Imagine living in the capital city of a major country, and suffering the level of pollution shown in the above photo on a regular basis. We used the photo in chapter 6 of Boom, Gloom and the New Normal when we highlighted how pollution was inevitably going to move up the political agenda in China. Controversial at the time, it warned:
“Recent growth in China and India has come at a price: Poor air quality, chronic water shortages and deforestation.”
By February 2014, the pressure to act was becoming almost overwhelming as:
“The problems have worsened, to the point where almost everyone now agrees that they are creating a major political problem. The new leadership simply has to solve this, if it wants to remain in office. Beijing and the 6 northern provinces have now been shrouded in smog for 6 days, and on Wednesday the US embassy reported that the levels of PM2.5, the small particles that pose the greatest risk to human health, were “beyond index” at 512.”
Guangdong province, close to Hong Kong, had already moved to clean up. But other provinces did little or nothing, as officials worried about the likely impact on jobs. A major part of the problem was that the economy is the Premier’s responsibility, and Premier Li has been more worried about maintaining growth via stimulus programmes.
This year, however, Xi finally lost patience ahead of next month’s 5-yearly People’s Congress – at which he will be renominated for another 5-year term. Having signed China up to the Paris Agreement on climate change in December 2015, he seized control of the economic agenda, as I noted in the Financial Times:
“Xi knows that reducing pollution, rather than maintaining economic growth, has become key to continued Communist Party rule. The recent rapid elevation of Beijing’s mayor, Cai Qi, to become party chief for the city is further confirmation of the high priority now being given to tackling air pollution and stabilising house prices.
“Taken together, these policies represent a paradigm shift from those put in place 40 years ago by Deng Xiaoping after Mao’s death in 1976. This shift has critically important implications, as it means growth is no longer the main priority of China’s leadership. In turn, this means that stimulus programmes of the type unleashed in 2012, and on a more limited basis by Premier Li last year, are a thing of the past.”
Since then, the Beijing area, and surrounding provinces such as Hebei and Henan, have become a centre of the battle against pollution. One key development has been the use of thousands of drones to spot, and measure air and water pollution, and then identify and photograph the culprits. As state-controlled Xinhua reported last week:
“A total of 599 companies, mainly construction materials, furniture, chemicals, packaging and printing, were relocated out of the capital, said the Beijing municipal commission of development and reform. Beijing also closed 2,543 firms and ordered 2,315 firms to make changes. About 73% had pollution issues.”
Similarly, a senior chemical industry executive told me last week:
“I was in/near Cangzhou the other day (another city on the list) where the government have created a large National Level Economic Zone including a dedicated chemical “park” to accommodate the companies that are being cleared out of Beijing and surrounds. This was an otherwise nondescript flatland whose only previous claim to fame was a Mao era collaboration with then Czechoslovakia to make tractors.”
The war on pollution has another side to it, of course, as it marks the end of the “growth at any cost” economic model.
As a result, realism is finally returning to discussion about China’s real growth potential. As last month’s IMF Report on China noted, GDP growth had only averaged 7.3% over the 5 years to 2016 because of stimulus: without this, growth would have been just 5.3%. As a result, the IMF also highlighted an increasing risk of “a possible sharp decline in growth in the medium term”, as well as a need to boost domestic consumption by reducing savings.
This is a welcome development. Too many companies and analysts have indulged in wishful thinking, wanting to believe China had suddenly become middle-class by Western standards. In reality, as the second chart shows, the growth surge was due to $20tn of stimulus lending via official and shadow banking channels.
At its peak, between 2009 – 2013, this lending reached 3.2x official GDP. And GDP itself was probably also over-stated for internal political reasons, as Communist Party officials were routinely judged for promotion on their success in generating GDP growth. Now the pendulum has swung the other way, as the Caixin business magazine has reported:
“In a document jointly released by the Ministry of Environmental Protection and nine other ministry-level bodies, if a city does not achieve 60% of the emission reduction target, the city’s vice mayor will be held responsible. If the city achieves less than 30% of its target, the mayor will be held responsible; and if the PM2.5 level ends up increasing instead of falling over the winter, the party secretary of the city will be held responsible.
