One of the frequently cited bright sides of the Chinese growth story is the nation’s [reportedly] advantageous fiscal situation, allowing it to enact relatively large stimulus measures. This is [reportedly] due to a large trade surplus, which gives the PBoC large foreign reserves; and very low levels of public debt [estimated at ~25%].

The sticker rate, however, ignores local government liabilities, which are a major source of infrastructure financing. “Local Financing Platforms” (地方融资平台) borrow from banks, and provincial / local government bureaus are ultimately liable. Provincial governments have begun to issue bonds through the central government, but the amount as of yet is miniscule compared to the amount of bank borrowing. Several reports; see here (Economic Observer), here (Jinan Daily, Chinese), here (FT China Confidential) and here (Xinhua, Chinese) have noted that the total amount of loans secured by local government bureaus is somewhere around Rmb6tr at the end of 2009. There is only reason to worry, however, if these liabilities turn sour, which many onlookers think is inevitable, citing the scale of credit expansion, and the notion that there cannot possibly be enough profitable investments left to make. This argument alone is dubious, though there is plenty of substantive evidence to worry about an increase in non-performing loans. For example, the Nov. 23 Jinan daily article notes that there have been instances of Local Financing Platforms abusing their privileged position (and lack of transparency among banks) to illegally obtain credit, effectively double counting infrastructure financing needs on a variety of projects:

Since the beginning of this year, rapid increases in loans have become a common phenomenon. For some, this is taken as proof of economic growth. However, in fact, what if it is really true? Local government investment platform business loans have become the main form [of this trend]. Regional and commercial banks have utmost confidence in local governments, but in practice the survey conducted demonstrated that, there are still a number of local financing platforms that just want to improve their own conditions, and exploit the opaqueness of information between banks to expand their position, to illegally obtain credit, harming banks’ interests.

These types of illegal activities are broadly of several types: the first is exploiting financing offered by numerous banks [simultaneously], illegally obtaining credit. For example, a park environment renovation construction project in some city in Jiangsu province had a planned investment of about Rmb800mn, of which nearly Rmb300mn was financed directly by the investment platform. For the first half of 2009 this company applied for a Rmb500mn project loan, and at the same time, used the same project to apply for another Rmb200mn in a revolving financing loan from a completely different set of banks. Though project financing relies on bank loans for efficacy, this is true in name only.

今年以来，城商行贷款激增成为一个普遍现象。这曾被一些舆论一度视为经济增长的有力佐证。但是，事实果真如此？通过地方政府融资平台公司贷款，是目前政府类贷款的主要表现形式。尽管城商行对地方政府高度信任，但实际调查显示，仍然有一些政府融资平台公司为了达到自身运作目的，利用与银行之间信息不透明的可乘之机或自身强势地位，违规侵占信贷资金，损害银行利益。

而这些违规现象基本有以下几类：一是利用一个项目向多家银行融资，套取信贷资金。如江苏某市的一个园林环境整治建设项目，计划总投资约8亿元，其中有近3亿元自筹。该公司2009年上半年在向某城商行分行申请到5亿元项目贷款的同时，又以同一项目向当地另一股份制银行分支机构申请到2亿元流动资金贷款，建设资金基本依赖银行，项目资本金有名无实。

So the banks will be left holding the Asian-manpurse-satchel; who cares, since Chinese banks are also normally cited as being well capitalized. Non-performing loans made earlier in the decade were swapped by state established Asset Management Companies in 2003 that issued bonds to the banks at par for the non-performing loans, guaranteed by the PBoC and Ministry of Finance (worth about Rmb1.8tr), thus removing bad loans from bank balance sheets. If more NPLs ensue as a result of the behavior described above, banks may be left with an unexpectedly large losses. Recently CBRC mandated a slightly higher capital reserve ratio, but not by as much as was rumored. Still, banks have had to go back to raising more funds for continued loans (more here and here, in Chinese). Reuters ran a similar article yesterday.

