|Summary: There is a fear factor in global markets that Chinese credit is out of control, and that the world’s second-largest economy is heading for a credit crunch. However these perceived risks are not supported by economic reality – strong investment, high savings levels and low foreign debt are some of the key ingredients in China’s ongoing growth story.|
|Key take-out: Concerns over China’s credit numbers simply reflect a significant misunderstanding about credit and its role in an economy.|
|Key beneficiaries: General investors. Category: Economics and strategy.|
Many may recall my view that one of the best ways to make money in this market is to take advantage of divergences between real risk and perceived risk. (see Carr’s Call of January 18: The risks that matter in 2013).
Now, as it turns out, the perceived risks have once again dominated the investment landscape. We only need to look at the market ructions that were caused by the Fed even mentioning the idea of a QE taper. While that has calmed down some, the market is also being disturbed by this idea that China is undergoing a credit crunch – or could be – whether policy induced or not, to deal with out of control credit growth.
For me this is just another manifestation of the never-ending China pessimism. Readers will already know that I’m just not convinced by this whole China narrative, and that especially goes for this idea that Chinese credit growth is out of control or there is a serious risk of a credit crunch. It’s more like the China credit crunch that wasn’t. Now, I can’t say for certain how long markets will remain panicky; how long this overbearing and misguided negativity will last in Australia. But it is having very real consequences, as we’ve seen. What I can say though, with some confidence, is that just as in previous episodes where perceptions of risk were askew, we have nothing to fear from this spike in perceived risk – and it does, once again, present some great money making opportunities.
China doesn’t have out of control credit growth
Take a look at table 1. These are the official credit numbers as a percentage of GDP. China, at 127%, is not onerous – much less than the UK, US, Spain etc and about the same as Australia. That’s not indicative of a bubble to me.
However, the International Monetary Fund, and the Chinese authorities themselves, have taken to talking about something called total social financing (TSF), which includes other lenders, not just banks. On this measure, some estimate that credit to GDP is something closer to 198% or more – which sounds alarming. There are some important things to note though.
- It’s a relatively new measure.
- Around 40% or more is accounted for by non-bank financing.
- While hard to estimate, this sharply increases the odds of double counting and TSF likely inflates the ‘credit’ numbers quite a bit.
Why? Because credit, true credit, can only be created by a bank – everything else is basically a transfer from savers to investors etc. So when you see that money flowing though the non-banking sector, this is the money multiplier in operation – not credit. This is why growth in the money supply is only about 13-14%, when growth in TSF is around 50%. That’s a very big difference.
More broadly, I suspect that concerns over China’s credit numbers simply reflect a significant misunderstanding about credit and its role in an economy. Credit obviously is the ‘lubricant of commerce’ – it’s essential. When you note that China has high nominal GDP growth, rates of investment around 20% or so, you would expect high rates of credit growth.
The rebuttal to that is credit growth has been running in excess of nominal GDP growth, which is potentially indicative of a problem. They blame this growth discrepancy on the surge in China’s money to GDP ratio of 190% , and many suggest this high ratio is of grave concern. Two things I’d say to that: one is that these rates are only a little above the average of the Euro area (170-180%) and East Asia more broadly. China’s numbers aren’t that alarming.
Secondly, and I’ll return to this point below, much of China’s money-GDP ratio reflects China’s huge savings – not credit. Finally, the discrepancy may lay in the fact that China’s GDP is being understated. It is often taken as gospel the figures are overstated, but strong credit growth in an economy that is export and investment driven suggests the reverse is true. Don’t forget that credit isn’t bad; it isn’t a dirty word. It’s about what is done with it. In the West, we have blown all our credit on a useless housing boom. So whenever Western analysts see strong credit growth, they instantly assume speculative boom. This isn’t always the case, especially for developing economies. China’s growth narrative is one of the world’s largest developing economy transforming, at a very rapid clip, into the world’s largest developed economy. That process isn’t even close to finishing yet. Rates of urbanisation are low, investment is high – thus credit growth is high. What really underpins this assessment of a bubble is the idea that there is some investment glut and that investment in China is inefficient and wasteful. These are qualitative assertions, which to be honest have little support in the data.
There is no risk of a crunch
Following the credit boom, many in the market are naturally concerned with the idea of a Chinese credit crunch and the spike in Chinese interbank lending rates was taken as evidence of that. Up front, the odds are very, very low. Maybe not 0%. Nothing is 0%, but it’s close enough. Here’s why.
For a start, that spike in shibor (the Shanghai Interbank Offered Rate) reflected ‘seasonal and emotional’ factors, according to the People’s Bank of China. It was deliberate and may have served as a warning for banks to get their balance sheets in order. More broadly, China has next to no foreign debt. All the Western countries listed in table 2 below have massive foreign debt, especially in Europe, with rates well over 100%. Check out China, in red, with its 8.7% foreign debt to GDP ratio – maybe that’s 10% now.
Why is that significant? Because it means China’s credit expansion is self-funded. Their banks don’t rely on fickle foreign capital and, the truth is, massive export earnings are paying for the Chinese development story – or at least helping to pay for it. The other notable thing helping pay for credit expansion is that very high savings rate I mentioned. China has 53% of GDP held in savings as you can see in table 3 below.
So, China has very low foreign debt, extremely high rates of savings – 53% of GDP is about $US4 trillion, and a vast pool foreign exchange reserves ($US 3.5 trillion). So you can see why any talk of a credit crunch is a fairly serious departure from reality – $US7.5 trillion in readily available cash, or nearly 100% of GDP.
So for me, the idea that there has been some kind of credit surge or that there is a risk of a credit crunch I think is just simply wrong. We know the Chinese authorities want slower, more manageable growth – and this includes slower credit growth. But this isn’t to deal with some out of control credit surge. This is to fend off inflation.
The government’s key economic concern is inflation – as stated publically. That aside, it’s very difficult to see how long the market’s obsession with a Chinese growth crunch, credit crunch, export collapse (however the fear manifests) will be. The problem is, since the GFC, market psychology has changed, and alarmism is the new normal.