“Possible punishment includes party disciplinary or administrative punishments, the document says.”
Large economies are like super-tankers, they take a long time to change course. As I noted nearly 2 years ago, China is now attempting to move in a radically new direction, away from export-driven growth and infrastructure spending – and towards a New Normal economy based on the mobile internet:
“The winners are developing services-led businesses focused on China’s New Normal markets – such as those aimed at boosting living standards in the poverty-stricken rural areas, or for environmental clean-up. The losers will be those who cling to the hope that more stimulus is just around the corner, and that China’s Old Normal will somehow return.”
Those who have done well under the old regime, like the Party heads focused on job-creation and the opportunities that it created for large-scale corruption, will inevitably fight hard to preserve their way of life. Next month’s Congress will therefore be critical in assessing just how much power Xi will have to pursue his reform policies in his second term.
As I noted a year ago, this Congress will settle key questions. Will Premier Li gain a second term, and continue to be able to obstruct reform? Will anti-corruption tsar Wang maintain his position on the all-powerful Politburo Standing Committee, despite being over the nominal age limit?
The Congress is therefore likely to the most important meeting since 1997, when Jiang Zemin gained re-appointment for his second term as President and led China out of poverty via membership of the World Trade Organisation. Now, as set out in the China 2030 Report (published when Xi became President), Xi has to led China in a new direction.
Otherwise, he will be unable to achieve his twin goals of
□ Making China a “moderately prosperous society” by 2021 (the centenary of the Chinese Communist Party)
□ Making it a “fully developed, rich and powerful nation” by 2049 (the centenary of the People’s Republic), and returned to its historical status as the Middle Kingdom via his ‘One Belt, One Road’ project.
Everyone remembers the old joke, “Why did the elephant wear dark glasses?”, and the answer, “So that she wouldn’t be recognised”. A new version popped into the blog’s mind this week, when finishing its new Research Note on the impact of China’s new policies on the global economy:
“Why did nobody notice that China was the ‘elephant in the room’, in terms of being the main cause of today’s downturn in global demand and financial markets?” Answer: “Because we were all wearing rose-tinted glasses”.
Over the past 5 years, China’s boom has stabilised the global economy. But it was based on the largest debt bubble in history. Lending went from $1tn in 2008 to $10tn last year,
Our rose-tinted glasses make us want to believe that the boom will return, and that the new leadership will soon begin another major lending programme. This was the pattern since 2008, as in Japan’s ‘lost decades’.
But what if we are all wrong?
The blog came to know of President Xi Jinping’s father back in 1987, when helping to lead ICI’s major expansion in the Asia-Pacific region. Xi Zhongxun had then been in charge of Guangdong for almost ten years. He had torn up the Maoist rulebook, and pushed forward with major economic reform, telling his nervous team:
“We have to do this, even if we have to lose our lives.”
Xi Jinping is his son, and grew up whilst his father was being purged under Mao. The blog thus suspects we are missing the key fact: “Like father, Like son”. History suggests instead that Xi Jinping will stay the course. Thus the new Research Note expects his new policies to have 7 major impacts on the global economy:
- Domino effect. US-centric observers have understandably but wrongly assumed that concern over the Federal Reserve’s taper is solely responsible for destabilising emerging economies in a wide arc from Argentina through India and Indonesia to Turkey. Historians, however, will almost certainly recognise these economic tremors as also being an early warning of the policy shift now underway in China
- Double-digit growth. The leadership have already made clear they intend to bulldoze polluting factories, and devote major resource to cleaning up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth are unlikely to ever return
- Deflation. Premier Li confirmed in October that maintaining employment was his key priority. China’s producer price index has been negative for 22 months, and it is likely exports will be a key focus for policy during the transition. This will effectively export deflation – as volume rather than profit will be the priority
- Export Demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, smartphones and relatively high-value chemicals into emerging and Western markets, based on the major new capacity installed in recent years
- Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to begin to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports
- Domestic Demand. Similarly, the focus of China’s domestic demand will change. Sales of high-end western luxury goods will continue to decline as the corruption campaigns continue. Instead, the focus will be on affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/day
- Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings for use at home – potentially putting upward pressure on Western interest rates
The new leadership have spent 2 years preparing for this moment. They know that we are at the end of China’s latest ‘Boom and Bust Cycle’ of the post-Mao period. Like Deng Xiaoping in 1977, and Jiang Zemin in 1993, Xi knows he has to push forward with the plan that has been developed. Once we take off our rose-tinted glasses, we realise the obvious truth – the risks of continuing with the old policies are simply too great.