Taking these together, Pivot Capital estimates that China’s public debt is somewhere in the neighborhood of 62%, much more comparable to international standards. China certainly does have more wiggle room for its size than many Western nations, and could probably continue to float Rmb bonds for a while if it needed to; but it’s total capacity to continue to expand fiscal stimulus type measures may be more limited than is commonly thought. Thanks to JG for pointers to many of the above links.

I’m fairly certain we lived through an instance of shady infrastructure financing last year. In Wuchang, there is an intersection known as 街道口, where highway construction was halted for over a year due to protestations by Wuhan University’s President, who holds a party rank equal to the city governor, since the highway was going to go right through the university (rather, ‘over’ a part of it). The intersection in question would have benefited from an overpass, a four-lane highway seemed like overkill. Maria details the event here. As a result of the stalled installation, one of Wuchang’s busiest intersections was perpetually jammed, from about 7am-7pm. A friend likened it to a “giant idle gas belching urban gash.”

This is a picture of the planned high speed rail network in China by 2020; the yellow represent maglevs, the rest should be apparent from the legend. If everything goes as planned, it looks like one will be able to high speed directly into Ta|wan. 台湾是中国组成的一个部分, of course, so this is only natural. Underwater maglev!?

An earlier post repeated Michael Pettis’ argument that investment in high technology doesn’t necessarily guarantee commensurate economic gain, particularly given that labor in China isn’t as productive as labor in the U.S. or Japan. Think of doctors and their secretary: a doctor could do his own scheduling, but at some income level it makes sense to pay someone else to do simple tasks. The same is probably true of a migrant worker – he’d be perfectly willing to take a 12 hour truck from Wuhan to Shanghai, and it wouldn’t have cost Chinese taxpayers quite so much to repair roads as importing a shiny new high speed train from Japan. Two things to consider:

• China’s average productivity is low, but there are several pockets of very high productivity (especially if they build the underwater tunnel to Ta|wan?) Shanghai to Beijing in 5 hours on a maglev sounds very appealing.
• Productivity is increasing over time, and since the results of infrastructure investment don’t really go anywhere (harder to build when the Yangtze River Delta has 150 million people living in it); they might as well over-invest while labor is cheaper?

Non-performing loans will certainly increase as a result of the current investment binge, but the magnitude of increase in totally unserviceable NPLs will largely be determined by how fast productivity and general economic conditions play catch-up with a deep and advanced capital structure. Large scale infrastructure investment tends to be path dependent, especially when you can’t bulldoze any house in your way at whim (I [perhaps naively] believe that institutions will continue to liberalize in China. For the moment it’s a lot easier to draw a line on a map and say BUILD, peasants be damned). Had the US built an extensive rail network along with the interstate highways in the 1950s we might not be quibbling over ethanol.

The ‘bubble’ narrative on China that’s been present in mainstream media seems to be shifting? The CSI-300 gained 5.2% on Friday (after an 8 day holiday including Mooncakes and a big parade). Mainland markets are notoriously volatile, so locals often tell me to take large movements with a large grain of salt. Still, 5%. Mooncake coma must inspire confidence… From Bloomberg:

“China is where we are putting most of our money out of the BRICs,” Peter Schiff, president and chief global strategist for Darien, Connecticut-based Euro Pacific Capital, whose clients have more than $2 billion in assets, said in a telephone interview. “Valuations are certainly better there. That is where the growth and profits are going to be.”

… Shenyin & Wanguo said it estimates the Shanghai Composite will rise as much 22 percent in the fourth quarter, compared with estimated gains of as much as 30 percent at GF Securities and 44 percent at Galaxy.

“We see the Shanghai Composite setting a new high for the year in the fourth quarter as signs increase that China’s economic rebound is accelerating,” said Teng Tai, a China Galaxy Securities strategist in Beijing. He predicted a “very strong rebound” in earnings.

This isn’t something you hear everyday, from a Tianya forum post: “American college graduates’ salaries are extremely high, but Chinese graduates’ salaries are equal to those of migrant laborers?” (美国的大学生收入优势大，但中国的大学生等同于农民工?) It’s a reference to this OECD report that lists lifetime earnings differences vs. non-college graduates in rich countries, by gender. It’s interesting that no one in the comments section seems to have picked up on the persistent gender inequalities present in the results.

