Slower loan growth does not necessarily equal lower FAI
By Michael Pettis
Does the market believe the declared loan tightening measures? After the announcement Saturday afternoon that the PBoC was raising the reserve ratio 1% to 14.5%, Shanghai opened down Monday (my assistant told me that it opened more than 1% down, but I am not smart enough to get the intra-day info off the SSE website) but quickly recovered, and then kept moving up to close the day nearly 1.4% in the black. Just another uneventful day, I guess.
As I said in yesterday’s entry, I am not too optimistic that the renewed determination to limit credit growth is going to be very useful.A serious attempt to reverse the monetary excess of previous years and to wring out inflationary expectations is going to require, like it or not, a real reduction in the rate of economic growth.That means a reduction in the rate of employment growth, too, and with unemployment edging up even with the ferocious growth we have seen in the past three years, that translates into rising unemployment, likely to be worse among the young. I am not sure whether the senior leaders really have that much appetite for an increase in unemployment, especially in an Olympics year.
In an Op Ed piece I wrote for today’s Asian Wall Street Journal (“Cooling China”, see entry below) I said:
Caps on loan growth have failed before, thanks to lax enforcement, although most reports suggest that this time authorities are far more determined. Whether that is likely to happen during the run-up to the Olympics remains to be seen, but there is reason to believe that even if the authorities were successful, loan caps would have only a minimum impact on moderating underlying conditions. The measure would only force excess monetary expansion into other conduits for funding rapid economic growth.
Several people have asked me what I meant by saying that the new measures “would only force excess monetary excess monetary expansion into other conduits”.
The Chinese economy is a very large, very complex system with many moving parts, huge inefficiencies, and different ways of doing things, and given the furious expansion that has taken place in a system chock-full of regulators, bureaucrats, restrictions, rule changes, and conflicting directives, it should be no surprise that one of the great strengths of Chinese businessmen is that they have learned to be very flexible and to find ways around the thousands of irritations that buffet them on a daily basis.
This entails a huge diversion of resources to non-productive uses, and since the goal of much of this activity is to get around stultifying government-imposed restrictions, not surprisingly it also complicates the attempt by the central government to impose discipline on the economy. If there is a ferocious demand for capital by rapidly expanding companies, and a huge supply of capital caused by the lack of a domestic monetary policy, successful attempts to interrupt the ability of commercial banks to intermediate the process might simply reduce the importance of banks as intermediators.In today’s Financial Times Henny Sender (“China Loan Curb Hits Businesses”) shows one way how this might happen::
…Working capital has become a problem for many businesses in China as, worried about the possibility of an overheating economy, the government in Beijing has tightened controls on bank lending.
…In response, many companies are finding ways to circumvent the measures.
…In a complicated game of cat and mouse, as regulators try to close down loopholes, borrowers and intermediaries seek to locate others in their search for funds. For example, leasing companies have escaped the clampdown on lending. So if a company is unable to finance the purchase of equipment from the banks, it can turn to leasing companies instead.
…The cash crunch is particularly dire for smaller and private companies because Chinese banks favour their larger, state-owned clients. So when the bankers have to cut back credit lines to meet Beijing’s rigid new quotas, they first turn towards what amounts to the bottom of the corporate food chain.
I suspect that if the credit growth capping measures are successful, we are going to see a growth in financial “ingenuity”.Informal banks and “non-bank” banks (as we used to call them when I was in business school) will increase their activity, and even the bond market will help take up the slack.
Not to end this on a note of pessimism, I see that one English newspaper is speculating that the Blackstone Group, perhaps with the help of the CIC or other Chinese institutions, may be preparing for a bid on Rio Tinto (which would involve at least $150 billion).Encouraging outward expansion creates its own set of problems for the Chinese economy, but it does have one great advantage (besides the obvious one of heating up the market for China-based investment bankers just when I am thinking of returning to the market) – it does reduce the pressure on domestic monetary expansion. But unless outward investments mushroom to frightening levels, none of this will really matter to overheating until the currency is fixed.
