Two Very Disturbing Forecasts By A Former Chinese Central Banker

Earlier today, Yu Yongding - currently a senior fellow at the Chinese Academy of Social Sciences in Beijing but most notably a member of the PBOC's Monetary Policy Committee from 2004 to 2006 as well as a member of China's central planning bureau itself, the Advisory Committee of National Planning - gave a speech before the Peterson Institute, together with a slideshow.

Since the topic was China's debt, economic growth, corporate profitability, and since, inexplicably, it wasn't pre-cleared by the Chinese department of truth, it was not cheerful. In fact it was downright scary. Among other things, the speech discussed:

  • Capital efficiency – low and falling (capital-output ratio rising)
  • Corporate profitability – has been falling steadily
  • Share of finance via capital market – Very low
  • Interest rate on loans – High
  • Inflation rate – producer price Index is falling

A key observation was the troubling surge in China's capital coefficient, first noted here two weeks ago in a presentation by Daiwa which also had a downright apocalyptic outlook on China, and wasn't ashamed to admit that it expects a China-driven global meltdown, one which "would more than likely send the world economy into a tailspin. Its impact could be the worst the world has ever seen."

The former central banker also discussed the bursting of China's market bubble. This, he said was created deliberately for two government purposes:

  • To enable debt-ridden corporates to get funds from the equity market
  • To boost share prices to stimulate demand via wealth effect

He admits this shortsighted approach failed and "to save the city, we bombed the city" adding that it brings "authorities’ ability of crisis managing into question."

He also observes that the devaluation that took place on August 11 was the government's explicit admission that its attempt to reflate an equity bubble has failed, and it was forced to find an alternative method of stimulating the economy. Of the CNY devaluaton Yu says quite clearly that it was simply to boost the economy: "In the first quarter of 2015 China’s capital account deficit is larger that than that of current account surplus" which is due to i) The Unwinding of Carry trade; ii) the diversification of financial assets by households; iii) Outbound foreign investment; and iv) capital flight.

And now that China has officially unleashed devaluation (which Yu believes should be taken to its logical end and the RMB should float) there are very material risks: "the implication of episode can be more serious than the stock market fiasco, with much large international consequences" and that "the failure will have serious consequences on China’s financial stability"

His ominous outlook: "Two bubbles have burst, what next?"

To answer this question we go back to Yongding's slidedeck, where two particular slides caught our attention: the former central banker's projections on Chinese debt/GDP and corporate profits. They need no further commentary.

Trajectory of corporate profitability (before interest payments) - slide 12


and Corporate debt-to-GDP simulation (baseline scenario) - slide 15

As a reminder, this is the base-case of a former central banker. One can only imagine how bad it really must be.

* * * 

Full presentation (pdf)