For some context: there’s been a lot of discourse regarding unemployment among college graduates in China, and general low level of salaries for even those graduating from top universities. Non-controlled TonySurveyTM results indicate that in Wuhan, a newly minted Wuhan U. (considered a top-10 school in the Mainland) grad can expect between Rmb 1.2-2.5k (US$ 170-380) per month. In Shanghai, it’s about twice that. A very good job (in Shanghai) would net someone Rmb 6-8k (US ~$900) per month – if they can find a job. In the past year there has been a lot of concern with graduate unemployment. The figures for average graduates are sort of comparable to experienced migrants: the average migrant can make between Rmb 800-1.5k per month; the amount goes up if they work in a larger city / possess trade skills (the max I’ve heard is about Rmb 2.5-3k, which is unusual).

Despite the massive wage differential between U.S. graduates and the rest of the world; there’s been some concern in the U.S. that graduate salaries are falling on average, and wage income inequality is generally increasing; certainly magnified by the awful employment situation throughout the last year. This Businessweek article doesn’t account for demographic changes – are boomers as a group more likely to have college degrees, and their retirement increases the percentage of the working population without a degree? That seems unlikely, but boomers would have much more experience – comparing a 25 year old with someone who has a Bachelor’s degree and 25 years of experience doesn’t tell you that much about long-term wage trends. It probably also depends on what people are studying – interesting comparison here between fields.

In general, Chinese education is rife with plagiarism, rote memorization and absenteeism. This is certainly less pronounced at the major universities, where exchange students and guest researchers are often posted, but is not representative of the higher education system as a whole. Even though China graduates ~600,000 engineers every year, McKinsey Global Institute (as of 2003) indicates that most of them are unemployable by Western standards, due to quality of education and language barriers. That’s certainly not a reason to ignore the low rate of graduation in these fields in the U.S. (would be nice to do a grad degree in CS or statistics, but first one must pay for the dumb thing), but it is a bit of perspective. Education in China isn’t yet all that developed by international standards, and won’t be for a while. This does beg the question as to why massive infrastructure investment is going into Burj Dubai mockups and bullet trains and not improving the quality of education. The answer I imagine is simply that improving education quality is very, very difficult.

Here are some of the replies to the original post:

Because when you all were at university you were busy flirting with girls, playing computer games. A university diploma doesn’t mean anything, the critical element is whether or not you can add any value.

因为你们在大学里忙着泡MM玩网游,大学文凭不能代表什么,关键是你能创造多少价值.

American graduates’ salaries are high because America demands that many college graduates, besides, America’s basic level level education isn’t really much at all. If you haven’t gone to a university, one with a good brand name, your lifestyle level will comparatively not be very good.

Chinese graduates cannot command value because China’s economy is currently in the developing stage, and originally doesn’t demand that many college graduates.

美国大学生收入高，是因为美国需要那么多大学生，并且美国的基础教育水平不怎么样，如果不是以大学升学、考名牌大学为目标的高中生，文化水平是相对比较低的；

中国大学生不值钱，是因为中国现阶段的经济发展水平，本来就不需要那么多大学生，大力发展高等教育本来就是出于推迟就业、缓解就业矛盾、迎合农村人希望 跳农门的心理赚钱的，从资源角度看，根本就是浪费教育资源，把本该提高高等教育水平的投入花在了高等教育普及化上；给本来应该去做农民工的人一张大学文 凭，最后收入还不如农民工，因为浪费学习专业技能的时间和机会，在大学里混文凭。

Because China doesn’t need university graduates, it needs migrant laborers! China’s GDP relies on cheap labor to manufacture; it’s the world’s factory ~ it doesn’t rely on technology to manufacture; on this point there’s no possible way to compare it to the U.S. or Japan.

因为中国不需要大学生，需要民工！中国的GDP都是靠低廉的劳动力创造的，世界工厂嘛~而不是靠科技创造的；这点跟日本美国根本没法比…

It shouldn’t be so! Because the costs of education can’t be compared; there are lots of households that are collectively contributing to help students make it to graduation. They should be able to make back their money.