Xi’s reforms mean major change is underway in China. His policy shifts are already impacting the global economy, directly and indirectly. We cannot know if he will succeed in moving the economy towards a more sustainable future. But the blog hopes this Research Note will help readers to better understand the scale of what is being proposed, and to prepare themselves accordingly.
Please take a moment to download the Research Note, and circulate it to your colleagues and friends for discussion.
Major change is already underway in China, with potentially enormous implications for all of us.
- Corruption is being stamped out via a policy of ‘shock and awe’
- Similarly, wasteful lending is under attack in both the official and the so-called ‘shadow banking’ sectors
- Thirdly, pollution is being tackled by literally ‘sending in the bulldozers‘ to destroy polluting factories under the eyes of TV cameras, and introducing quotas on car sales in the major cities
It is impossible to underestimate the scale of the changes now underway. Just as under Deng and Jiang, they are being led from the top by a new leadership group headed by Xi himself. Its key focus is on the “economy and ecology“, highlighting the economic and political crisis that developed during the “lost decade“.
Equally, as the blog has detailed this week, these challenges clearly mirror those faced by Jiang and Zhu in 1993, and by Deng and Zhao in the post-Mao period after 1977:
Today’s challenge is not to restore order after the chaos of the Gang of Four, or after Tiananmen Square. Instead it is to head off an existential crisis over pollution, coupled with demographic decline. The Party’s main think-tank, China’s Academy of Social Sciences, has thus headlined the “shrinking demographic dividend, overcapacity, choking pollution, risks from the property sector and local government debt“ as key threats to be tackled immediately.
Bankruptcy was the key economic challenge facing Deng in 1977. Whilst as the World Bank noted, the major risk in 1993 was that ”China could have lost economic control and landed in a Latin American-style inflationary spiral”.
This time, as a major World Bank report with China’s National Reform and Development Commission has warned:
“China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the ‘middle-income trap’.”
This comprehensive Report was issued to coincide with the 5-yearly Party conference in March 2012 and highlighted 5 key risks:
“The end of export market growth; wasteful infrastructure investment; the need to boost personal consumption via higher wages (which has the downside of reducing profit margins and job creation); managing the transition to a new economic model; and the threat of hitting ‘the middle income trap’ described by Nobel Prize winner Sir Arthur Lewis”
Xi and Li follow the Deng/Jiang model
In response, it is clear that the new leadership is closely following the successful strategies developed by Deng and Jiang in response to similar crises:
- The return of ‘the man who knows what to do’. Deng was brought back in 1977, having been purged 3 times, because he was the only person who could manage the situation. Similarly he returned a second time with his Southern Tour in Q4 1992 to build Jiang’s powerbase. This time it has been Jiang who returned. He ensured the removal of the corrupt Bo Xilai, and forced through the leadership changes in November 2012 that meant 6 of the 7 current Politburo members are his men
- The immediate assumption of control over the military. The Bo Xilai affair highlighted the risk of military unrest – there were well-reported rumours of tanks moving in Beijing in March 2012. Xi has followed Deng and Jiang in immediately taking control of the Central Military Commission by becoming its chairman
- The use of the World Bank to develop a policy framework. Again, Xi has followed Deng and Jiang in this, with no delay. In fact, the World Bank began work even before Xi formally took power – highlighting his early awareness of the depth of the crisis that China faces
- Focusing on the economic challenge immediately. Deng had premier Zhao Ziyang, and Jiang had premier Zhu Rongji, both entirely focused on the economic issues. Today, Li Keqiang is taking the same role. Equally important is that Xi has followed Deng and Jiang in taking personal leadership of the issue via chairmanship of the new “Leading Group for Overall Reform”. Without his active involvement, reform will inevitably be blocked by those who would lose out as a result
- Willingness to take tough measures. China’s new leadership have 10 years of power ahead of them. Thus they are already sending in the bulldozers to destroy polluting factories over the heads of local government officials. Whilst Xi’s appointee at the central bank, Zhou Xiaochuan, is taking power back from the regulators who have failed to control the shadow banking sector. All this has clear parallels with Deng and Jiang’s ‘no nonsense approach’, and their appreciation that a sense of urgency is critical for success
What does this mean for the outside world?
