Chronicles of a Crash Foretold Visualizing the Sequence of a Chinese Hard LandingWord格式.docx

Chronicles of a Crash Foretold Visualizing the Sequence of a Chinese Hard LandingWord格式.docx

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∙China’ssurgeininvestmentfrom2008coincidedwithadeclineinitsmarginalproductofcapitalandamassiveincreaseinitsdebt-to-GDPratio.Itsmarginalproductofcapitalfellfromanaverageof1.0inthefirstsevenyearsofthedecadeto0.75from2008through2010.Afteraccountingforoff-balancesheetandshadowbanklending,weestimatethatChina’soutstandingdomesticdebtincreasedfrom164%ofGDPin2008to207%in2010.

∙WeestimateaboutRMB9trillion（US$1.4trillion）oftheRMB43trillionincreaseinChinacapitalstockfrom2008through2010waswastedonunproductiveinvestmentsthatwillresultinbaddebts.Thesebaddebtswillchokeoffinvestmentinthecomingyears,andthereisnoalternativesourceofgrowththatcanprovideanoffset.Thesituationiscomingtoaheadsoonerratherthanlater,aslocalgovernmentsareonthehookforRMB900billion（US$140billion）ininterestpaymentsthisyearalone,andtheiroff-balancesheetrevenuestreamsareunderpressure.

∙Wesketchthreescenariosofhowthisislikelytoplayout:

A“muddlethrough”scenarioinwhichthegovernmentoffersadebtexchangeandpushesthroughfinancialsectorreforms;

a“slowgrind”scenarioinwhichthegovernmentoffersapartialbailoutforexistingdebts,butallstakeholderssharetheburdenofadjustment;

anda“crashandburn”scenarioinwhichhighinflationlimitsthegovernment’spolicyresponseanditcannotpreventordelayafinancialcrisis.

∙Inanappendix,weputthecomingbailoutinhistoricalcontext.NearlyalloftheproblemsChinaisgoingtofaceinthecomingyearsareonesthatithasdealtwithinthepast.

TABLEOFCONTENTS

∙GettingaHandleontheSituation

∙TheStockProblem

∙TheFlowProblem

∙TheDebtProblem

∙It’sAlltheGovernment’sProblem

∙AndItEndsWithaGrowthProblem

∙TheEndgame:

ThreeWaystoKillaGrowthModel

∙Scenario1:

MuddleThrough（15%probability）

∙Scenario2:

SlowGrind（63%probability）

∙Scenario3:

CrashandBurn（22%probability）

∙Appendix:

TheGhostofChinaBrokeninthePast

∙RestructuringtheState-OwnedBanks

∙China’sShadowBankingSystem

∙TheHainanPropertyBubble

∙HistoryRepeatsItself

China’sgrowthmodelhasalreadycrossedtheeventhorizon;

theonlyquestionishowitwillbecrushed.Overthepastdecade,60%ofChina’sgrowthhascomefrominvestmentandnetexports,asarapidlyexpandingphysicalcapitalstockhashelpedtoimproveitsexportcompetitiveness.Thiswasnevergoingtobesustainableinthelongrun—shiftingdemographicswouldhavestartedtoreversetherepressionofhouseholdincomes,whichwouldhavebiduptheartificiallycheapcostofcapitalmakinginvestmentmoreexpensiveandensuringthattheRMBwoulddriftupwardtowardfairvalue—butitwasthemaniaofthe2008-11investmentboomthatpushedtheChinesegrowthmodelintotheabyss.

AsNourielRoubinirecentlyargued,thisinvestmentboomisleadingtomassiveovercapacitiesthatwillgeneratecolossalnonperformingloans（NPLs）,riskingahardlandingsometimeafter2013.Here,wequantifytheproblem,sumupthelikelycostsandprovidethreedistinctscenariosfortheendgame.

GETTINGAHANDLEONTHESITUATION

TheStockProblem

Chinaisnowthesecond-largesteconomyintheworldand,basedonourcalculations,itisthethird-richestcountryintermsofphysicalcapital,ortheaccumulatedvalueoffixedassets.WebaseourestimatesonanupdateofNehruandDhareshwar（1993）,whichcalculatedthestocksof92emerginganddevelopedmarketsfrom1950through1990.Usingtheirestimatesofeachcountry’sinitialcapitalstockintheearly1950s,weemploytheperpetualinventorymethodtoestimatecapitalstocksin2010.Inthiscalculation,theflowofnewinvestmenteachyearisaddedtotheexistingcapitalstock,whichdepreciatesovertime.Weholdtheirassumptionthatexistingcapitalstocksdepreciateatauniform4%rateeachyearacrosseverycountry,eventhoughthisiscertainlyasmallerrorthatcompoundsovertime.

WhileChinaranksnearthetopofourleaguetablefortotalcapitalstock,itcomesclosetobottomonaper-capitabasis.Thissuggeststhatithasyearsofcapitalaccumulationaheadofit,andthatChina’sinfrastructureisnotover-builtintheaggregate.Inthelongrun,thisiscertainlytrue.However,inthenearterm,theinfrastructurethatChinahasbuiltisnotaddingtooutputfastenoughtopayforitself,and,withaninvestmentrateofnearly50%ofGDP,thisisnosmallproblem.

