A few years ago (September 2009), with China's economy apparently leaping from success to success, Thomas Friedman of the New York Times wrote a famous column singing the praises of the supposedly enlightened authoritarianism of China's leaders. Excerpt:
[W]hen [one-party autocracy] is led by a reasonably enlightened group of people, as China is today, it can . . . have great advantages. That one party can just impose the politically difficult but critically important policies needed to move a society forward in the 21st century. It is not an accident that China is committed to overtaking us in electric cars, solar power, energy efficiency, batteries, nuclear power and wind power. China’s leaders understand that in a world of exploding populations and rising emerging-market middle classes, demand for clean power and energy efficiency is going to soar.
Well, who would the mere Manhattan Contrarian be to quibble with the state-directed capital allocation choices of these enlightened geniuses? Of Friedman's list of investments favored by the Chinese autocrats (electric cars, solar power, energy efficiency, batteries, nuclear power and wind power), my bet is that only two, energy efficiency and nuclear power, will actually add to the people's wealth in the end, versus subtracting. Maybe these guys have a perfect crystal ball. If so, they would be the only people in the world who do. More likely they are committing the well-being of their citizens and taxpayers to vast investments in risky projects, most of which will fail spectacularly. Time will tell.
But if you are one of those people who think that the Chinese autocrats might actually know what they are doing, you really need to take a look at what they are doing today. It seems that about a month ago the Chinese stock markets started to go into sharp decline. After peaks in mid-June, within a few weeks the two main indices had fallen by about 30% (Shanghai) and 50% (Shenzhen). In the past week or so there has been talk of various measures by the government to support stock prices. And now today they announce a fund of some 3 trillion yuan ($483 billion) to buy stocks to keep the prices up. From Bloomberg News this morning:
China has created what amounts to a state-run margin trader with $483 billion of firepower, its latest effort to end a stock-market rout that threatens to drag down economic growth and erode confidence in President Xi Jinping’s government. China Securities Finance Corp. can access as much as 3 trillion yuan of borrowed funds from sources including the central bank and commercial lenders, according to people familiar with the matter. The money may be used to buy shares and provide liquidity to brokerages, the people said, asking not to be named because the information wasn’t public.
To give some perspective, the entire GDP of China is about $9 trillion (if you believe their numbers), which would make this new stock-buying fund more than 5% of annual GDP.
Is there any level on which this makes any sense? A July 6 article in Fortune gives the P/E ratio of the Shanghai market as 23 and of the Shenzhen market as about 50 -- and that's after most of the recent declines had already happened. By contrast, the current P/E of the Dow Jones Industrial average is under 17, while the P/E of the S&P 500 is about 21. So even after the recent declines, the Shanghai and Shenzhen markets remain substantially overvalued on general world standards. Here's the take of Minxin Pei (of Claremont McKenna College), the author of the Fortune article:
Chinese leaders tend to view economic issues from a purely political perspective. Unsurprisingly, the performance of the stock market has been made a barometer of the popularity of the current regime. The head of China Security Regulatory Commission not too long ago called the soaring market “a reform bull market,” suggesting that investors were giving a vote of confidence in the leadership’s promised reform programs. A plunging market would imply a loss of confidence and falling popularity of the current leadership—an intolerable prospect.
So, to protect their political image and narrative, the great leaders of China are in the process of transferring some 5% of GDP from their taxpayers and citizens into the pockets of stock market speculators, in a completely futile effort to prop up stock prices that with a high likelihood are destined to fall no matter what. Yup, that makes a lot of sense.
But Pei points out that this is just the latest of multiple examples of the Chinese leaders opting to commit the government fisc to shoring up markets on the brink of collapse. Other recent examples in China have occurred in the real estate market and in the market for local government debt:
In addressing the real estate market bubble, Beijing has opted to keep insolvent developers alive by forcing their lenders to roll over the loans. Consequently, the glut of unsold inventory hangs over the real estate sector. Because there is such an excess in the supply of housing, it is unlikely that those zombie real estate developers will return to life and pay their creditors in full.
Beijing has used a similar recipe for shoring up its debt-laden local governments. After the bond market rejected Beijing’s plan to float the debt issued by local governments earlier this year, Chinese leaders simply ordered state-owned banks to buy such debt, adding assets of dubious quality to their balance sheet.
So far the infinite credit card seems to be succeeding at covering over all the problems. The official measures of GDP continue to show big increases. They count new real estate developments at 100 cents on the dollar in GDP, even as the developments sit totally empty.
You can cover it over just so long, and then when it falls apart, it happens all at once. And no, they don't have any idea what they are doing. They've had a run of good luck, but it won't last forever.