There will be no Minsky moment for China

It has become fashionable lately to borrow American financial crisis lexicons such as 'Lehman Moment' or 'Minsky moment' to describe the dark cloud hanging over China’s economy. Analysts are spotting similarities between the US just before the Wall Street meltdown and present day China.

Concerns over shadow banking, credit default and local government debt increasingly weigh on investors' confidence in the world’s second largest economy, which has been responsible for much of the global growth in the last few years.

The latest bearish report is from Morgan Stanley, appropriately named China’s Minsky Moment. Hyman Minsky was an American economist who was regarded as a maverick, if not a crackpot, during his life for his persistently negative view of Wall Street. However, he has been incarnated lately as a messiah and his “financial instability hypothesis” is now often referenced by Wall Street analysts as well as central bankers.

In essence, Minsky’s hypothesis suggests that the financial system becomes more speculative over time as the economy expands. And the longer the economic expansion goes on, the greater share of speculative and Ponzi finance, and the more unstable the economy becomes.

Morgan Stanley analysts suggest that China has reached that Minsky Moment when a disorderly process of unwinding the country’s mountain of debt will start. It believes China will face a sharp correction in its economy and fall from its current growth rate of 7.7 per cent to 5 per cent in the next two years.

Adam Purzitsky, a senior portfolio strategist  from one of the UK’s largest pension funds, Ignis, told Business Spectator that he  expected Chinese economy to fall sharply soon. Purzitsky said he would short the Australian dollar, which is widely regarded in the investment community as a proxy for the Chinese economy.

There is an impressive array of evidence supporting the theory that China is on the verge of crisis. For example, China’s private sector debt increased from 115 per cent of GDP in 2007 to 193 per cent at the end of 2013. In recent years, only Spain and Ireland have achieved debt growth faster than China. We all know what happened to these two countries.

So has China reached the tipping point? Are we going to see a spectacular end to China’s three decade-long economic miracle?

Not so fast. The ‘coming collapse of China’ school of thought has been around for a long time and has been especially popular in the last few years. Predictions of China falling off a cliff should always be treated with caution.

Yiping Huang, a former chief Asia economist for both Citigroup and Barclays, said: “Some economists in China have been forecasting the bursting of a property bubble for 10 years now. While economists benefited from their insights, investors who followed their advice lost 10 years of investment opportunities.”

Let’s deal specifically with the Minsky’s theory. Lou Yi, a top analyst from China Merchant Bank, explains why it is hard to graft Minsky theory and apply it to problems in China. In the US, financial crisis happens when the system loses its confidence and investors start to sell off assets and seek quick exit. This often results in chaos in the market and rapid falls in asset prices.

However, Lou argues that such disorder is unlikely, if not impossible, to unfold in China when the government has strong control over financial institutions, including the four gargantuan state-owned banks. When a crisis hits, Beijing has strong administrative as well as political power to ensure there is not going to be a stampede to exit the market, and to rein in short selling when asset prices are falling rapidly.

Lou made a cheeky but salient point when he said the US Treasury Secretary Hank Paulson had to get on his knees to beg Nancy Pelosi, who was the speaker of the US House of Representatives during the crisis, for a rescue package. And such a scene would never happen in China.

The Chinese government, with its enormous power, could act decisively to prevent a crisis from getting worse (How China’s Keynesian experiment paid off, March 19).

Wang Tao, chief China economist for UBS, made a similar point in the bank’s global Macro Strategy forum when she answered the question: “Is this China’s M-moment?”

“While shadow bank credit defaults are expected to rise, the lack of leverage in the sector, ample liquidity in the financial system and the government’s control mean that systematic risks can be contained and a sharp deleveraging will be unlikely,” she said.

Yes, China faces huge challenges this year in dealing with mounting debt problems and a slowing economy. But we cannot ignore the fundamentals, such as strong balance sheets and reform momentum. If history tells us anything, it's that Beijing has a strong record of proving pessimists wrong and shorting China has never been an easy proposition.

Follow Peter Cai on Twitter: @peteryuancai

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