Sneakily but steadily, the Chinese government is pumping torrents of money into its banks. And many trillions of yuan have been flowing into stocks via the interbank lending markets.
Just as interesting, though, is where the cash isn’t flowing. Despite the flood from the central bank, the money geysering forth isn’t making its way into ordinary people’s pockets, their checking accounts, or growth-boosting infrastructure projects. That’s a disquieting hint that China’s $30 trillion in debt is terrorizing its economy far more than the country’s robust 7% GDP growth rate implies.
The first thing to note is the scale of the sums gushing out of the People’s Bank of China. Sources of this largesse include interbank lending, lowering of bank capital requirements—which freed up an estimated 1.5 trillion yuan ($240 billion)—and “innovative liquidity tools” (meaning, backdoor lending to banks).
This money should spur growth. However, Wei Yao, economist at Société Générale, has spotted a curious divergence that suggests it’s not.
The gray line in the chart below shows annual growth in spending on urban fixed-asset investment (FAI) projects—big economy-juicing ventures like building airports, trains, or condos. China-watchers see FAI as the primary indicator of capital spending. While it’s been gradually easing, that outlay is still rising at a brisk 11% annual pace. The blue line, which tracks the annual growth in received funds for these same projects, is what’s worrisome. Since 2014, growth in received funds has been decelerating faster than urban fixed-asset investment. The three-month moving average expanded at a meager 5.7% in June.
But why, then, is investment growing so much more quickly? Chinese government data is notoriously marred with inconsistencies, and that might be what’s at work here. While local governments are supposed to report actual expenditures, they’ve been known simply to report planned project spending (pdf, p.12), which keeps their district’s GDP looking healthy enough to avoid censure. The deviation between funding and spending growth would seem to confirm that some of these purported investments aren’t actually happening.
This brings us to another discrepancy. Slowing FAI funding is largely due to banks pulling back; in the second quarter, bank loans for urban infrastructure projects fell by nearly 5% versus the same quarter in 2014.
Considering China’s zippy 7% second-quarter growth, this doesn’t make sense, says Christopher Balding, associate professor at Peking University HSBC Business School, Shenzhen.
“What bank lowers lending by 5% in an economy growing by 7%?” he tells Quartz, noting that “the only thing keeping this investment-driven economy afloat is government investment.”
Those data were from the National Bureau of Statistics. Weirdly, central-bank data show overall bank lending rising at a much faster clip than growth in financing for FAI projects:
“Given the rise in credit and the fall in actual investment, you have to really wonder where these loans are going,” says Balding. “China hasn’t grown enough Silicon Valleys [meaning, high-growth sectors] to change the entire financial landscape in a year. This indicates a large number of bad loans, and liquidity problems.”
To unpack what Balding means, a company that can’t pay back a loan has a few options. It can fire workers and sell off assets, file for bankruptcy, borrow from someone else to cover the debt, convince the bank to extend the loan for another year or so, or get the bank to lend it even more money. Why would a bank manager do the latter two options? Insolvent loans put bank managers in a tough spot. Cut off the money, and when that customer defaults the bank has to write that money off. That could cost the manager her job.
This is why these companies are dubbed “zombies”—keeping them on a steady drip of financial life-support prevents the dead from truly dying.
The gap between credit and investment suggests this is happening. The reason banks are so hungry for more money is because, quite simply, they’re not being paid back. This is potentially a big problem for China’s growth outlook; bank loans account for three-quarter of China’s total financing. That compounds itself—slower growth makes it even less likely that banks will eventually get paid back. As more and more money shifts toward keeping “zombie” companies alive, there’s less and less that can go to entrepreneurs and households that could really use it.
But the horror movie analogies don’t stop there. When debt hits a certain level, an economy starts to cannibalize itself, devouring its own potential. Credit that could support good companies goes to postpone defaults. Corporate profits go to pay off debt, and aren’t reinvested in expansion. Shriveling demand drags down prices.
Falling prices effectively make debt more expensive, since the cost of loan repayments are fixed. That rise in borrowing costs then discourages more would-be entrepreneurs from expanding. Monetary policy is powerless to stop this; adding more money merely produces more fat to cannibalize. Yet without economic growth to raise prices and generate profits, the central bank must keep feeding the beast liquidity to stave off a cash crunch à la June 2013. Or worse.
A clue that this is what’s happening comes from money supply data, as J Capital Research highlighted in a recent note. The broadest measure of money—which includes cash, deposits, and less liquid holdings like money-market funds and time deposits—is rising by about 10% annually. However, cash in circulation (and held by the central bank) has nosedived.
Thus, the inundation of money sloshing around the system is somehow drying up before it reaches Chinese businesses and individuals. “This gap,” says Anne Stevenson-Yang, head of J Cap, shows “the way in which money has slowed down in the real economy and metastasized into the speculative one.”
Much of this is hard to see—the evidence can be obscure, confusing, and contradictory. A notable exception is the Chinese government’s daring stock market rescue. The central bank is now pumping trillions of yuan into stocks to keep them from falling, presumably in hopes of steadying stock indexes enough to convince investors to pile back in.
If this doesn’t happen soon, though, the Chinese government will either have to accept a selloff—threatening the Communist Party’s popular credibility—or just keep the money coming. That will zombify the stock market, adding another member of the financial undead to join the ghoulish horde.