The years after 1977 and 1993 were stormy periods in China’s history. The period to 2020 is unlikely to be different, and there are no guarantees that the new leadership’s policies will succeed. But it is already possible to identify some of the likely major impacts on the global economy:
- Domino effect. US-centric observers have wrongly assumed that the Federal Reserve’s taper has somehow begun to destabilise Asian economies such as India and Indonesia. They will now have to rush to catch up, as it becomes clear that this is really early warning of China’s massive policy shift
- Double-digit growth. The imperative of political survival means the leadership have to continue to bulldoze polluting factories, and also clean up the one-sixth of China’s farmland currently contaminated with toxic waste. Therefore the days of double-digit economic growth will never return
- Deflation. Premier Li made clear last year that maintaining employment was his key priority. We can therefore expect China to focus on maximising export sales during the transition, effectively exporting deflation – as volume rather than profit will be the priority.
- Export Demand. China’s main export focus will no longer be the cheap textiles and plastic products of the past. Instead it will create jobs via an aggressive drive to sell affordable cars, relatively high-value chemicals and other products into Asian and developing country markets, based on its vast new capacity.
- Dollar strength. China’s economic crisis will come as a shock to most of the financial community, as did the US subprime crisis. We can therefore expect China’s currency to fall in value, and the US$ to rise, all other things being equal. This, of course, will also help to boost China’s exports
- Domestic Demand. Similarly the focus of China’s domestic demand will change. Sales of western luxury goods will continue to decline as the corruption campaigns continue. Instead, the focus will be affordable necessities such as $50 refrigerators for the 90% of the population who earn less than $20/
- Debt. China’s record $1.3tn holding of US debt was built up as a form of vendor finance, to support US purchases of China’s products. But this strategy is no longer relevant, so we may well see China slowly reduce its holdings as it will have more use for the cash at home – putting pressure on Western interest rates
Readers will no doubt have their own insights into the impact of these changes on their own businesses and personal lives. But one thing is very clear. China not only has to go down this path, as we described in chapter 6 of ‘Boom, Gloom and the New Normal’ in November 2011. But its leaders now clearly recognise that they have to change policy with great urgency.
The blog always feared that the recent boom would turn out to be another of the ‘boom and bust’ cycles that have characterised the post-Mao period. No sane person would ever want to go back to the days of the Great Leap forward and the Cultural Revolution. It therefore hopes that Xi and Li will not only manage to overcome the current crisis, but also succeed in establishing a more sustainable future for the country.
President Jiang Zemin inherited a difficult economic and political situation when taking power in 1993, as did Deng in 1977 and current president Xi last year. Jiang had to set in motion China’s second economic cycle of the post-Mao era, or risk seeing the country fall back into poverty and the political turmoil of another Cultural Revolution.
Similarly today, as the Financial Times warns:
“Former President Hu Jintao and Premier Wen Jiabao ruled China from 2002 until late 2012 …and have been accused by powerful Party figures of overseeing a “lost decade” of missed opportunities to put the country on a more sustainable path. Time is running out for the old Chinese model, based as it is on credit-fuelled property and infrastructure investment, and highly polluting low-cost manufacturing.”