I envy the students of economics today. They can actually see economic problems and the actions to try to cure them in action and in failure rapidly so you can actually cover a large portion of macroeconomics in one year with real examples.
Back in the bad old days, it takes many years to see all these tools deployed. Now you can see all these measures firing at rapid succession.
By L. F. Flaherty - 12/10/2007 12:49 AM
I am sure this is old news to the pros watching, but there is also the fact that Chinese bad debts are all yuan denominated, and the Chinese do not want the bad debts to appreciate. Consistent governmental rejection of yuan appreciation, in that light, can be seen as more evidence that the true scope of bad debts in the Chinese economy is vastly disproportionate to what the market seems to believe.
Yuan appreciation would effect the 1997 Asian financial crisis in reverse--in Thailand and S Korea, dollar denominated bad debts to foreigners were the problem, and currency depreciation caused those debts to balloon relative to the domestic pie, which had shrunk in world currency terms.
In China's case, yuan denominated debt is the problem, and a yuan revaluation would cause the value of those debts to explode relative to China's accumulated FX deposits, even as all other currencies (dollar/euro) would *lose* value, at least temporarily, while the yuan assumes its 'fair market value' at the expense of all other currencies. The FX reserves are China's only real insurance against a run on the banking system, and they would depreciate further even as the relative mass of Chinese interbank and intercorporate liabilities would explode. Therefore it can't be allowed to happen. All China can do is hope that dumb foreign money picks up as much slack as possible.
In the meantime, Chinese authorities are not going to seriously consider a yuan revaluation of the magnitude necessary to quench inflation, because they is not able to do so politically or economically. I do not think it's much of a coincidence that bank reserve requirements are at their highest since 1987. That marked the commencement of two years of a run on the banks and inflation, resulting in regime-quaking unrest.
Just a dumb thought as E. Cartman mentioned the bad-debt in Chinese banking system. It is a good time now to let banks write off their hiding bad debt now, isn't it? Although it sounds un-market economic, it seems that this move can temporarily clean the banking system, and take some liquility out of system.
I don't think this is a major issue. True the liabilities of the banks are yuan-denominated, but so are the assets, so appreciating the yuan has no effect on the banking system bad loans issue (which I think is yesterday's problem, and not a major issue at this point).
E. Cartman: The FX reserves are China's only real insurance against a run on the banking system, and they would depreciate further even as the relative mass of Chinese interbank and intercorporate liabilities would explode.
Actually they aren't. The insurance against a run is ultimately the Chinese governments power to tax. The other thing is that the big banks are extremely liquid and have enough reserves to handle any sort of deposit shock. (Smaller joint stock commercial banks do less well.)
That's the main reason that Chinese banks didn't fall apart in the first place. They had a matched liquidity and currency structure, so they could avoid a run while being insolvent. Last time I checked, most deposits in the big banks were corporate deposits from SOE's who can be ordered not to withdraw. Household deposits are matched with government bonds which could be sold back to the government and cash. Again, this is for the big banks. Joint stock commercial banks are a completely different story.
Also, we are light years away from 1987. The big problem in 1987 was that you had a centrally planned economy with low fixed prices and wages next to a market economy with higher variable prices. Prices are much more variable and can absorb shocks much more than they could in 1987. Also in 1987, the government still issued most production targets for state-owned enterprises, which meant that monetary policy was totally ineffective.
Also the movement of borrowing from banks to non-banks doesn't defeat the purpose of the tightening. An SOE who goes to a quasi-bank for a loan is going to be paying higher (and in most cases much higher) interest, so a moving loans out of the banking system will cause monetary tightening.
One other thing is that I think we do have a disagreement over what caused the flash of inflation. My current theory is that the relationship between inflation and monetary policy is that for several years, China was able to deal with massive foreign reserves by exporting that money back to the United States in the form of mortgage loans. In June, that channel got blocked (see Brad Sester's blog for some dramatic numbers) and somehow this is creating inflation.
