China’s financial markets seem to be signaling trouble, as a government crackdown on corruption and loose credit begins to bite and jittery local investors scramble for safety.
China remains an opaque country, and even the most knowledgeable experts say they aren’t sure how to read the tea leaves. But the warning signs are growing that, after decades of economic expansion and exploding wealth, China is moving toward the scary side of the perpetual seesaw between greed and fear that drives financial markets.
An early warning that China might be facing a liquidity squeeze came from Patrick Chovanec, chief strategist of Silvercrest Asset Management, at a conference I attended in Shanghai in February. In a subsequent report, he explained that “a steady stream of defaults has raised awareness of China’s mounting bad debt problems” and that “China’s existing growth model has reached its sell-by date.”
Signs of trouble abound: A report last week by the China Index Academy noted that real estate sales during the first quarter of this year in China’s four biggest cities were more than 40 percent below the levels of a year ago. To sell property and raise cash, developers are said to be cutting prices sharply in some smaller cities. According to Anne Stevenson-Yang, a Beijing economist who blogs for the Financial Times, 40 percent price cuts have been offered by developers in Changzhou and Qinhuangdao, and developers in Ningbo, Wuxi and Suzhou have offered discounts of up to 40 percent.
The slowdown in China’s super-hot property market appears to be part of a broader pattern of difficulty. In mid-March, a big developer in Zhejiang province defaulted on $600 million in loans, according to the Wall Street Journal; a few days later, a commercial bank in Jiangsu province was hit with a run by skittish depositors. Investors’ nerves were frayed partly because China had suffered its first modern bond default in early March, when a solar energy company in Shanghai failed to make scheduled payments.
The cascade of bad news in the Chinese construction and commodities sectors has been chronicled by a recent Journal series on “China’s Rising Risks.” Reporters explained how pell-mell borrowing by private Chinese companies — corporate debt issues nearly doubled from 2011 to 2013 — hit a wall this year. A cement maker in Zhejiang canceled a $161 million offering in March; a plastic maker had to withdraw a smaller offering; an aluminum maker’s bonds were put on a watch list because of losses; trading in the bonds of a power-equipment maker was suspended.
During China’s seemingly perpetual boom, such reversals rarely happened. It was assumed that the government would intervene to supply liquidity and control the credit boom that was fueling the country’s astonishing economic rise. According to a recent report by the Emerging Advisors Group, the overall stock of domestic private credit, including the shadowy non-bank lending market, grew from 125 percent of GDP in 2008 to 190 percent at the end of last year. The authorities periodically tried to cool the economy and its “irrational exuberance,” but without much success.
What’s different now is partly that Xi Jinping and Li Keqiang, the new Chinese president and prime minister, respectively, seem to mean business about puncturing the bubble economy. Stevenson-Yang quotes a 2013 warning from Li that reforming China’s banks would be like “disarming land mines,” because they had made so many questionable loans.
Despite the risks of contraction, the government has pressed ahead — squeezing not just the banks but also the corrupt deals fueled by their loans. The most spectacular dragnet yet was reported March 30 by Reuters, which said authorities had seized assets worth $14.5 billion from family members and cronies of Zhou Yongkang, the former chief of domestic security. According to the news agency, more than 300 of Zhou’s relatives, allies and staff have been arrested or questioned.
This crackdown is a laudable attempt to deal with the culture of greed that has accompanied the Chinese boom. But it appears to be triggering panicky behavior by some of China’s new rich, who are rushing to sell assets in a market where cash is suddenly scarce, continuing a process of capital flight that Chovanec estimates has totaled $250 billion annually in recent years.
The Chinese government has an amazingly good record of managing macroeconomic policy. But as economist Herbert Stein said many years ago, in connection with U.S. trade deficits, “If something cannot go on forever, it will stop.” The China question is how sudden and hard the stop will be.