If Xi does not move today, he will lose all the momentum that he has painstakingly built up over the past year. Essentially, it is ‘now or never’ for Xi and Li to act. The playbook they have followed till now is modelled on that developed earlier by Deng and Jiang, suggesting they understand what they have to do.
1993 – 2012, Jiang Zemin’s era, and its aftermath
Jiang took over as president from Yang Shangkun in 1993, having been General Secretary of the Chinese Communist Party since 1989. Like Deng, he was not impressed by ideas of democracy or political liberalisation.
His first move, after appointing Deng’s protégé Zhu Rongji as central bank governor, was to follow Deng’s 1980 policy initiative and call in the World Bank for advice. The reason was simple, as Zhu said when welcoming the World Bank team, “Foreign monks know more than local monks“.
This Dalian conference of June 1993 set out the economic programme to be adopted, with the aim of bringing China back from the abyss, and formalising Deng’s earlier dictum of the ‘socialist market economy’. The aim was simple – to keep the Communist Party in power by providing the population with increasing living standards.
Jiang inherited a number of major economic problems, as the opening up of the economy had provided wonderful opportunities for corruption to flourish. The privileges of the Special Economic Zones such as Shenzhen were being increasingly abused by corrupt leaders able to buy products and services at advantageous prices for their own personal profit. Economic disaster, in turn, was leading Party hardliners to demand a return to the ‘old ways’.
Zhu’s first objective was to resolve the enormous debts that had been built up by the powerful State Owned Enterprises as a side effect of the economic liberalisation. At the same time, he implemented extremely tight policies to bring China’s chaotic financial markets back under control. Asset prices had been allowed to rise out of control whilst corruption had flourished.
His policies led to a decade where China achieved double-digit economic growth, whilst tackling major problems of bad loans in the banking system and rising unemployment. Jiang/Zhu maintained Deng’s control over the army and his focus on raising living standards and personal consumption, and aimed to tackle the power of the SOEs via large-scale privatisations.
Equally, Deng’s policy of opening to the outside world was maintained. This encouraged the emergence of a strong export sector, which helped to support the economy through the Asian financial crisis and led finally to China’s entry into the World Trade Organisation in 2001.
The ‘Lost Decade’ under Hu and Wen from 2003-2013
However, just as with Deng’s period, these early successes were not maintained once Jiang and Zhu left power in 2003. New president Hu and premier Wen instead focused on the easy option of developing China’s role, post-WTO entry, of being the ‘manufacturing capital of the world’. The SOEs were able to regain powerful positions in major industry sectors, whilst corruption again flourished.
Then in 2008, just as in 1989, crisis intervened. Once again it was both economic and political in nature. The global financial Crisis sharply exposed China’s economic dependence on export orders, as personal consumption had actually declined since 2000 as a proportion of the economy. And so when orders disappeared in Q4 2008, 26 million people lost their jobs. Hu and Wen thus felt driven to replace this lost growth with a massive lending stimulus, as shown in the above chart.
It is fair to say that no country in history has ever undertaken such a policy on such a scale:
- Official lending doubled from $719bn (Rmb 4.9tn) in 2008 to $1.5tn in 2013 (blue column). In addition, as the blog will discuss tomorrow, the banks were allowed to develop an unregulated shadow banking system that has been lending as much, or maybe more, than the official system
- This temporarily rescued economic growth. Electricity consumption (red line) jumped an unprecedented 50% between 2009 and 2013. But the price was a massive increase in pollution, as factories and coal mines were allowed to cut costs by emitting toxic fumes
- The lending also stimulated another boom in asset prices. Jiang/Zhu had opened up the urban property market in 1998. From 2008, easy lending policies led to major speculation, with prices rising almost exponentially as buyers panicked over being left behind
- Auto sales also took off, adding more risk to the financial system, as well as more pollution in the cities. They have grown so fast, and in such an unconstrained way, that traffic jams are now an endemic part of almost any journey. Whilst pedestrians and cyclists now routinely wear masks in the major cities during days of heavy pollution
Now, as in 1977 and 1993, it looks as though the new leadership will have to pick up the pieces. As the blog described in November 2012, it is clear that the return of Jiang to a more active role was the prime cause of the changes that are now underway. The attack on corruption is a carbon copy of his earlier policy, as was the decision to bring in the World Bank for policy advice. Clearly, too, the trial of such a prominent and well-connected figure such as Bo Xilai could never have taken place without Jiang’s support.