What I think might be happening is that dollars that would have made it back to the United States are now staying in China, and that is causing monetary expansion.
I don't think banks have that much bad debt, and there are some major misunderstanding about where the bad debt problem came from. Until the 1990's, state owned companies were responsible to providing social services to their employees (housing, health care, social services). These social obligations were killing state-owned enterprise profits and to pay for these services, the SOE's turned to the banks which provided loans to provide welfare benefits to workers that the government could not.
There reason that this is not a problem anymore is that social services are now being paid for by government borrowing and taxes rather than bank loans.
There is a possible problem with the smaller joint stock commercial banks, because their loans come from real estate lending, and if that breaks then you will have your classic bad bank problem.
When people say that "bad debts are a problem," they mean that "bad debts are a problem relative to Chinese banks' capital reserves and assets." The CCP's $1.5trn pile of dollars is a huge implicit asset for Chinese financial institutions regardless of what the legalese says. When I have talked to anybody about my bearish concerns about China, the discussion always stops at, "Well, you've got to remember that China has 'so much money sitting there' that there's no way even a big default could cause a financial collapse..."
I think it is fair to say that Chinese forex reserves are a major confidence booster for all kinds of domestic transactions as well as foreign investors, even if the reserves are not "insurance" for Chinese banks in a technical/legalistic sense. Much as American "government sponsored enterprises" are able to secure much lower market rates because they have the implicit backing of the US Treasury.
In that sense, Chinese banks across the spectrum have a huge dollar-denominated asset, whereas their liabilities are all yuan. So on net, whether the liabilities are focused more on the joint-stock shops or the Big 4 (the CIC bailout suggested a lot of problems within the big banks), the fact of the matter is that the Chinese banking sector as a whole does not want to see upward yuan revaluation. I do not see how Beijing's tax power has any more muscle now than it did in 1987, when it was clearly insufficient. The provinces call most of the day to day economic shots, and when they are collectively in trouble, Beijing will not be able to afford to bail them out.
I think you are probably right that the Chinese government has no interest in subsidizing US debt in the future, making it much more difficult to recycle trade surpluses back into the US economy. However, there has not been a jump in Chinese economic indicators commensurate with the apparent dropoff of foreign investment in August.
I think that inflation is rising much faster than official government statistics would indicate. Beijing has been in denial about food prices for a long time and has not adjusted their price basket to reflect changes in food prices. Price caps on all kinds of food and fuel commodities have not reflected recent changes in market prices, which is why lines have gotten longer and why we have seen occasional instances in which people have killed individuals trying to "jump the queue."
I see no reason why Beijing's rosy bad-debt numbers should be trusted. Bad debt doesn't just go away because Beijing says it does. Why do you think the CIC has designated at least 65% of its money for repaying bad debts?
I would be very interested in Prof. Pettis' take on the composition of bad debts in China, if it's politically permissible. The Chinese government says it has gone down to 13% or so of GDP, but every independent estimate I have seen has been north of 35% of GDP, and personally I believe it is in the 50-65% range, and getting worse every day that the yuan creeps up.
Cartman: In that sense, Chinese banks across the spectrum have a huge dollar-denominated asset, whereas their liabilities are all yuan.
No they don't. One of the tricky parts of banking reform was to arrange things so that the commercial banks didn't get the impression that they could run off to Uncle every time something went bad. The many assets that the banks have are the loans that they hold, and the government has been very careful about dipping into the foreign exchange pool to recapitalize the banks.
Cartman: I see no reason why Beijing's rosy bad-debt numbers should be trusted. Bad debt doesn't just go away because Beijing says it does.
The two reasons are that the books have been audited by big four accounting firms, and several major US banks have considered three of the four banks a good enough deal to put there cash on the table.
Also, if you run the numbers, all of the bad debt is accounted for. The pre-1997 bad debt is still there, but it's been transferred to the asset management companies, and there it has been paid down.