It’s not so! It should also be an effective investment. Think of politics, class struggle and this sort of thing – the more one studies the more stupid they speak. Of course, our constitution is based upon class struggle, so if there’s no study of that then that’s no good either.

不应该，因为教育成本不能同日而语，一个家庭要供养一个学生直至大学毕业所付出的是很多的。应该得到适当的回报。

不是吧！那也要是有效投入才行。像政治啊，阶级斗争这些东西越学得多可能越傻的说。当然，我们的宪法是以阶级斗争为基础的，不学还不行。

So I emailed Professor M. Pettis a while ago, asking about: ‘China is a target rich environment; do we really expect *that* many loans to go bad? You could draw a line on a map, build a train, and people would use it…’ He writes thusly – probably to more intelligently phrased questions in the same vein:

… The second objection – perhaps not so different from the first – is that since China is so much less developed than Japan was in 1987, an infrastructure investment surge is a lot more sustainable. After all, Japan already had great infrastructure in place at the time, so that much of its new investment after 1987 was inevitably in the form of highly wasteful “bridges to nowhere”. Since China has much lower quality infrastructure stock, they argue, there is much more it can do in the way of sustainable investment.

I am always a bit puzzled by how widely-held these views seem to be, especially in China but also abroad. The idea that being poorer makes policy easier can’t have emerged from looking at the experience of developing countries. I suspect that it arises from assuming that poverty does not represent differences in real factors – worker productivity, education, the institutional and legal framework, etc. – so much as in policy mixes.

It is true that poorer countries are able generally to achieve faster growth rates than richer countries, perhaps because they have only to play catch-up, but there is little evidence from other countries that poverty leads systematically to more profitable investment or to more sustainable consumption growth. I think both objections stem from implicit assumptions that there is some highly attractive upward limit to either consumption or infrastructure investment, and that the further away we are from that limit the stronger the attraction towards it. But if that assumption weren’t mistaken poverty should have ended long ago.

And the key point for me:

… The scope for nominal improvement in infrastructure is certainly higher in China than in Japan, but nominal improvement doesn’t matter. It is the economic value of that improvement that matters, and the economic value of improving the railroad in China is not necessarily higher than in Japan since, for example, every hour of transportation time saved in Japan may be substantially more valuable than an hour saved in China.

In fact I would argue – as have many economists, by the way – that China’s obsession with high-technology or state-of-the art infrastructure is extremely wasteful because the benefits of the most advanced technology only justify the costs if labor productivity and labor costs are very high.This is perhaps another way of saying that China’s highly capital-intensive growth is far from optimal for China, and probably only reflects the fact that capital is so cheap in China, at least for the capital-intensive SOEs that get the bulk of bank financing. This means that achieving Japan-style levels of infrastructure are not necessarily the best way to invest in infrastructure.The optimal infrastructure level in China is lower than the optimal in Japan, so the fact that China starts from a lower base does not automatically mean that it has more scope for profitable investments.

Via Pragmatic Capitalist, SocGen analysts on the similarities between China and Japan, and what it portends for (as they contend) China’s imminent implosion:

Studying the lessons from Japan’s lost decade(s) is key for anyone seeking to understand today’s post-bubble world. But a closer reading of Japan’s financial history illuminates today’s China far more. In the early 1980s, on the eve of its financial liberalisation, Japan was the rising power from the East set to overtake the West. Younger and growing rapidly, it was still a decade away from its climactic and catastrophic bubble peak. This is where China is now…

They argue that the bubble will inflate when China liberalizes its currency. It’s already taken a lot of steps in that direction (settling cross border trade using Rmb, issuing Rmb bonds, listing wholly foreign stocks on the Shanghai exchange). Full convertibility may only be several years away: at that point the Rmb appreciates vis-a-vis the USD, to around 3-4Rmb per dollar. The argument is that money is flooding into China during this period, sticking to anything that looks remotely like an infrastructure project.

