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

1、Chronicles of a Crash Foretold Visualizing the Sequence of a Chinese Hard LandingChronicles of a Crash Foretold: Visualizing the Sequence of a Chinese Hard LandingBy Adam Wolfe RGE Share Aug 22, 2011 12:30:00 PM | Last Updated Chinas surge in investment from 2008 coincided with a decline in its marg

2、inal product of capital and a massive increase in its debt-to-GDP ratio. Its marginal product of capital fell from an average of 1.0 in the first seven years of the decade to 0.75 from 2008 through 2010. After accounting for off-balance sheet and shadow bank lending, we estimate that Chinas outstand

3、ing domestic debt increased from 164% of GDP in 2008 to 207% in 2010. We estimate about RMB9 trillion (US$1.4 trillion) of the RMB43 trillion increase in China capital stock from 2008 through 2010 was wasted on unproductive investments that will result in bad debts. These bad debts will choke off in

4、vestment in the coming years, and there is no alternative source of growth that can provide an offset. The situation is coming to a head sooner rather than later, as local governments are on the hook for RMB900 billion (US$140 billion) in interest payments this year alone, and their off-balance shee

5、t revenue streams are under pressure. We sketch three scenarios of how this is likely to play out: A “muddle through” scenario in which the government offers a debt exchange and pushes through financial sector reforms; a “slow grind” scenario in which the government offers a partial bailout for exis

6、ting debts, but all stakeholders share the burden of adjustment; and a “crash and burn” scenario in which high inflation limits the governments policy response and it cannot prevent or delay a financial crisis. In an appendix, we put the coming bailout in historical context. Nearly all of the proble

7、ms China is going to face in the coming years are ones that it has dealt with in the past. TABLE OF CONTENTS Getting a Handle on the Situation The Stock Problem The Flow Problem The Debt Problem Its All the Governments Problem And It Ends With a Growth Problem The Endgame: Three Ways to Kill a Growt

8、h Model Scenario 1: Muddle Through (15% probability) Scenario 2: Slow Grind (63% probability) Scenario 3: Crash and Burn (22% probability) Appendix: The Ghost of China Broken in the Past Restructuring the State-Owned Banks Chinas Shadow Banking System The Hainan Property Bubble History Repeats Itsel

9、f Chinas growth model has already crossed the event horizon; the only question is how it will be crushed. Over the past decade, 60% of Chinas growth has come from investment and net exports, as a rapidly expanding physical capital stock has helped to improve its export competitiveness. This was neve

10、r going to be sustainable in the long runshifting demographics would have started to reverse the repression of household incomes, which would have bid up the artificially cheap cost of capital making investment more expensive and ensuring that the RMB would drift upward toward fair valuebut it was t

11、he mania of the 2008-11 investment boom that pushed the Chinese growth model into the abyss. As Nouriel Roubini recently argued, this investment boom is leading to massive overcapacities that will generate colossal nonperforming loans (NPLs), risking a hard landing sometime after 2013. Here, we quan

12、tify the problem, sum up the likely costs and provide three distinct scenarios for the endgame. GETTING A HANDLE ON THE SITUATIONThe Stock Problem China is now the second-largest economy in the world and, based on our calculations, it is the third-richest country in terms of physical capital, or the

13、 accumulated value of fixed assets. We base our estimates on an update of Nehru and Dhareshwar (1993), which calculated the stocks of 92 emerging and developed markets from 1950 through 1990. Using their estimates of each countrys initial capital stock in the early 1950s, we employ the perpetual inv

14、entory method to estimate capital stocks in 2010. In this calculation, the flow of new investment each year is added to the existing capital stock, which depreciates over time. We hold their assumption that existing capital stocks depreciate at a uniform 4% rate each year across every country, even

15、though this is certainly a small error that compounds over time.While China ranks near the top of our league table for total capital stock, it comes close to bottom on a per-capita basis. This suggests that it has years of capital accumulation ahead of it, and that Chinas infrastructure is not over-

16、built in the aggregate. In the long run, this is certainly true. However, in the near term, the infrastructure that China has built is not adding to output fast enough to pay for itself, and, with an investment rate of nearly 50% of GDP, this is no small problem. Figure 1: China Is a Rich Country, F