Cartman: Why do you think the CIC has designated at least 65% of its money for repaying bad debts?
That's not the number. CIC is funded with US$200 billion in RMB bonds. Of this about US$65 billion will be used to buy Central Huijin from the finance ministry. Another US$20 billion will be used to recapitalize Agricultural Bank of China, and some unspecified sum will be used to buy out China Development Bank.
Cartman: Why do you think the CIC has designated at least 65% of its money for repaying bad debts?
Details matter. The problem here is that when people summarize things they miss important details. Of the money that CIC is planning on spending, only about US$20 billion would considered a bailout, and the problem with Agricultural Bank of China has been known for years.
The big banking problems aren't with the state banks, they are with the rural credit cooperatives and the joint stock cooperative banks.
Cartman: The Chinese government says it has gone down to 13% or so of GDP, but every independent estimate I have seen has been north of 35% of GDP, and personally I believe it is in the 50-65% range, and getting worse every day that the yuan creeps up.
What reason do you have do believe this? If you can quote actually numbers to get a value, we can discuss that. The trouble with these discussions is that people take a number like 35% figure it is an underestimate because obviously the Chinese government is lying, and so the number becomes 50%. The trouble then is that people then take 50% and then figure that the Chinese government is lying and the number becomes 70%, and so on and so on and so on.
It's also important to talk about *which number*. You could be talking about:
1) the fraction of bad debt to total loans for three of the four state banks 2) the fraction of bad debt to total loans for all four state banks 3) the fraction of bad debt to total loans for all the state banks plus the asset management companies 4) the fraction of bad debt to total loans for the entire banking system include rural credit cooperatives and joint stock cooperative banks 5) the estimated fraction of bad debt in the JSCB's if the real estate bubble goes bad 6) the fraction of bad debt in (the big 3, the big 4, the big 4+JSCB's, the big 4+JSCB's+RCC's) to total GDP 7) the fraction of total debt to GDP 8) the fraction assuming bad things happen
So when you quote that 13% number, what number are you quoting...
If you are going to fight inflation and overheating, FX reserve will not help you much. However, when you are dealing with recessions, FX reserve will become handy then.
Correct me if I am wrong here, CIC only bails out the last bank in big 4 and another one. It just takes the stakes in other three in big 4. It sounds to me more like a political decision.
I still think this inflation is mainly derived from outside world, especially energy and agri. Now raw mats and mining add to it. It looks like sprillover effect to me. The M2 number in Nov. is troublesome. Is the 18% the year-to-year growth rate? If not, there might be other explanation. One of my friends in bank once told me that the bank tends to promote or push to increase the deposit rate near the end of year. This is usually a temporary phenomenon. So if this seasonality is consistent every year, it is not a big deal.
By fatbrick - 12/10/2007 7:44 AM
Also what the Chinese government did between 1998-2001 was to turn a lot of the bad state owned enterprise debt into good government debt. Bad debt becomes good debt if you find someone willing to pay for it.
Normally this would be considered a bad bailout, but in the case of China it was acceptable because the government simply started assumed social welfare liabilities that was its responsibility anyone.
I don't think that anyone really thinks that the pre-1998 debt is a problem. The worry is that banks have been accumulating new bad debt in the form of real estate loans. The danger in all of this is that you spend your time worrying about the wrong thing. Part of what has happened is that the PRC has been so worried about another massive run like the Asian Crisis, that it has ended up creating a system that produces a different problem.
fatbrick: Correct me if I am wrong here, CIC only bails out the last bank in big 4 and another one. It just takes the stakes in other three in big 4. It sounds to me more like a political decision.
The other three banks have already been bailed out. Agricultural Bank of China has special problems because rural incomes are stagnant so it doesn't have a depositor base or good loans. China Development Bank has some interesting political ramifications that I'm trying to think through. Basically CDB was originally intended to be China's policy bank, but someone among the powers that be has decided to convert it into a commercial bank.