There are good reasons to be concerned about China within the next 20 or so years, but very few of them are because China bears any sort of similarity with Japan. From an American perspective the narratives are perhaps analogous purely due to the notion that ‘upstart liberalizing Asian country may overtake U.S. economic hegemony.’ That’s it, and it’s a rather ethnocentric viewpoint (SocGen analysts should be French?) They do point out important demographic trends, but this too is analogous with much of the rest of the world.

The two competing notions present within media discourse, 1) an overheating China destined to implode and 2) inevitable rise of great power are both oversimplifications, and not necessarily mutually exclusive, especially depending on your time scale and degree of geographic specificity within China.

The China bubble notion seems to have achieved widespread mainstream acceptance. Recently, China’s central government has effectively promised not to do anything to prematurely remove the punchbowl (Clusterstock). Like most things here, it’s possible that could change rapidly. Be there a bubble? From WSJ:

… Shares in dozens of other companies sell for two, three or even four times as much in Shanghai or Shezhen as they do in Hong Kong. The average sells for 42% more…

Chinese real estate, already at lofty levels, has risen alarmingly fast lately… average home prices in some cities on the mainland, such as Shanghai and Shenzhen, may have risen by more than a quarter since the start of the year. That may leave average prices in relation to household incomes higher than they are in New York, London, San Francisco and Sydney.

… The Chinese economy continues to grow — it expanded by 7.9% in the second quarter – the real juice, as usual, has come from easy money.

Bank lending is at high levels. The Chinese government has embarked on a $586 billion stimulus plan that includes giant infrastructure projects to keep the economy rolling. Interest rates are low: Since last September the typical three-month deposit rate has fallen by about half, to 1.7%. So mainland Chinese investors are looking for other ways to grow their money.

Capital restrictions make it difficult for that group to invest abroad, so lot of their money has flooded into real estate and the “A” shares…

Research Reloaded notes:

The government may fear the potential repercussions of deflating asset prices in the short term so much that they are willing to ignore the longer term consequences of fueling asset prices further. Fair enough, sounds like standard human nature when it comes to politics and just today Chinese officials have said they will investigate price gains but won’t cap new lending.

Katsenelson ups the ante and explicitly suggests deflation as an inevitable likely future scenario:

It appears that deflation is a more likely scenario as China is ridden with overcapacity – the country was geared for much higher global growth… in the long run, inflation appears an unlikely outcome: overcapacity and slower demand from the US and Europe will force Chinese producers to cut prices to increase utilization and stimulate demand.

Prior to the crisis, the central government was largely worried about ‘hot money’ inflows caused by high interest rates that couldn’t be altered due to the currency regime – allow the currency to appreciate, ‘hot money’ inflows would cease, and exports would fall. It seems they are in a similar sort of bind now – Chinese investments have long been cheap (even from a Chinese perspective) due to the exchange rate. Some of these commentators have pointed out that now China’s export machine lacks the security net of growing global demand, a-la 2003-2007, and so the eventual bubble pop is going to be even worse than had it occurred in 2008, at the peak of the global recession.

The optimist says that China’s domestic demand can pick up the slack – the pessimist notes that most domestic consumers are more price sensitive than their European and American counterparts, purely due to lower average incomes, but also the ‘cultural element’ I’ve argued previously. Personal opinion: there is a lot of pent-up demand for apartments, cars, air conditioners, washing machines… and evidence to support that increases in income are plowed directly into these products. However, if incomes stagnate, they are also much more quick to substitute out of such ‘necessities.’ There are extremely active second hand markets for all sorts of things, all the way down to half-smoked packs of cigarettes and half-empty bottles of liquor – the point being that decreases in income at any level will affect consumption patterns throughout a larger part of the distribution for just about every type of consumer good.

As a result of this (and numerous other factors I’m not smart enough to note), the notion here therefore seems to be manage this transition away from export reliance as slowly as possible – and why not? For the time being, they have a very deep bowl – let us hope the punch is not spiked. [Sorry to torture the metaphor. In reality, punch spiking isn't really practiced here - 白酒 doesn't mix so well. Need to work on cross-cultural allegories: 'the tea leaves are muddled - let us hope we do not misinterpret.' No...]