Guest Post: China's Difficult Choice

Tyler Durden's picture

Submitted by Zarathustra of Also Sprach Analyst,

Over the weekend, we pointed out that the old mechanism for the People’s Bank of China to expand its balance sheet and create base money has been broken by new funds flow pattern, and it will sooner or later require some sort of large scale asset purchases programme a.k.a. quantitative easing to offset the impact of the broken mechanism (after other tools such as cutting RRR reach their limits). However, we also mentioned that as the private sector is currently quite overstretched and will start the deleveraging process (if they have not already started), and that would render traditional monetary tools useless, and quantitative easing ineffective. And that would necessitate deficit spending at both local and central government levels.

Quite a number of commentators (particularly those within China) believe that there is no money for the government to spend to offset the current slowdown. Many points to some statistics showing that local governments obviously do not have enough tax revenue to support any large-scale investment projects (as we have mentioned some of the figures here), not to mention that many local governments have also become quite overstretched after the massive credit expansion post-financial crisis.

These are not inaccurate, yet we believe that the idea that the Chinese government can actually run out of money is not correct. The idea that a country can possibly run out of the money which they print is absurd. This applies to countries like the United States, but not for countries like Greece, which has surrendered their ability to create money to the European Central Bank. We think the same should hold for China just as well. With the Chinese banking system dominated by state-owned banks, and with the most powerful tool to control credit growth being state-directed bank lending, there should not be any actual funding constraints for stimulus programme in the forms of investments into infrastructure and productive capacity. The only way that China can really run out of money is when the government decides that “enough is enough” and imposes spending constraints deliberately.

Even so, the choice between stimulating the Chinese economy aggressively or not is not a straight forward one. We have noted for quite a long time that the massive stimulus after the 2008 financial crisis has been widely regarded as a big mistake by commentators and economists within China, and we believe that some inside the government’s decision making body share that view. This has very likely contributed to the delay of (much anticipated) stimulus, and the stimulus (if any) will not be as massive as the previous one. Some economists and commentators within China also believe structural reform should be the top priority. After all, the economy urgently needs rebalancing, and more investments into overcapacity will only delay the process of rebalancing. On top of that, some also believe that the involvement of the state should be minimised, thus government deficit spending will not be at odd with such an idea. The biggest critics of China’s economic policies for the past few years are anyone from the West, but many economists and commentators within China.

If we have read the social mood correctly that China might be more pro-austerity than pro-Keynesian, and if policymakers indeed share that view, then the consequence in the near term could be rather grim. The delay in stimulus as well as the small size of it so far has already done damage, if you like. The economy is already on course to hard landing. Companies are now in trouble as sales fall, inventory increases, profit squeezed, credit standard becomes higher, leverage becomes too high, mutual guarantee scheme blows up, etc. Some who have invested/speculated heavily in real estate will probably in trouble. The whole scenario is consistent with debt deflation. Private sector is too highly leveraged, and those with assets will be forced to dump them to repay debt, while other individuals and companies go bankrupt or something. If there is zero government intervention and minimal central bank monetary easing, this will continue and get worse.

There is another choice, of course. Given a stimulus which is large enough (let say RMB4 trillion to be spent every year, to exaggerate things a bit), the government can create GDP simply by spending money into investments in infrastructure and productive capacity. The private sector might be deleveraging and destroying jobs, but government spending could offset that as long as it is large enough, and asset prices would probably fall in an orderly way.

The longer term consequences will be different of course.

If austerity is the choice, it will be very painful in the short-term. We will not be talking about a sub-7% or so GDP growth. In fact, we might be looking at a downright economic contraction. Longer term, however, after unprofitable businesses are closed and investments into new excess capacity are stopped, those who survive might have a chance to see their returns on investment enhance over the medium term. And although consumption will be hard hit in the short-run, with investments grind to a halt, the economy will probably rebalance rather quickly regardless. The economy will no longer be growing at 7-8% after the recovery, but that is hardly an important consideration. The short-term outlook will become almost apocalyptic, yet without doubt, there will come a life-time opportunity to invest.

In the “economy on steroid” option, the economy can keep growing at whatever rate the government sees appropriate. The government can invest in ever more infrastructures and productive capacity despite already absurdly low capacity utilisation. While private sector shrinks, the state-owned sector increases to pick up to slack. Meanwhile, PBOC can perform quantitative easing to ease liquidity. For the sake of maintaining jobs, state-owned companies can be instructed to maintain production even though it will not make any profit. The long term consequence is that growth will slow down, yet you are not going to see any dramatic contraction of economic output or massive deflation. However, economic growth cannot be possibly maintained if government withdraws its support one day. In other words, the economy will need permanent government support, and the support required will probably be growing as government stimulus (we suspect) will decrease in effectiveness.

