Why China's Latest Mini-Stimulus Failed Again, In One Chart

It was over a year ago, when we wrote about "The True Chinese Credit Bubble" and we showed the following chart which succinctly explains everything that happens in China's economy:

... by "everything" we mean the now traditional feedback mechanism of "boosting growth", which starts with a monetary easing impulse i.e., a credit shock, which boosts GDP by up to 1% annualized, and then promptly fades to subtract from growth in quarters 2 and onward since the credit injection, and then when the response goes from euphoric to depressed, it forces the PBOC and the SOEs to inject even more credit to offset not only the initial weakness but the subsequent stimulus response, and so on.

Which is why we warned a few months ago that the joy from the latest "mini-stimulus" that took place in China would be very short-lived. Over the weekend, we were again proven right when virtually every metric of China's economy missed expectations. Which in turn unleashed the usual suspects who one after another, have once again had to admit that contrary to prevailing mass delusions, such a thing as an escape velocity stimulus event as far as China's economy is concerned, simply does not exist.

And, as a result, we get blurbs such as this one from Evergreen GaveKal who now, after the fact, are Monday-morning quarterbacking as follows:

"So Much For China's Mini-Stimulus"

So much for the ‘mini-stimulus’. The data on China’s economic performance in August released over the weekend were dismal, showing a significant and unexpected decline in growth. The boost from the government’s suite of supportive policies was always going to be temporary, but renewed weakness is appearing much sooner than expected. We had previously thought that policy could keep growth stable for a couple of quarters (see Fears For China’s Growth Postponed), but it only really worked for two months (May and June). So it looks as if the government has already lost its bet that it could keep GDP growth near its 7.5% target with only minimal intervention. With China transitioning out of its high investment phase, growth is on a downward trajectory. To alter that trajectory would require large scale monetary easing, but the government does not yet look inclined to support such a big shift in strategy. All of which points to more of the same: modest policy support and weaker growth.

The August numbers were dire: growth of industrial value-added slumped to 6.9% year-on-year, from 9% in July, to give the lowest reading since 2009. Official statisticians blamed a high base effect for the slowdown, since growth was 10.4% last August. But their explanation is hardly convincing, as growth on a sequential basis was also extremely weak. Meanwhile fixed asset investment growth declined to 14% in August from 16% in July, as the private sector remained cautious and the pickup in spending by state-owned enterprises ended. The brightest spot was the external sector, where export growth accelerated and the trade surplus hit record highs in both July and August. There is also good news from the labor market: new urban jobs have increased by 9.7mn in the first eight months of the year, almost achieving the full year target of 10mn.

Why did domestic growth slow so sharply after a decent second quarter? Fundamentally, China’s growth is slowing because private sector investment sentiment is weak: fixed asset investment by non-state companies has been steadily decelerating since 2010. In part this reflects a necessary adjustment of companies’ growth expectations—no one expects GDP of 10% growth anymore—but there is also much uncertainty about how the transition away from the investment-driven model will play out. The government has used state sector investment to smooth this slowdown, and the latest boost led to a slight rebound in the second quarter. But the support from state investment did not last, as monetary policy did not get looser, and fiscal spending was forced to slow to stay within budget guidelines.

So the weak growth ultimately derives from a failure to sustain the pickup in credit growth that began in May and June. Our estimate of total credit growth slowed to 15% year-on-year in August, after reaching 17% in June, as loan growth was only modest and shadow financing has collapsed. Both bankers’ acceptances and trust loans declined outright in July and August—a simultaneous sustained decline that has never happened before. The People’s Bank of China has traditionally been more hawkish than the rest of the government, and its support for ‘selective easing’ was half-hearted at most (see The Risks Of Selective Easing). While it did inject more liquidity into the traditional banking system, it also rolled out new regulations on interbank borrowing that contained the growth of shadow finance. At the same time, banks are getting much more cautious about lending, given the increase in their own bad loans, the poor state of corporate balance sheets, the deteriorating property market and falling commodity prices. It is likely the crackdown on fraud in trade finance in Qingdao has also made banks more risk-averse. Given all this, banks are unwilling to accelerate lending without very strong support from the central bank—support which so far has not been on offer.

So will policymakers change their mind and deliver a bigger easing in monetary policy to arrest the slowdown in growth? China’s GDP growth has been on a mostly downward trajectory since 2007, and short term growth is greatly dependent on credit. So policymakers are facing a tough choice: accept higher debt in order to get higher short term GDP growth—which brings longer term risks—or accept slower growth in the near term. The signals have been extremely inconsistent this year, but at the World Economic Forum last week, Premier Li Keqiang said the government is comfortable with growth “a bit lower” than its target. At the time Li was clearly aware of the weak August data, yet he said the government would not engage in major monetary stimulus. The central bank also still seems unwilling to loosen monetary policy as it is worried about China’s rising debt. Therefore we believe that the government will just continue with its ‘selective easing’ policies, and will not take more radical measures such as an interest rate cut, or at least not in the near term. With the help of net exports GDP growth in 2014 can stay slightly above 7%. Nevertheless, it will miss the government’s 7.5% target.

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At least GaveKal is correct in observing that a massive stimulus here will do nothing to boost the long-term trendline higher. Which is much more than we can say about most other sellside penguins, for whom the failure of the latest mini-stimulus is simply the catalyst China needs to launch... a maxi-stimulus.

Or, as Einstein would call it, insanity.