Twofish: I can't respond to every one of your points, but as far as your "Big Four audits" are concerned, Ernst&Young, Fitch, and McKinsey all examined the Chinese debt situation in 2006. Ernst and Young came out with a report stating that China's bad debt totaled over $900 billion in 2006, although Beijing browbeat them into withdrawing it because it embarrassed Beijing. I have seen higher, credible, estimates than that.
I presume that the E&Y number was their best estimate of your number (6). "Aggregate bad debt as a percentage of GDP by all credit originators."
Was there any increase in Beijing's liabilities as a % of GDP, when they "turned the bad debt into good debt" and assumed so many of the SOE liabilities?
E. Cartman: Ernst and Young came out with a report stating that China's bad debt totaled over $900 billion in 2006, although Beijing browbeat them into withdrawing it because it embarrassed Beijing.
I blogged about the E&Y report when it came out. It was a piece of marketing literature which was embarassing because they added $300 billion twice. I can cite the exact page and column where they did that. Fitch came up with $500 billion, of which $200 billion was in the state banks, $150 billion was in the rural credit cooperatives, and $150 billion was possible losses due to future bad loans.
E&Y had to withdraw the report because 1) it (deservedly) made E&Y look like total idiots and 2) they had certified the accounting statements of one of the banks ICBC to be correct, and hence had major legal problems if they now contradicted their own certifications.
Sometimes Beijing happens to be right about some things.....
E. Cartman: I have seen higher, credible, estimates than that.
How do you know they are credible? Most of the "credible reports" come down to "those lying thieving communists must be covering something up, so we take whatever number we are given and the real situation must be worse." There's circular reasoning here. How do we know that the Chinese government are full of liars? Well they make up statistics. How do we know that the statistics are made up? Well the Chinese government are full of liars.
In any case, we can start with the totally amount of money loaned between 1990 and 1995 and assume a huge bad loan rate (say 50%). The maximum number you come up with is $500 billion of which about $200 billion has been paid off, and the rest are no longer on the balance sheet of the state banks. I'd really like to see someone who can add (and E&Y couldn't) come up with $1 trillion in bad loans through arguments other than "well there must be a cover up."
Of that $500 billion, about $200 billion were "possible post-1998 bad loans." It should be noted that this is a "worst case" scenario since you'd basically would have to assume a 20% default rate to get that number. We don't know what that number is. But we don't know means *we don't know* it doesn't mean "we don't know" therefore it's really, really bad.
I should point out that one argument that has been used is that "see, there is so much fraud and corruption around here is the situation has to be bad." The trouble with that argument is that the examples of corruption I've seen are in the tens of millions of dollars, and sometimes not even that high. Fraud and corruption could lose you billions and perhaps tens of billions of dollars, but it won't get you to several hundreds of billions in losses.
E. Cartman: Was there any increase in Beijing's liabilities as a % of GDP, when they "turned the bad debt into good debt" and assumed so many of the SOE liabilities?
The SOE liabilities became central government liabilities. The amount is roughly 10% GDP which isn't a huge number for government debt. The amount of SOE debt in 1998 wasn't overwhelming. The problem was that in 1998, the hole was getting deeper and deeper, and there was some massive restructuring that made the SOE's profitable. As late as 2004, there was an interesting debate about whether Chinese SOE's were really making money (google for Louis Kuijs). It don't think it is possible at this point to argue that SOE's aren't making massive amounts of money.
The big problem that Michael Pettis seems to be worried about is that the bank and corporate balance sheets look good right now, but if there is an economic downturn, some of the good loans and profits might turn out to be duds. It's a legitimate worry, although I'm more optimistic than he is about the situation. In the absolute, sky falls down, armageddon explodes situation, you end up with $200 billion in losses (which has already been counted in the $500 billion that Fitch mentions). I'd be surprised if the number was that high, but I think it is rational for people to argue that it could be. My guess for bad loans in the joint stock commercial banks is on the order of $10-$20 billion. (To get that number I take the total volume of loans issued by JSCB;s and assume a high default rate of about 10%. In a well run bank, that number shouldn't excess 0.5%.)
