China’s central bank data, the stock of social financing scale at the end of March was 294.55 trillion yuan (RMB, same below), up 12.3% year-on-year, and the year-on-year growth rate of social financing was below 13% for the first time in 8 months. Liquidity brakes again.
01 No money is a long-term problem
In 2020, China’s macro leverage ratio is 279.4%. By sector, the leverage ratios of the residential, government and corporate sectors are 72.5%, 45.7% and 161.2%, up 7.4, 7.1 and 9.1 percentage points, respectively, from 2019.
China’s resident leverage ratio has largely matched or even surpassed the level of developed Western countries. A problem, however, is that there are two measures of the resident leverage ratio, one is based on total resident debt/GDP and the other is total resident debt/disposable income.
The former is used as the data caliber for calculating the residential leverage ratio in China, which would underestimate the actual debt pressure on the Chinese residential sector.
In general, emerging countries have a low ratio of resident disposable income to GDP, a feature that is particularly evident in China.
According to the Bureau of Statistics, in 2020, China’s GDP per capita reaches 72,000 yuan, while the disposable income per capita reaches 32,000 yuan, and the disposable income of residents only accounts for 44% of GDP, while this figure reaches 76% in the United States.
Using total resident debt/resident disposable income, China’s resident leverage ratio is over 160%. Consumption potential = disposable income + new debt borrowed – debt repayable
1) Disposable income is very low
2) Leverage is very high and the pressure of debt repayment is very high
3) New borrowing debt is rarely used for consumption, mainly for housing. at the end of 2019, the housing loan balance accounted for 54% of the total debt of all residents already.
02 Upstream price hike tide, downstream by printing money
Corporate leverage grew by 9.1% in 2020, the highest growth rate among the three sectors (residents, businesses, and government), with a corporate leverage ratio of 161.2%, properly at the world’s end.
In the aftermath of the epidemic, China has vigorously stepped up its credit support for enterprises to support their resumption of work and production with credit.
Two issues emerged here.
1) The rapid recovery of corporate capacity increased the demand for upstream raw materials.
2) A large amount of liquidity was released, and the M2-GDP-CPI value was the highest in 10 years, which showed that real enterprises simply could not consume so much money, and a large amount of money had to go to idle arbitrage. The rebound in raw material demand has increased the space for speculation.
Upstream raw material demand recovery, idle money and more, the bulk of the price speculation up.
But downstream commodity prices are constrained by sluggish demand can not raise prices.
Flour is more expensive than bread appeared, downstream losses can not be avoided.
But losses do not mean that bankruptcy will occur. Business losses are the key condition for bankruptcy, but not as long as the losses will appear bankruptcy. As long as someone is willing to lend money to a loss-making enterprise, the enterprise will not go bankrupt.
In the 1990s, there were a large number of SOEs that were losing money, but in order to ensure employment in SOEs, the government printed money to protect SOEs, and the enterprises could survive.
The survival of a large amount of mid- and downstream capacity after the epidemic relied on the fact that then not someone was willing to take the risk of lending money to small and micro enterprises. If money could be borrowed, long-term loss-making enterprises could also survive without going bankrupt.
After the epidemic, a major focus of China’s business support policy was to increase the risk tolerance of commercial banks so that they could lend money to midstream and downstream enterprises (most of the midstream and downstream are MSMEs) to keep the downstream capacity alive. In order to let the downstream production capacity survive, the policy of extending the deadline for MSMEs has been repeatedly extended.
MSME capacity has not been cleared, it is difficult for downstream commodity prices to go up, and inflation is stable.
One advantage is that printing money to protect MSMEs can keep a large amount of terminal loss capacity out of the clear, which can stabilize employment and keep inflation down.
One problem is that if this was a good solution, the wave of bankruptcy of state-owned enterprises in the 1990s, it would not have happened!
03 Money Printing and Inflation
The more capacity is preserved, the lower the inflation, which seems to have been the exact opposite of common sense (that watering down would be inflationary).
But in reality, this is only a lagging effect. In the long run, common sense is right, the more water is released, the more inflationary; but in the short run, the more water is released, the more likely to cause excess capacity downstream, the lower inflation will be; while after tightening the money, the excess capacity downstream will be cleared, inflation will repair the historical distortion, but will be higher.
In 1992, money in circulation grew at a rate of 36.4% and the Chinese economy grew at 13.2%.
In 1993, currency in circulation grew at 35.3% and the Chinese economy grew at 13.4%.
