Constructive Simplicity for China’s Communist Party Plenum

The People’s Bank of China cut benchmark interest rates by 0.25 percent on Friday.  This was the sixth time they’ve lowered interest rates within a year.  Bank reserve requirements were also reduced by 0.5 percent.

Economic growth has gradually declined in China over the last several years.  The official rate of GDP is at 6.9 percent, though that number should be taken with a grain of salt.  Nonetheless, a 6.9 percent GDP isn’t quite up to Beijing’s edict.  Something must be done.

Stimulating demand with cheap credit is the expedient policy for central bankers.  This move may even propel government statistics in the direction they want.  But, given that China’s economy has already been stimulated to death, what is it that the People’s Bank of China is trying to achieve?

Beijing’s policies of mass credit creation have enticed the Middle Kingdom’s corporations to borrow gobs of money.  Naturally, how this borrowed money was spent hasn’t always penciled out a return.  In short, borrowed money has been invested in losing enterprises.

Corporate debt in China has run up to $16.1 trillion…or 160 percent of GDP.  This is the largest corporate debt pile in the world.  It’s double that of the United States.  So what good is extending more cheap credit to over indebted corporations?

Consuming Credit at a Loss

The situation Chinese businesses find themselves is the unfavorable place where debts are rising while profits are fading.  Borrowing more money to increase production thus compounds the problem.  Companies can’t make up for profit losses with higher volume.

Making matters more difficult is the economic structure of China.  Namely, the abundance of state-owned enterprises.  These companies are notoriously inefficient.  Still, they’re propped up by the government so they can continue consuming credit at a loss.

In fact, most Chinese bank lending goes to these government companies.  So this new round of monetary easing will not be used to create new jobs and wealth.  It will merely lower the borrowing costs for state-owned enterprises…allowing them to sputter and convulse a bit longer.

The reduction of short-term interest rates may also fuel additional stock market speculation.  Although the Shanghai Composite Index crashed from over 5,000 to about 3,000 between early June and late September, it has since run back up about 400 points.  Perhaps lower rates will reignite the animal spirits of Chinese speculators.

But what good is this, really?  Will higher stock prices somehow improve the economy?  Will they make investors feel wealthier and compel them to spend more money?

Constructive Simplicity for China’s Communist Party Plenum

This week leaders of China’s Communist Party are going to hold hands and collectively bang their heads against the wall in unison.  They call it their plenum.  From what we gather, one of the main purposes of the gathering is to outline a five year plan to scale back the role of the state.

“The next five years will be very important for restructuring the economy,” said Jia Qingguo, associate dean at Peking University.  “The traditional way of managing the economy is meeting more and more obstacles.”

What will Beijing’s brain trust come up with?  Will it involve a step by step process for incrementally withdrawing the state’s influence on the economy?  Will there be metrics and targets?  Will there be contingencies for when targets are missed?  Will there be monthly and quarterly reports with charts and graphs?

Sounds like a giant waste of time as far as we can tell.  From our perspective, simplicity is elegant.  Conversely, complexity is shambolic.

Thus in the spirit of constructive simplicity we offer China’s Communist Party some unsolicited advice…

Take everything you’re currently doing and everything you think you should do going forward and do precisely one thing.  That is, do the exact opposite.

Stop propping up state-owned enterprises.  Stop manipulating the yuan.  Stop stimulating the economy by cutting interest rates.  Stop intervening in the stock market.  Stop promoting construction of ghost cities.

Maybe then China will achieve the economic restructuring it says it wants.

Sincerely,

MN Gordon
for Economic Prism

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