These two extreme scenarios are, of course, exaggerated and imaginative on purpose to illustrate the two ends of the spectrum, namely, “do nothing policy” and “whatever it takes policy”. The actual scenario to be played out will most likely be something in between, although our current judgment is that the choices being made leans towards do nothing. As a result, the economy will continue to perform disappointingly, particularly for those who have been hoping for massive stimulus.  Of course, our judgment may change should the government become much more proactive.

There is one final thing that we must make clear: advising the government what to do is the last thing we are interested in. Although we occasionally have views on what the “right” thing should be, we are not making any judgment on which policy choice will be the “right” one. We really do not care. As someone interested in investing in China, the only thing we really care is the likely policy path, the consequence of that, and how we might position ourselves to take advantage of the economic consequence.

Other than that, we leave the discussions of “what China should be doing” for the wonks. We couldn’t care less.

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Abraxas's picture

So, what happends to gold and silver prices if China slows buying? Not to mention the miners.

I feel awfully exposed over here...

Xibalba's picture

The LBMA will continue to sell gold that doesn't exist.  

Abraxas's picture

Sooo, the price goes ... down?

hedgeless_horseman's picture



The only way that China can really run out of money is when the government decides that “enough is enough” and imposes spending constraints deliberately.

This will never happen, because the central planners are so well insulated from inflation.  They are not, however, well insulated from the fallout of austerity. 

China will print, too, along with everyone else in this global syncronized diving event.

Xibalba's picture

Not if you aquire gold the right way, in it's physical form.  Take 2008 for example: Spot drops 200 per ounce, premiums on physical coins rise 200 per ounce. In other words, a gold coin remains a gold coin.  Paper gold will get bombed into oblivion.  In fact, some gold carries a VERY significant premium to the spot price right now.  So I could argue that these prices are still not reflecting the supply/demand dynamics.  

lemonobrien's picture

yeah, sell everything now. go long dollars.

Abraxas's picture

Do I detect a scent of sarcasm? You can't be serious.

lemonobrien's picture

hey, if you sell; price goes down; i can buy cheaper.


just remember; this is a big dick game; go long, very long.

francis_sawyer's picture

I only clicked because I wanted to see the ENLARGED FOTO of the 'hard landing'...

francis_sawyer's picture

Curses!... Foiled again by Tyler...

fourchan's picture

lol got me too.



ps fuck you bernake

Pejorative Requiem's picture

Awesome.......  thanks for the link. But I would expect no less from someone who has been to the moon and back.

duo's picture

Bring back Miss Venezuela!

LongSoupLine's picture



I don't see how a "Chinese" hard landing has anything to do with a beach blonde falling down...oh, wait.

Intoxicologist's picture

I thought it was AnAnon slipping on his own feces.

Cranios's picture

Third option: Spend massively on building military hardware, especially if Romney is elected and they feel we will be sitting in their backyard to keep them under control. The Chinese leaders are paranoid of the populace becoming discontent, so they will spend, they will not choose austerity.

Pejorative Requiem's picture

Agreed...... blatantly obvious option left off the board. Lots of positive angles here for the peopled republic. A committment to a deep water navy alone could be the biggest stimulus plan in history.

Alea Iactaest's picture

Not to mention that by gearing up the war machine China could find a use for some of its "excess" population. Combine austerity, increased production of military equipment, the current imbalance of males:females, an increasingly hawkish military command and a dash of xenophobia... frightening.

Robot Traders Mom's picture

Call me an optimist for holding out hope we can still salvage this mess! PS-Fuck China and fuck the RNC


fuu's picture

Hence the anti-Paul sock puppet parade today.

Stuck on Zero's picture

Who would have guessed that trickle-down doesn't work in China any more than in the U.S.?


buzzsaw99's picture

china is great kleptocracy they were better off commie and the usa will be too. capitalism is dead. viva la revolucion. ps: don't touch my junk comrade-bitchez!

Vegetius's picture

China yes indeed stuck between a rock and a hard place; lets not beat around the bush these guys are holding a big load of IOUs from the USA ( anyone remember who was in this boat).