The trouble is that people then go into the "Chinese government are lying thieves" mode, and the total worst case number becomes the average, and the numbers get worse and worse, and pretty soon they are pretty disconnected from reality.
This is bad for policy because if you are worried too much about one thing, you might make another problem worse. For example one thing that the government has done is to cap depositor interest loans at the same time allow banks to charge whatever lending rates they want. If the banks are insolvent, this makes sense. If they aren't, it makes less sense. If you worry too much about the SOE's and the big four state banks, this means that you have less time to worry about fixing the rural credit cooperatives.
Twofish, $90 billion of QDII aren't really in the pipeline. I am not sure where your numbers come from but I know that a number of investment banks have made estimates that QDII in 2008 will amount to $90 billion. As I have mentioned in other entries I am very skeptical about that number and expect it will be much lower, perhaps even negative on a net basis, since it will be damned hard to earn the 12-15% return in dollar terms necessary to break even with local bank deposits. These kinds of dollar-equivalent returns are possible, of course, but every hedge fund in the would be eager to lock those in and it is not clear to me that Chinese QDII managers will be able to do so. I guess my basic point is that when everyone (including me and most of my banking friends) are trying to bring as much money as possible into China to stick in the bank to earn very high, pretty safe, returns, it is hard to imagine why local investors would be so eager to take it out absent some kind of domestic crisis.
EC, I think Twofish is right in that an RMB appreciation will not affect NPLs to any significant extent. I think he is much more optimistic than I am about the extent of the NPL clean up. Most reports still suggest that NPLs, if correctly accounted, exceed capital and reserves by enough that under most reasonable collection scenarios the banks would be bankrupt, and I don’t think all the analysis is of the “those dirty, lying commies” kind. The Chinese themselves that I know tend to be very skeptical of the numbers and some of my PBoC friends are very worried.
Of course the thing to remember is that this doesn’t matter under current conditions, but it does matter primarily during an economic contraction, and I guess from previous postings and comments that Twofish and I both worry far more about new NPLs under those conditions. A large NPL portfolio can be incredibly pro-cyclical. By the way most analysts ignore the value of the AMC bonds exchanged for “cleaned up” NPLs, but remember that the AMCs are completely bankrupt too, and it is only the MoF guarantee that keeps the bonds from being NPLs themselves. This might be enough protection, but if conditions turn bad enough, the MoF guarantee becomes a problem if government credibility is in any way undermined. Basically the way I see it is that to a still large extent the “cleaning up” simply turned unrecognized losses into recognized ones (via the MoF guarantee), but did not resolve them.
By the way, Twofish, as you know I place little informational value on the fact that foreign banks bought into the “cleaned up” banks. This does not indicate at all that they believe the banks to be clean (a senior banker at Citibank, who got badly hurt because they pulled out of what the Chinese thought was a commitment to invest, hinted to me that the reason they pulled out was because of the shocking extent of bad loans). As you and I discussed in another, earlier posting, bad banks in reforming economies are still great investment plays, and there are many, many cases around the world of sophisticated foreign banks buying into local banks with terrible loan portfolios and still making a killing. It could be a “time value” bet, not an “intrinsic value” bet, and those have completely different informational values..
EC, I think Twofish is right in doubting the value of reserves in bailing out the banking system. It is only more local borrowing buy the MoF that can do that, and so the extent of a bailout is limited by the borrowing capacity of the MoF (during an economic contraction). Reserves are not wealth, but are simply foreign-currency assets against which the PBoC has domestic liabilities, and there is no way the PBoC can convert the dollars into RMB without creating another set of possibly even bigger problems.
Lots of other great points but it would be tedious to cover them. Twofish, I have read several times about your suspicion that the sub-prime crisis may have set off Chinese inflation but I cannot figure out how that would work. I don’t under the transmission mechanism. Please explain (knowing, however, that if I think you are right I will promptly steal your idea and use it in an article while giving you little credit for it).