17、ull of Poor PeopleSource: Nehru and Dhareshwar (1993), IMF, World Bank, National Statistics, RGEThe Flow ProblemWhile there are some problems with Chinas stock of fixed assets, the real problem has to do with its flow of investment. Any country that builds a new highway is going to see a jump in GDP

18、 (gross capital formation) and an increase in productivity (more efficient movement of goods and labor). Simultaneously, building a railway of equal value parallel to that highway would double the boost to GDP, but the productivity gain from each project would necessarily be less, which would weigh

19、on growth in the longer run. This is the situation in which China finds itself todaya rising flow of investment, with a lower return on its capital. Figure 2: The Flow Investment Overwhelms Consumption (% of GDP)Source: National Bureau of StatisticsWhen demand for Chinas exports collapsed in 2008, p

20、olicy makers in Beijing needed an alternative source of growth and so they opened the flood gates for local leaders to build nearly anything they wanted, so long as it created jobs and GDP. This led to a massive investment in high-speed railways, highways, airports, luxury apartments, wind power and

21、 heavy industrial capacity. While in the aggregate China still has a deficit of infrastructure, the speed in which these new projects are coming on line negates the usefulness of each of them. There was no time for a real assessment of which new highways were needed, let alone how those roads would

22、be affected by the new high-speed rail line planned along the same route. Instead, anything that was on a local leaders wish list was given instant approval. The reason every leader had such a long wish list was because the National Development and Reform Commission had previously judged most propos

23、als as lacking in any economic justification. However, even if these plans had been sound, production simply cannot be shifted around fast enough to keep up with the pace of Chinas current investment rate. The end product of poor planning and rapid investment is clear: There are massive traffic jams

24、 going into Beijing while the city is ringed with empty luxury apartments and villas. Wind-powered generators sit unconnected to the state grid, while new coal-fired plants are built down the road. High-speed railways run nearly empty, while coal shipments overwhelm the existing freight network. The

25、 result has been a collapse in the marginal product of Chinas capital, or the amount of GDP each dollar of investment generates, a problem that will compound as long as policy makers cannot find alternative sources of demand.Figure 3: Investing for GDP, Not Profit (RMB, trillions)Source: Nehru and D

26、hareshwar (1993), IMF, World Bank, National Bureau of Statistics, RGEA decline in the productivity of capital is a warning sign of problems to come, as it implies investment growth is not sustainable at its current rate. Chinas marginal product of capital fell from an average of 1.0 in the first sev

27、en years of the decade to 0.75 from 2008 through 2010. Given our growth forecasts for 2011-12, we expect Chinas marginal product of capital to remain close to 0.7 this year and next. South Korea and Malaysia saw similar declines in their capital productivity in the five years prior to the 1997 Asian

28、 financial crisis. Brazils ratio fell sharply in 1996, two years before its currency crisis. The marginal productivity of capital in Spain declined sharply in 2002 and stayed low until the bottom fell out in 2008. In the U.S., the ratio declined steadily from 2004 through the crash in 2008. Although

29、 China does not run a current account deficit or have an overvalued currency, it too will run into a wall as long as it continues to pour funds into unproductive investments.The Debt ProblemThe weakness in Chinas growth model, as with all of those above, is that the vast majority of these unproducti

30、ve investments were financed with debt. We estimate that Chinas domestic debt-to-GDP ratio increased from 164% in 2008 to 207% in 2010, as total debt outstanding increased by 60% to RMB82 trillion (US$12.4 trillion). A sharp increase in debt-to-GDP is another warning sign of coming problems. In Hyma

31、n Minskys financial instability theory, an increase in debt without a similar rise in output indicates that debt is drifting from “hedge” borrowing, in which cash flow can cover debt obligations, to “speculative” borrowing, in which cash flow can only cover interest payments or “Ponzi” financing, wh

32、ich requires ever rising asset prices to cover even interest payments. That much of the increase in 2010 came from off-balance sheet lending, similar to the special purpose vehicles we saw during the U.S. subprime bubble, compounds the risk. It seems that loans that could not be repaid have been rolled over into debts that regulators cannot easily find. If banks find themselves unable to keep rolling over these obligations, NPLs would quickly eat through the state-owned banking sectors provisions. Figure 4: Chinas Growing Debt Burden