Yep, just like Japan in the 80s except they have a lot, A LOT of poor people who scrape by day to day so if -

The USA print loads more IOUs  or Europe implodes a bit more  or there is a war in the middle East it is to quote a great man -

Oh dear Lord Jesus, this ain't happening, man... This can't be happening, man! This isn't happening!- Hudson


Bread and Circuses thats what its about

lightning's picture

There is a variable concerning China's economy that is often not mentioned, and I think it needs mentioning.  China has 1 Billion people.  As many folks on this site say, people truly don't understand the difference between million, billion, or trillion and it is true not only with money but with people.  The communist chinese want to keep power.  If they choose to print they increase inflation, which is already problematic for the average Chinese citizen.  If the communists wish to stay in power they need to make sure that whatever economic system they adopt feeds the people or else the people will eat them.  One billion people is no joke.  These people have also been educated and expect that with hard work comes the ability to sustain ones self.  The communists resistance to printing and efforts to curb inflation speak to my point.

Donnie Duvanie's picture

My solution is to legislate that on day one every creditor take a big fat fucking loss, and on day two everything is back to normal - no lawsuits, no revolution, nada - all that crap is made illegal. This would work equally well in the USA. The only problem is that after mass murders and suicides, it's too late to do much of anything about them.

Whoa Dammit's picture

I would love it if the factories that our jobs were off-shored to went TU and consequently took down the global megacorps that make their products there. Nothing against the Chinese, they are a great people, but I am tired of the corporate induced race to the bottom.


What happens in China, doesn't stay in China...

Pejorative Requiem's picture

Yeah........ but who cares. Only wonks according to the article.

Madcow's picture

China will be fine - because they have saved for a rainy day - something like $30 Trillion in UST.

So, they'll be able to spend that money now until the global economy improves.  The "West" does not have a rainy day fund to spend.


El Tuco's picture

They are going to need it..... when all the provinces go bankrupt and all the bad loans never get repaid. Hey what the hell at least they will have plenty of ghost cities and ghost trains......

Bunga Bunga's picture

When they start spending it a loaf of bread will go quickly to $3 million.

F-X's picture

That's not savings. In fact, it costs a lot of money to maintain. Here's an explanation from Tom Holland of the South China Morning Post:

China's financial institutions pay a heavy price because Beijing's policy of currency intervention necessarily entails a massive accumulation of the country's foreign exchange reserves, which reached a monstrous US$3.2 trillion at the end of June.


Such a big pot of reserves is ruinously expensive to maintain. The People's Bank of China finances its foreign currency purchases partly by selling short-term debt to the country's commercial banks and partly by raising the proportion of their customers' deposits that banks are required to lodge at the central bank as mandatory reserves.


According to calculations by Joseph Gagnon, Nicholas Lardy, and Nicholas Borst at the Peterson Institute for International Economics in Washington, paying interest on these short-term bills and required reserves costs the People's Bank US$77 billion a year.


That cost is only partially offset by the returns the central bank earns on its foreign reserves. With government bond yields in the US, Europe and Japan so low, Gagnon and his colleagues estimate that the bank's holdings generate income of just US$11 billion a year, leaving the central bank facing a net financing cost of US$66 billion.

merizobeach's picture

"something like $30 Trillion in UST."

Really?  So two trillion in dollar demoninated assets plus one more trillion in Euro, Yen, etc somehow equals "something like $30 Trillion in UST"?

Good job, noisy numbnuts, you're part of the 90% margin of error crowd.

Dr. Engali's picture

So the point of the article is: China may stimulate or they may not , but we don't really give a shit either way.... Got it. .... Neither do I.

moskov's picture

Don't understand EU, Japan, US economists would have the nerves and time at this moment to concentrate on China's landing so much while their home bases are literally on the track towards to an end-game scenario between both currency death and derivative explosion.

China does not welcome Kenyes anymore except those retarded NGOs and US paid 'think tank' keep spreading lies and rotten knowledge from the American economic textbOoks in order to mislead the Chinese policy continuely.

Let's just wait for the end game as all the stinking money like dollar, euro, yen garbage have a sudden death then the new world order and gold standard can replace the current joke as a world we are
Living in!

q99x2's picture

Nationalism is very contagious wherever people are gathered in close proximity. When social unrest sparks in any of the large Chinese cities it can easily go viral. As a prevention any political person can make a run for the top by promoting nationalism, and then, by showing everyone who the enemy of the world is. Which this time as everyone knows is the central banking cartel.

Interesting. China may provide a solution for the rest of the world this time.

Let The Wurlitzer Play's picture

From the photo it looks like China bought Facebook also.


Flakmeister's picture

Do you mean Austerity in the sense that there is nothing on the plate to eat no matter how many yuan are created or not?

If so, then yes, I think Austerity will be the outcome....

pamriallc's picture

China is already making those tough choices. The government intentionally pricked its own housing bubble and industrial companies are restructuring debt through equity swaps at the local bank level. Ask us, we are on the ground. Game On!

voshnishki's picture

I'm pretty sure the PBoC lowered rates 2 times already this summer to inflate again..