By Michael Pettis - 12/10/2007 7:55 PM
Ok, but the PBOC's liabilities (to banks--the locuses ? of the hypothesized bad debt problem) are all yuan. And its assets are pretty much all euros, yen, and dollars.
Pettis: Most reports still suggest that NPLs, if correctly accounted, exceed capital and reserves by enough that under most reasonable collection scenarios the banks would be bankrupt.
I'm not sure I understand this statement.
The remaining NPL's certainly are larger in volume than the capital and reserves of the banks, but I think this is more or less irrelevant, since the NPL's are now the problem of the Ministry of Finance rather than the banks. It's meaningless to compare, for example, the total volume of non-performing loans with the total capital of the big banks because the big banks aren't legally responsible for those loans anymore. If I have $10 and my cousin owes $5 billion, this is pretty irrelevant for my own solvency.
What is the important number is comparing the capital of say China Construction Bank with the bad loans that CCB is legally responsible for, and I don't think that number is negative. The numbers for the rural credit cooperatives, and the asset management companies are wildly negative, but those debts have been implicitly by the Chinese government which has the reserves to pay them. (They've been implicitly assumed, because the alternative is social revolution.)
Pettis: Basically the way I see it is that to a still large extent the “cleaning up” simply turned unrecognized losses into recognized ones (via the MoF guarantee), but did not resolve them.
I'd argue that they did resolve them. Those debts originated because of social welfare obligations of state-owned enterprises, which were public welfare responsibilities of the government, and by transfering them to the government, it put the responsibility for those expenses to the entity that was responsible for public welfare. One's perspective on the pre-1998 NPL's changes if you view them as social welfare spending rather than bad investments, which is what they were.
The problem is that banks are not set up to be welfare bureaus and now that they no longer have that job, that problem is fixed.
Pettis: it will be damned hard to earn the 12-15% return in dollar terms necessary to break even with local bank deposits.
It's actually pretty simple. Buy Hong Kong listed shares of companies whose major business is in Mainland China. At this point you benefit from the 20% discount Hong Kong shares have over Shanghai, and if the currency revalues, this will boost the earnings of the company so you get any benefit of revaluation.
Pettis: This does not indicate at all that they believe the banks to be clean (a senior banker at Citibank, who got badly hurt because they pulled out of what the Chinese thought was a commitment to invest, hinted to me that the reason they pulled out was because of the shocking extent of bad loans).
It indicates that they believe that the banks that they put money in are clean. In the case of Citibank, their main strategy in China circa 2004 was to partner with joint-stock cooperative banks in large part to develop a credit card markets. It's in the JSCB's that I think you are likely to see huge problems. But it's important to realize that problems in JSCB's may or may not indicate problems in the "big four" banks.
Pettis: It could be a “time value” bet, not an “intrinsic value” bet, and those have completely different informational values..
In the case of investments into the big four banks, the structure of the deal was to make them "intrinsic value" plays in order to signal that the big banks were clean. In particular, there are major restrictions on how quickly the banks can pull out their money.
Pettis: Twofish, I have read several times about your suspicion that the sub-prime crisis may have set off Chinese inflation but I cannot figure out how that would work. I don’t under the transmission mechanism. Please explain (knowing, however, that if I think you are right I will promptly steal your idea and use it in an article while giving you little credit for it).
Feel free to steal the idea.
The big question that I have is "where did the money go"? In Q1 2007, you had this massive current account surplus that was getting recycled into treasuries and mortgage backed securities. In June, purchases of treasuries and MBS's just stopped cold. Where is this money going?
My guess is that this money is somehow making its way into the Chinese economy causing monetary expansion and inflation. This may be happening through non-bank channels. Something big happened in June because suddenly inflation switched on like a light switch.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (18) for "Slower loan growth does not ...
- 12/9/2007 10:35 PM
December, 2007