In 1994, currency in circulation grew at 24% and the Chinese economy grew at 11%.
In 1994 alone, China’s money growth rate fell by more than 10%, and the match between money growth and economic growth rate also improved significantly, but inflation was higher in 1994 instead. The reason for this is the lagged effect of printing too much money in the first two years.
In 2021, the money growth rate started to drop significantly and began to match the economic growth rate.
But there was a lot of money printing in the previous decade or so.
04 Braking Background Comparison
Why was there a wave of bankruptcy and unemployment in the 1990s? None other than the brakes on money printing.
Before that, the loss of Chinese SOEs was a long-term problem, and they had been relying on money printing to keep the zombie SOEs running.
And once the liquidity brakes are applied, there is no ability to protect the zombie enterprises, only to dump the burden. A wave of bankruptcies and big layoffs emerged.
Why did the brakes come in 1994?
After 1992, a lot of investment and infrastructure, a lot of money issued, the price of raw materials in China skyrocketed, accelerating the transmission to inflation, and inflation exceeded 20% in 1994. Both the Chinese exchange rate and inflation were under great pressure (the exchange rate depreciated by nearly half in 1994), eventually forcing China to tighten its policies. This was a time when marketization was low and liquidity was largely dominated by policy will.
Why the brakes on 2021 liquidity?
In 2021, China is more market-oriented and the problem is more complex. Policy generally has to influence the liquidity of the financial system to indirectly influence real liquidity through market-oriented influence, and since it is through market-oriented influence, the market will have its own ideas.
Liquidity is no longer determined by policy alone, but by both policy will and market factors.
After the credit bond market turmoil in November 2020.
1) China’s central bank has increased its input and interbank liquidity is loose in terms of SHIBOR (3M) reference, with SHIBOR (3M) generally declining since November 2020.
2) Real market liquidity indicators are tight by reference to social finance, which has continued to decline in growth since October 2020. It took five months to fall from 13.7% to 12.3%.
This is a good indication of the conflict between policy will and market ideas, which determines that even if monetary policy seems to have room (inflation does not seem to be high enough), if the space is too small, it will fail to reverse the market trend.
The growth rate of social finance is the result of a combination of central bank base money injection, commercial banks’ risk appetite, and real financing demand.
(1) Since October 2020 onwards, after the credit bond market turmoil the central bank has obviously increased its input and the interbank market liquidity has become more accommodative, but the social financing growth rate is tightening. This shows that it is the financing market itself that has tightening momentum.
2) The dollar is more market-oriented than the yuan, and the Fed is still increasing easing, but the market-oriented rate hike in the dollar has affected a rapid reversal of dollar liquidity. With the reversal of dollar liquidity, the interest rate differential between the U.S. and China is rapidly narrowing, leading to increased external pressure on China. From the point of view of external pressure, China’s policy is also under pressure to tighten.
3) With the surge in commodity prices and soaring upward PPI, internal pressure began to exert pressure on monetary tightening.
The monetary policy motive is constrained by commodity prices and the US-China interest rate differential, while the market capital supply side is concerned about risk and the capital demand side has nowhere to invest.
Policy and market both have tightening pressure, liquidity began to brake.
05 The vicious circle of bankruptcy tide
However, the survival of downstream enterprises seriously depends on liquidity support. Liquidity tightening, downstream factories will lose financing support. The downstream loss problem will start to be exposed when it loses liquidity cover, and a bankruptcy tide will appear.
The bankruptcy tide will appear in two directions of impact, part of the people’s jobs are gone, part of the money invested is gone, and the consumption power of the people concerned will decline.
Inflation, however, will be repaired upward by the withdrawal of downstream capacity, affecting demand even more depressed.
Demand is sluggish, the entity financing will have nowhere to invest, financing demand will fall, the market impact of liquidity continues to tighten; inflation is on the upside, pressure on monetary policy continues to tighten. Both the market and policy have braking pressure, liquidity continues to tighten.
Liquidity continues to tighten, corporate losses are exposed more.
Upstream price increases start, a metaphor for increased losses downstream. And liquidity brakes, a metaphor for the vicious cycle of bankruptcy tide has begun.
Summary: upstream price tide, downstream bankruptcy tide; downstream capacity, inflation will rise; inflation rose, the currency to brake; currency brake, bankruptcy tide again. The vicious cycle of bankruptcy tide has already begun. When painkiller dependence has been formed, just stop taking the medicine when the most pain.
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