Tuesday, October 13, 2015

Lessons for Singapore from China's 2008 $600 Billion Big Bang: Effect and Side-Effects.

As Singapore faces a possible economic technical recession, many are hoping that the government will unleash a slew of measures that will stimulate the economy, and hopefully keep it from falling into a recession. But like medicine, economic stimuli only treat the symptoms and effect a temporary cure. Also, like medicine, economic stimuli (especially of the loose monetary policy kind) will have side-effects. China's bold economic stimulus in 2008 is an example of what can happen with loose monetary easing, which the Americans euphemistically call 'quantitative easing'. 

In 2008, the world faced a financial crisis as the fall-out from the US sub-prime mortgage crisis caused a liquidity crunch in the global credit markets. Over the years the world, and all financial markets- debt, equities, forex, commodities- had become increasingly intertwined due to the instantaneous flow of information made possible by advances in communications technology. At the onset of the crisis, the best blue chip stocks in the portfolios of international fund managers were sold off at ridiculous prices to raise cash, because they were the easiest to sell; and not because they had no value. The flow of funds affected currencies as well as commodities, metals, oil and shipping rates which had historically quoted in US$ because being the most abundant currency it was the currency used for international trade. 

It was in such a setting that the Chinese government implemented it's 4 trillion Yuan (US$600 billion) big bang monetary stimulus package, the size of which the world had never seen. Funding and credit was made readily available through the central government, local government and participating banks-for everything from infrastructure projects like high-speed railway, to personal car loans, to loans to factories for their operational expenditure. In reality the total amount of credit created was at least 10 trillion Yuan as controls on bank lending became almost non-existent, and local governments were encouraged to issue their own bonds for projects, many of which were simply a waste of money-from bridges that led to nowhere, to museums for local heroes, to golden arches at the entrance to the town. 

The effect of this stimulus on the economy was almost immediate. As the charts above shows, there was a  sharp spike in car loans, electricity consumption, and railway freight- three indicators of an active economy.  However, as can also be seen from the charts, the effect of the ' medicine' had petered out by end-2010. 

But the side-effects of this ' medicine' soon became evident. Over 35% of the credit was spent on building infrastructure. Roads, railways, schools, hospitals may be a wise way to spend money. But the construction of such items caused a huge demand for steel (and therefore iron ore and coking coal) with the consequent over-investing in steel factories and coal mines. By 2013 we see Chinese steel companies suffering a  production overcapacity, and having to export their steel abroad at cut-throat prices. In coal mining provinces such as Shaanxi and Hubei, the effect as coal mines shut down trickled down to the local economy, with bad debts and unemployment rising; and many once-flamboyant coal barons became bankrupts. Today, Australia is also suffering from the drop in Chinese demand for its iron ore and coal. 

The liberal landing by the banks has caused a huge overhang of bad debt on their balance sheets, which even today remain on the balance sheets as under-performing loans not-yet-written-off with the unrealistic hope that someday the debt will be repaid. At the provincial level, many state-owned enterprises had borrowed money to speculate in the stock market or the property market-and even to re-lend at higher interest rates to non-state-owned enterprises that could not readily access credit. 

In the property market, over-building caused a boom which soon led to ghost cities where tens of thousands of units remain unsold, such as in the coal-mining Inner Mongolia city of Ordos, with some of the buildings abandoned mid-way as funds and demand dried up.

Will China once again enact a big-bang act in the light of its present slow-down? It is not likely,  as the Xi Jin Ping government  has stressed that its economic objective is structural reform and qualitative, not quantitative economic growth- to steer the economy away from being one based on Exports and Investment to Domestic Consumption and high value-added Services. Nevertheless, the moves of the Chinese government remain inscrutable as can be seen by the sudden devaluation of the Renminbi, and the confusing and often contradictory regulations imposed on the stock market from time to time. 

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