Tomorrow’s post will therefore draw out these parallels, with the aim of highlighting the key developments that we should expect the new leadership to implement with speed. It will be a very bumpy ride, but Xi and Li know that the alternative of ‘kicking the can down the road’ would risk leading to disaster.
China’s economic policy has gone through 2 complete cycles since Chairman Mao’s death is 1976. Under new president Xi, it now seems to be about to start a 3rd cycle. If this cycle follows the pattern of the previous cycles, it will have very major implications for anyone doing business with China, either directly or indirectly.
As yesterday’s post discussed, China’s lending programme since 2009 has been the largest in the world, at least $9.7tn – more than twice the US Federal Reserve’s. It now has to be substantially reduced, to avoid economic and political crisis. No country has ever been in this position before. But we do know what happened in China’s 2 previous economic and political crises, and these provide clear insight into how the new leadership will operate.
Today’s post looks in detail at the first cycle, which ended with very similar problems to today’s.
1977 – 1992, Deng Xiaoping’s return, and its aftermath
Deng returned after the death of Chairman Mao in 1976, following his 3rd purging. His first task was to deal with the chaos caused by the failed bid for power by Mao’s widow and the Gang of Four. As the photo shows, Beijing was then a very backward city. Deng, who had not travelled outside China since the 1920s, was astonished to find on visiting Japan and Europe/USA that China was decades behind them in technology and living standards. He moved quickly to improve the position, but faced entrenched resistance from those who believed that ‘combating bourgeois liberalism’ via political correctness, not ability, should remain the main criteria for official appointments.
Deng set about opening up the economy during his time as paramount leader – with president Xi’s father, Xi Zhongxun, playing a leading role in the transformation of Guangdong’s economy. Equally, he developed a close working relationship with the World Bank under Robert McNamara. This led the Bank to despatch a team of 30 experts in 1980 for a 3 month study period, to develop recommendations on how to rebuild China’s economy. This was the first time the World Bank had ever undertaken such a programme. Its purpose was described by Deng as follows:
“We are very poor. We have lost touch with the world. We need the World Bank to catch up. We can do it without you, but we can do it quicker and better with you.”
Major reform followed as Deng set out what became known as the philosophy of the ‘socialist market economy’, or ‘socialism with Chinese characteristics’. At the same time, Deng took bold steps in relation to the army, cutting its budget and manpower dramatically so as to free up cash to invest in the broader economy and boost living standards. As a former army general, he could see that the prospect of invasion, so feared by Mao, had become most unlikely, and he was able to push through his changes despite strong opposition.
Deng began to set his retirement in motion around 1985, introducing the important reform of a maximum of 10-year terms of office for the senior leadership – a policy which still continues. But the collapse of the Soviet Union, and the Tiananmen Square protests in 1989, brought him back into a more active role. Hardliners in the government saw a chance to reverse Deng’s economic reforms, whilst clamping down on political protest. This prompted Deng to argue instead that the Russian Communist Party had lost power due to ‘too much glasnost (openness) and not enough perestroika (economic reform)”.
This led him to the final act of his career, the famous Southern Tour of 1992, when he summarised his views on economic development in two phrases:
- “To get rich is glorious”
- “It doesn’t matter if the cat is black or white, as long as it catches mice’
The tour was at first unreported in official media, but as the blog will discuss tomorrow, new president Jiang Zemin was then able to consolidate his position on the basis of continuing Deng’s policies of economic reform. At the same time, he kept a tight lid on political protests which risked destabilising Communist Party rule.
The years from 1985-92 were thus a period of considerable uncertainty for the future direction of economic policy.
