The consensus on Wall Street is that looking at China’s gross domestic product to understand its growth rate doesn’t work.
That’s because investors have noticed that no matter what happens, the government’s projections on the first day of the year always seem to come true.
Exports can tank (as they did in July), the property market can slow (as it has all year), manufacturing output can look dismal (also a recent theme), but no matter what, the government insists the country is still growing at 7% GDP.
So what do China investors look at to figure out how the country is doing?
Jim Chanos, founder of the short hedge fund Kynikos Associates, has been bearish on China for years. At a China Institute discussion in New York City, he explained what he looked at while investing.
“China is still a debt-driven, some say addicted, society,” he told the crowd.
In other words, Chanos believes this is a story about an explosion in credit.
So he and his associates look at China’s banking system for direction. They look at loan growth, capital adequacy, and credit expansion and/or contraction.
By his estimation, in 2001 China’s GDP was roughly $1 trillion. Bank loans were also $1 trillion, with $400 million of those loans nonperforming.
Now China is an $11 trillion economy with $30 trillion in loans with 1% to 2% of those loans nonperforming, he said. Dangerous stuff.
Loan growth is continuing, even during this time of economic duress. The percentage of nonperforming loans has been growing as a result.
If you are looking at what he is looking at, it is ugly.
Back in 2011, China came up with a data point to wrap up a lot of what Chanos looks at. It’s called total social financing (TSF). The measure is supposed to calculate the fundraising going on all over the country, including banks and corporations.
China’s central bank describes it as “a money-added concept, indicating total fundsthe real economy obtained from the financial system over acertain period of time.”
Chanos describes it as “the most underappreciated number in global finance.”
It includes Chinese bank loans in yuan, foreign-currency loans, bank-acceptance bills, corporate bonds and non-financial-institution equity sales. It’s basically the debt everyone is racking up including, ideally, what’s going on in the world of shadow banking.
Here’s what that looks like:
- Morgan Stanley
In June and July, total social financing expanded faster than Wall Street analysts expected. Part of that was due to the government’s coming to the rescue of the stock market. New loans surged, almost hitting the level they were at when China flooded the economy with cash during the 2009 financial crisis.
In August, new loan issuance slowed as the stock market rescue came to an end, but TSF still grew to 1.08 trillion yuan ($169 billion) for the month from 718.8 billion yuan in July.
Depending how you look at it, this is good (because it keeps money flowing through the economy during a slowdown) or bad (because it’s adding debt to the economy during a slowdown).
Take your pick.
How this gets ugly
China’s “new normal” plan to move the economy from one based on investment to one based on domestic consumption has not been going as planned. The economy is slowing down faster than anyone expected.
Part of that is because of debt. State-owned enterprises are so busy paying it back and keeping people employed that they’re not focusing on productivity. This is how you get zombie companies.
So part of the new-normal plan is to restructure these companies, but the government didn’t want to do that through loans because there was already so much debt on the books. That’s why it encouraged Chinese people to get into the stock market – so companies could be capitalized during their transition.
Of course, that didn’t work. The stock market crashed in both June and August.
So China will have to find another way. One that most likely means more debt issuance and more easing to keep money flowing through the economy. We’ve already seen some of that, as China’s central bank, the People’s Bank of China, has cut rates four times this year already.
The question, though, is whether these loans will be productive. An economic slowdown doesn’t help – it means people will have trouble paying back loans. Banks are already starting to feel that.
Plus, as Societe Generale analyst Wei Yao points out, Augusts’ TSF data doesn’t really give you the whole picture of how much debt is being taken on, because it didn’t include a bond swap with local governments to the tune of 415 billion yuan (around $65 billion).
That swap still didn’t spur productive economic growth. August was an ugly month for data across the board.
“The unpleasant implication is that even the most effective growth stabilizer of loan-backed infrastructure stimulus has not yet gained enough traction,” Yao said in a recent note. “The only solution is to do more infrastructure investment, which we expect.”
These infrastructure projects could be productive. China, however, has a history of building things it doesn’t need.
“They’ll put a smoke belching factory in the middle of a city,” Goldman Sachs CEO Lloyd Blankfein said in an interview last week. “In China, when they want to pump up their economy … they build 82 airports.”
Of course, he added, 30 of those airports would be in the wrong place.
And that means the country is just adding to its massive pile of debt with loans that may never be paid back.