Michael Pettis on China’s very own zaiteku

Financial Times

Here’s something for anyone who thought last week’s bank lending figures from the People’s Bank of China showed the country was succeeding in its tightening efforts. It’s a statement from PBoC member Sheng Songcheng. In it, Songcheng writes that “society-wide financing” might act as a better guide for monetary policy than net new loans. And according to that measure, total financing came in at RMB 14.3 trillion in 2010, up 1.5 per cent year on year, due to a surge in off-balance sheet lending, which more than doubled to RMB 4 trillion in 2010. We’re aping the words of SWS’s Chen Long here — but with good reason.

SWS analyst and all-round China expert Michael Pettis brings up his colleague’s work in his latest China Financial Markets newsletter. In it he argues that bank lending is still a major risk factor for the Chinese economy, but also that one of the most worrying aspects of the recent numbers was a decline in corporate deposits. Here’s Pettis on why:

« So why did corporate deposits drop? My guess is that large businesses may be finding it much more profitable to lend money to other businesses, especially those who don’t have easy access to bank credit, than to deposit cash in the bank at such negative real rates. Both the Credit Suisse report and an email I got last month from a friend of mine at Bank of China suggests that there may be an increase in intercompany lending, and to me this would be a very plausible consequence of negative real deposit rates. … Those of us old enough to remember the 1980s will be reminded that the Japanese had a word for this kind of activity: zaiteku. According to the Japanlink website, zaiteku is an abbreviation of zaimu tekunorojii, which means “Raising profit by utilizing capital for securities investments, real estate and the like.” In the late 1980s Japanese companies, faced with the combination of highly repressed borrowing costs and the prospects of ever-rising asset prices (sound familiar?), discovered that it was far easier and more exciting to make money by speculating than by normal operations, and it became the great fashion among Japanese corporations. But it came with a huge cost. Japanese companies began relying increasingly on zaiteku for profits and imbedded increasingly risky structures into their balance sheets. When the seemingly impossible happened, and asset prices stopped rising inexorably, the impact on Japan’s subsequent contraction was made much worse. « 

So the point Pettis is making is that things like overinvestment, excess liquidity, credit expansion, off-balance sheet activities, and zaiteku can all conflate to generate huge growth — but also very big risks. This is what the PBoC is trying to manage. If you think, however, that Pettis is one of the uber-bears on China — think again.

« I’ve noticed over the past two years that a lot of commentators in China and abroad are citing me or my arguments in support of their own claims that China is about to collapse, but although I have been very skeptical of the growth story here for many years, I have never argued that China would collapse. On the contrary. In my opinion, a financial collapse requires specific balance sheet structures in which inverted liabilities (i.e. the opposite of hedged) are combined with self-reinforcing mechanisms that exacerbate changes on both the up cycle and the down cycle. I believe however that with Beijing’s control of the liquidation process, of interest rates, and of investor behavior, the Chinese financial system is organized in part to prevent financial crises. But in so doing it is also organized to exacerbate underlying imbalances and ultimately to increase the cost of the adjustment. This means that if we are nearing the end of the growth model’s life (in the next year or two if there is a strong consensus at the top, or in the next three to four years if there is a difficult leadership transition), the adjustment will not occur as a crisis but rather as a long and sharp slowdown in economic growth. « 

Got it? Not collapse, but a very cutting decline.

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