs (corporate bond, AA-rated) over the government bond yield, and the yield spread of the short-term financing cost (bank acceptance bill rate) over the government bond yield. The liquidity risk index is the average of the spread of the 3-month interbank rate over the overnight repo rate, and the spread between bank bond financing and the risk-free rate.
Selective policy support to continue; we do not expect broad macro easing or an interest rate cut
On net, a tradable sector recovery, continued prudential rules to curb excessive risk-taking and targeted/selective policies should help to keep the balancing act on track, allowing the government to continue to pursue the structural agenda.
While we expect the general policy stance to remain accommodative, we do not expect significant further monetary easing. Indeed, as cyclical conditions improve, interbank rates are likely to drift up again and financial conditions could become tighter in H2. We do not expect an interest rate cut for the reasons discussed above.
Meanwhile, targeted policies to assist SME/agricultural sector borrowing, as well as further easing in housing-purchase-related, restrictions will continue. The PBoC may elect to use the PSL – or Pledged Supplementary Lending (a newly created facility to provide long-term liquidity to selected banks) – for specific sector support. Bond issuance by local governments is also likely to pick up to offset the expected dwindling of local land sales.
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Of course, Goldman has been modestly bearish on China for months and this merely confirms that view but their perspective (at a time when the Fed is pulling back) is notable in that it leaves the ECB as the only treaty-busting player in the room that can surprise (since the BoJ is hampered by both proven ineffectiveness, soaring misery, and inflation pain).
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It's already in the pipeline. Open wide and say "moar" fiat.
The more yuan the Chinese prints, the more yuan there is to replace the dollar. This is their true fear.
Eh, they are prolly reading ZH. Dollar can be greater place in the Chinese Economy.
But maybe the USA has a plan to partly replace CYN with USD in the Chinese Economy (Probably Greater than the boundaries of China by now)
Fx broker Armada makes a surprise move by alerting it's clients about increases in market volatility - tells clients to reduce risks. Post here.
Reckon the inverse could be true
Yuan can be greater place in the US Economy. Fixed it.
...And the rest of the Planet asks rhetorically...Who is really in charge of the USSA, because We know Congress and Obama aren't?
tail risks.... all abound, but no catalyst takes hold... China is the death of the world and WW3 will be the end of globalization.
Who gives a fuck? Party time.
Aug 20 (Reuters) - JPMorgan Chase & Co and Bank of America Corp are planning to hike salaries of junior employees by at least 20 percent, people familiar with the proceedings said.
"Goldman Warns Additional Chinese Stimulus Risks Global Financial Stability"
There isn't any financial stability to begin with. A gigantic global debt bubble is anything but stable.
Isn't that the ultimate truth.... the keep calm and keep buying needs to come to an end and the reality that everyone seems to ignore needs to come front and central...
WTF for China ... "further monetary easing would have incrementally less of an impact and would come at the cost of financial stability"
and for the US ... "the FED needs to avoid deviating from their present course to mitigate a collapse of the markets"
Does monetary easing in China enrich Goldman? no
Does FED printing create more wealth for Goldman? yes
history says no mad max gonna happen...just the opposite... consolidation coming...gold spike than hard crash and back to whatever currency is introduced
PM takedown now. Looks like another run for $1180 for gold. Maybe drop to $1050 then spike back.
the pm miner stocks are much over valued too.
"...an improved global outlook...."
Ok.
Goldman Sachs, ladies and gentleman. A big round of applause, please.
Haven't seen hide nor tail of Blankfein or Dimon for that matter lately. Probably already in the bunkers.
I doubt they could show their faces in public.
Goldman could suck the sweat off a dead mans balls.
The debate continues as to how stable china really is. Much of the recent growth in China after 2008 came from a massive 6.6 trillion dollar stimulus program that expanded credit and poured massive amounts of money into the system. This money encouraged expansion and construction with little regard as to real demand or need. Like a plane on autopilot China continued in the direction it had been on.
Now China finds itself in a credit trap. For years the people of China have had the habit of saving much of what they earn but the low interest rates paid at banks has not rewarded savers. With few investment options much of this money has drifted towards housing and driven housing prices sky high. The economic efficiency of credit is beginning to collapse in China and the unwinding of China’s giant credit spree could be very painful. More in the article below.
http://brucewilds.blogspot.com/2014/03/china-and-great-credit-trap.html
Goldman does not run China and they really have no sway on their financial development.
I wonder what the real purpose of the report is. hahaha.
Tital of the article made me smile, fall off the fucking chair and roll on the floor clutching my stomach in pain of laughter.
Chinese??? ... Nothing to do with the US creating billions in QE month on month, oh YOY. You got to love the comedy.
TRUTH:- GOLDMAN DON'T FUCKING LIKE IT BECAUSE THEY DON'T OWN IT LIKE THE DOLLAR hence a very restricted market for them. If anything maybe we should sleep a little more soundly knowing they are restricted.
So if this goes for China how come Goldman never warned about this for the U.S.?