Has China fallen into an unorthodox liquidity trap? On paper, it’s inconceivable to think this way with a variety of monetary instruments on the table for the PBOC, especially with an interest rate way above zero. But in reality, China has always been facing with the same paradox – an over-levered corporate sector together with an under-levered household sector. Liquidity has been an issue for Chinese corporates, but for household, it is locked up in properties. Banks may have the ways and means to make distressed corporates solvent on paper, but it struggles to provide any meaningful relief to a slowing industrial sector, or in this case, price recovery or growth. On the other hand, rising property prices have become another source of concern for an economy yearning for more consumption spending. People are not just saving for the rainy days, they are in fear of a consistent inflation in the asset market, which consistently outperforms their income growth and renders their liquid savings meaningless in volume.
No personal bankruptcy system a key
The problem with China’s banking sector is to maintain an overall credit growth to sustain the economy, while deferring corporates from being over-levered. It is very hard to control banks’ behaviors on a micro-level, especially given China as a relationship-based society where lending preference is not purely risk-based. But the overall cashflow of the corporate sector is not ideal, especially compared to the household sector. (See following chart for a contrast of sources vs. uses within the banking sector between household and corporate sector)
You may think Chinese households are dumb, because they are “definite pessimist” in Peter Thiel’s sense as they never spend ahead of time. But in fact they weren’t – not only they are saving for subsistence, they are also anticipating a huge spending item for themselves or children – buying a property. One of the key strategy the government is working on, is a debt to equity swap of the corporate sector – via more listing and follow-ons. The idea is a good one, as Chinese corporate sector was in dire need of a disintermediation of the banks to achieve cheaper means of financing, and Chinese households are in desperate need of a sound asset class to invest, but clearly the market screwed up last year. In this year’s NPC, registration reform led by the previous CSRC regime was not mentioned. The root cause to that was complicated, but it was clear that an artificial boom in the equities have led to an expensive price check – both for the government and households to swallow.
(In Peter Thiel’s From Zero to One, he correctly labeled Chinese as definite pessimist, as they trust nothing but their savings/assets)
But the solvency alarm continues to ring, despite that banks cannot simply accept all zombie firms to bankrupt immediately. They are replacing the old debt with new ones, but it doesn’t solve the real issue – companies in the industrial sector was over-levered and they need both restructuring and an impetus for growth. The plan B came, which is using policy levers to “destock” the residential property market via levering up the household sectors.
The key consideration point here is straightforward: China does not have a personal bankruptcy system, which means any liability/debt on a person is debt with full-recourse. There is no precedent in courts so as to speak on a Chinese in negative equity who is unable to pay its debt, but the government certainly can make stakes much higher than one could even imagine – you could have no access to any public service, not a bank account, a social insurance account or join the public sector. The full recourse can be extended to your children. While a firm can just go bankrupt and cause banks headaches on its headline NPL ratio, a levered household sector is much easier to control for both the government and Chinese banks.
Levering up household sector – A double-edged sword
China’s housing reform started way back in 1994. Back in the days, Chinese firms or governments offered practically free or low-cost housing to their employees or public servants. The reform didn’t pick up steam until early 2000s, when local governments started to enjoy the fruits of land transfers and encourage more renovations and new starts in residential housing. In retrospect, China may rethink of its policy to offer substantial supply of public housing to those who simply cannot afford any sorts of housing priced in the market. Unfortunately, this has not been the case.
That said, a class of affluent residents benefiting from the property boom has arisen from the horizon. These people are clearly smart and have rolled their dices multiple times, as they may have little chips in their pocket from the beginning. House purchase restrictions in major cities have constrained them from hoarding valuable assets further, and they have resorted to diversify via immigration and luxury spending. But the majority is staying put, not because they are not savvy enough, but they lack the incentive to do so. Meanwhile, on a data-driven perspective, China’s accumulated property sales (first-hand only, data series started since 1991) has now accounted for more than 90% of household savings, showing that a “healthy” household balance sheet may be in dispute.
This is not a perfect proxy though, by all means. Property sales can be driven by hidden FX inflow of non-residents and even financing overseas; there are clearly statistical issues of consistency regarding the property sales number since the early 1990s; most importantly, savings growth can be driven from selling properties at a high price. Nevertheless, it is time to rethink about affordability as prices have driven up dramatically. There is a point when even affluent class find it ridiculous to trade. On the other hand, mortgages as of total was subdued at 14%, much lower than that of US at 31% or other OECD countries.
Chinese consumers still unwilling to use leverage
In 2015, China’s overall consumption spending was roughly above 30 trillion RMB. 6.7 trillion of which was done via credit card, but only 44% of which comes down to real credit, which is less than 10% of total consumer spending. On top of this, credit card “bad debt”, defined as overdue credit for 6 months or above, was only 0.57% of total credit card lending. On top of this, auto loan was less than half of a trillion in 2015, almost negligible percentage wise. Chinese consumers were still extremely risk-averse in terms of consumer credit, fearing default and social security. While it takes the risk of widening wealth gap in China via propping up the property market, it is surely more effective than to promote consumer credit. The “unorthodox liquidity trap” is just a reflection of a social perception, which is hard to mean-revert in the short term.