Deng’s reforms had led to major gains in living standards. But the privileges of the Special Economic Zones such as Shenzhen were being increasingly abused by corrupt leaders able to buy products and services at advantageous prices for their own personal profit.
Equally, economic disaster was leading Party hardliners to demand a return to the ‘old ways’. The political turmoil of 1989 had provided the perfect excuse for those who had never supported reform. They demanded that the reforms should be reversed, on the basis that otherwise Communist Party rule was threatened.
As the World Bank noted afterwards:
“China could have lost economic control and landed in a Latin American-style inflationary spiral. If that had happened, the reform process would have halted and China might not have been able to avoid a financial crisis.”
Tomorrow’s post will look at how Jiang adopted Deng’s playbook from 1977, and managed to create the springboard for China to embark on double-digit economic growth.
Imagine for a moment that you had become president or premier of China following the leadership transition in March. You know that the country’s economic model has to change. But you also know that you have to carefully develop your powerbase, whilst also putting in place new policies.
Probably you would take things cautiously at first, particularly as you have a major economic policy conference due in November. You would take charge of as many power centres as possible, as quickly as possible, including the army. And you would make sure the conference voted unanimously for your reforms.
This indeed seems to be the playbook that president Xi and premier Li have followed. Now comes the hard part, making the necessary reforms. And Li has already given a vivid description of their likely impact to warn people:
“This self-imposed revolution would even feel like cutting your own wrists”
Plus we also have as guidance the famous phrase from Xi’s father in 1978, when he set about reforming the Chinese system under Deng after Mao’s death:
“To develop, we have to change. We have to do it even if we have to lose our lives. Comrades, let us work hard”.
The chart above shows one of the major changes they have to achieve. The key issue is the way China has become totally dependent on bank lending to boost its economy since the boom years began in 1999. As the People’s Bank of China noted as long ago as March 2009:
“By the end of 2007, outstanding consumer loans reached RMB 3.28tn ($480bn), an increase of RMB 3.14tn over the level at the end of 1999, representing an average year-on-year growth rate of 48% over the period. Meanwhile, as corporate direct financing gained in importance and household incomes rose, consumer loans became an increasingly important asset class”
But this was nothing compared to the lending bubble inflated after the financial Crisis of Q4 2008. A panic-stricken leadership increased total bank lending by 148% in 2009, as it tried to preserve jobs whilst faced with the loss of Western export markets. And although lending slowed again between 2010-11 as Western central banks went on their own lending binge, it then rose again as the leadership transition took place between Q2 2012-Q3 2013.
The chart highlights how auto sales (y-axis) have thus become dependent on bank lending (x-axis) since 2008:
- Lending and auto sales were still under relatively tight control in 2008 (purple)
- They then both exploded in 2009 (blue), with auto sales up 49%
- Auto sales continued to rise in 2010, before slowing in 2011/early 2012 (black) as lending slowed
- But 2013 then saw a further 17% auto sales rise, following the 18% rise in lending in 2012 (green)
Now it looks as though Xi and Li have decided to put the rhetoric into action. The Bank of China has doubled short-term interest rates to 9% over the past week, whilst the Bank’s head has made it clear this is no accident:
“Zhou Xiaochuan, the head of China’s central bank, has on various occasions reminded the financial sector about the importance of serving the real economy rather than becoming an isolated money churning machine pumping up a virtual economy.”
Nobody outside the leadership knows what they plan to do next. But the 1993 leadership transition may provide some clues. Property prices dropped 40% in a year, as president Jiang Zemin and premier Zhu Rongji initiated a major credit crackdown to curb speculation. Auto loans didn’t matter then. But if the same squeeze happens now, they would also be an obvious target for major lending cutbacks.
Companies can’t claim this would be a surprise, as they have had nearly 2 years since March 2012 to prepare themselves for a repeat performance. And something major may well be about to happen, as president Xi has recently undertaken an urgent round of briefing foreign leaders – something quite unprecedented in recent times.
In their place, would you do anything different?