Figure1:

ChinaIsaRichCountry,FullofPoorPeople

Source:

NehruandDhareshwar（1993）,IMF,WorldBank,NationalStatistics,RGE

TheFlowProblem

WhiletherearesomeproblemswithChina’sstockoffixedassets,therealproblemhastodowithitsflowofinvestment.AnycountrythatbuildsanewhighwayisgoingtoseeajumpinGDP（grosscapitalformation）andanincreaseinproductivity（moreefficientmovementofgoodsandlabor）.Simultaneously,buildingarailwayofequalvalueparalleltothathighwaywoulddoubletheboosttoGDP,buttheproductivitygainfromeachprojectwouldnecessarilybeless,whichwouldweighongrowthinthelongerrun.ThisisthesituationinwhichChinafindsitselftoday—arisingflowofinvestment,withalowerreturnonitscapital.

Figure2:

TheFlowInvestmentOverwhelmsConsumption（%ofGDP）

NationalBureauofStatistics

WhendemandforChina’sexportscollapsedin2008,policymakersinBeijingneededanalternativesourceofgrowthandsotheyopenedthefloodgatesforlocalleaderstobuildnearlyanythingtheywanted,solongasitcreatedjobsandGDP.Thisledtoamassiveinvestmentinhigh-speedrailways,highways,airports,luxuryapartments,windpowerandheavyindustrialcapacity.WhileintheaggregateChinastillhasadeficitofinfrastructure,thespeedinwhichthesenewprojectsarecomingonlinenegatestheusefulnessofeachofthem.Therewasnotimeforarealassessmentofwhichnewhighwayswereneeded,letalonehowthoseroadswouldbeaffectedbythenewhigh-speedraillineplannedalongthesameroute.Instead,anythingthatwasonalocalleader’swishlistwasgiveninstantapproval.ThereasoneveryleaderhadsuchalongwishlistwasbecausetheNationalDevelopmentandReformCommissionhadpreviouslyjudgedmostproposalsaslackinginanyeconomicjustification.However,eveniftheseplanshadbeensound,productionsimplycannotbeshiftedaroundfastenoughtokeepupwiththepaceofChina’scurrentinvestmentrate.Theendproductofpoorplanningandrapidinvestmentisclear:

TherearemassivetrafficjamsgoingintoBeijingwhilethecityisringedwithemptyluxuryapartmentsandvillas.Wind-poweredgeneratorssitunconnectedtothestategrid,whilenewcoal-firedplantsarebuiltdowntheroad.High-speedrailwaysrunnearlyempty,whilecoalshipmentsoverwhelmtheexistingfreightnetwork.TheresulthasbeenacollapseinthemarginalproductofChina’scapital,ortheamountofGDPeachdollarofinvestmentgenerates,aproblemthatwillcompoundaslongaspolicymakerscannotfindalternativesourcesofdemand.

Figure3:

InvestingforGDP,NotProfit（RMB,trillions）

NehruandDhareshwar（1993）,IMF,WorldBank,NationalBureauofStatistics,RGE

Adeclineintheproductivityofcapitalisawarningsignofproblemstocome,asitimpliesinvestmentgrowthisnotsustainableatitscurrentrate.China’smarginalproductofcapitalfellfromanaverageof1.0inthefirstsevenyearsofthedecadeto0.75from2008through2010.Givenourgrowthforecastsfor2011-12,weexpectChina’smarginalproductofcapitaltoremaincloseto0.7thisyearandnext.SouthKoreaandMalaysiasawsimilardeclinesintheircapitalproductivityinthefiveyearspriortothe1997Asianfinancialcrisis.Brazil’sratiofellsharplyin1996,twoyearsbeforeitscurrencycrisis.ThemarginalproductivityofcapitalinSpaindeclinedsharplyin2002andstayedlowuntilthebottomfelloutin2008.IntheU.S.,theratiodeclinedsteadilyfrom2004throughthecrashin2008.AlthoughChinadoesnotrunacurrentaccountdeficitorhaveanovervaluedcurrency,ittoowillrunintoawallaslongasitcontinuestopourfundsintounproductiveinvestments.

TheDebtProblem

TheweaknessinChina’sgrowthmodel,aswithallofthoseabove,isthatthevastmajorityoftheseunproductiveinvestmentswerefinancedwithdebt.WeestimatethatChina’sdomesticdebt-to-GDPratioincreasedfrom164%in2008to207%in2010,astotaldebtoutstandingincreasedby60%toRMB82trillion（US$12.4trillion）.Asharpincreaseindebt-to-GDPisanotherwarningsignofcomingproblems.InHymanMinsky’sfinancialinstabilitytheory,anincreaseindebtwithoutasimilarriseinoutputindicatesthatdebtisdriftingfrom“hedge”borrowing,inwhichcashflowcancoverdebtobligations,to“speculative”borrowing,inwhichcashflowcanonlycoverinterestpaymentsor“Ponzi”financing,whichrequireseverrisingassetpricestocovereveninterestpayments.Thatmuchoftheincreasein2010camefromoff-balancesheetlending,similartothespecialpurposevehicleswesawduringtheU.S.subprimebubble,compoundstherisk.Itseemsthatloansthatcouldnotberepaidhavebeenrolledoverintodebtsthatregulatorscannoteasilyfind.Ifbanksfindthemselvesunabletokeeprollingovertheseobligations,NPLswouldquicklyeatthroughthestate-ownedbankingsector’sprovisions.

Figure4:

China’sGrowingDebtBurden