Courtesy of The Automatic Earth.
Russell Lee Farmer’s truck at state rice mill, Abbeville, LA September 1938
Sometimes similarities have an entertaining effect. Noticing how the US and China deal with their similar though not identical debt levels in similar though not identical ways made me think of the “it’s turtles all the way down” version of the origins of the universe – which has an ancient Hindu version that says the earth rests on an elephant which rests on a turtle -. It seems a pretty good fit when trying to describe the global financial system, the debts that are dragging it down, and the insidious schemes with which governments and banks try to hide from the public that their part of the system is busy collapsing under the weight of its own debt.
A few days ago, I quoted David Stockman’s take on how the Fed does it.
The Fed Desecrates The Constitution
… if [the Fed’s] $4.5 trillion balance sheet is permanent, then the Fed’s post-crisis money printing spree amounts to a massive monetization of the public debt. To be sure, all of this was done in the name of rubbery abstractions like “accommodating” recovery, supporting the “labor market” and “stimulating” consumption and investment spending, but the real world effect was quite different and far more tangible: It allowed Washington to treat the financing cost of our $17.5 trillion national debt as a free good.
In a world in which even the official inflation rate (CPI) has averaged 2.4% during the last 14-years, there is no other way to describe a policy that actually drove the 5-year Treasury note yield to a low of 75 bps, and pulled the weighted average cost of the total Federal debt down to about 2.5%—which is to say, zero, nichts, nada or nothing in real terms. And part of this fiscal scam is even more egregious than the Fed’s own acknowledgement that it’s artificially suppressing the treasury coupons. What the Fed is also doing is issuing second-hand “greenbacks” – those notorious non-interest bearing IOU’s that financed the Civil War. Since the crisis the Fed has returned $400 billion of “profits”, including $80 billion each in the last two years, to the US treasury, thereby off-setting upwards of 25% of the interest cost on the Federal debt.
… how is it that the Fed is more profitable than the wholesale, retail, entertainment, food service and hospitality industries of America combined? Self-evidently, its the magic of printing press money: The Fed buys treasuries and MBS with a coupon; pays for them by issuing new liabilities without a coupon; collects the spread which gets recorded as a “profit”; and then returns this ‘profit” to Uncle Sam at year-end. Had the Treasury Department dusted off Lincoln’s playbook, instead, it could have simply issued “greenbacks”, and dispensed with the round trip. In less polite company it might be called a fiscal circle jerk.
And then today I read Sara Hsu at The Diplomat on the Chinese version. As I said, not identical, but certainly similar. A longish quote for context.
How Much Bad Debt Can China Absorb?
The first step in answering this would be to examine what types of debt has gone bad in China and what is likely to continue to sour, as well as how these products have been dealt with. There are three general categories of bad debt that have been bailed out in recent years (there is other bad debt that has not been bailed out): bank loans, trust loans, and loans from smaller sectors such as informal finance and credit guarantee companies. Problems with trust loans and loans from smaller sectors have generally been handled by local governments, while bank loans have been bailed out via asset management companies funded through the Ministry of Finance.
The second step is to consider how well the central and local governments can cope with a potential increase in bad debt. While local governments are overly indebted, as revealed by a recent report by the National Audit Office, and have experienced fiscal shortfalls for some time, the central government has maintained relatively low deficits, even coming in under the projected deficit in 2013. The way in which the central government deals with non-performing loans is easy on the fiscal budget as long as the debt can be recovered ; the worst impact of this process is that it may very lightly constrain lending, as non-performing loans are taken off books and bonds are issued and purchased by banks, changing the nature of capital held on the books.
In reality, however, much of the distressed debt is not recovered, and in the past has been purchased by the Ministry of Finance. Both central and local governments, then, face issues with bailing out bad loans either directly or indirectly.
The third question we ask is whether the scale of bad debt will grow sufficiently to threaten the financial health of the central and local governments. For local governments, the question is moot. Their health is already threatened by a serious lack of revenue. [..] As it stands, it seems that the fallout from trust bailouts has been relatively low and may turn out to be less onerous on local governments than it has been on the psyche of financial analysts, but if the trust debt increases and bailouts do rise, local governments will suffer, as they have little capacity to withstand a further accumulation of debt.
The central government can bear a small increase in bad debt, but as long as the deficit is kept in check, bailouts will replace policies that spur much-needed growth, trading future prosperity for past profligacy. The recent 3-year non-performing loan amount of just less than 1.5 trillion RMB (about 500 billion per year and growing) seems like a tidy sum compared to fiscal expenditures of 7 trillion RMB (in 2013). With mounting non-performing loans and declining revenue in the short run, the gap between these numbers will only narrow. Although the government can pay down the debt later, postponing the bailout, many new nonperforming loans would present a challenge to officials as to how to classify, recover, and ultimately relieve the financial system of this burden.
… it does not appear that China can bear a very large increase in debt, and that the idea that the government can simply “bail out the financial sector” is erroneous, or at least, a stretch. China does not have the luxury of the United States, which can spend excessively because foreign countries continue to buy U.S. government debt (as the dollar is the world reserve currency). If the leadership attempts to spend down its large cache of dollar reserves, it will lose control of its currency, as a larger supply of U.S. dollars relative to the Chinese RMB would depreciate the currency unless sterilized. The only remaining option is the least savory: the Chinese government must control its debt, and this includes reducing overindulgence within the real economy. It seems that the punch bowl is empty already and the party is winding down.
It seems that if things get bad and smelly, wherever you are in the world, there’s always a carpet to sweep them under. And the Chinese make nice carpets. But everyone can figure out that this is not some sort of endless accounting innovation. If this would work, we’d all have been doing it for centuries, and we’d all be awfully rich. Instead, what Stockman calls circle jerks are mere sleight of hands, and that doesn’t change just because government accountants have become addicted to them.
One thing Hsu omits from her assessment of Chinese government debt, as many with her do, is shadow banking. And just because you can’t see it doesn’t mean you can ignore it. You need to find out, hard as it may be, how much bad debt is in the shadow system. If only because much of that debt will belong to local governments. You would also need to find a way to gauge how much leverage there is in the shadows; there’s no doubt it’s – even – higher than in the official banking sector. Without some way to incorporate this shadow banking debt in your picture of Chinese liabilities, you can’t get more than a very limited idea of what goes on. Which Beijing would prefer, obviously, just like Washington does.
Makes you wonder how China will deal with this info just in from Caixin:
Home Sales In China’s Big Cities Down 40% In Q1 (Caixin)
The country’s property market has gotten off to a slower start this year than in 2013. The number of homes sold in the first quarter in tier-one cities – Chinese property market jargon for the major cities of Beijing, Shanghai, Shenzhen and Guangzhou – was more than 40% lower than during the same period last year, data released by China Index Academy on April 1 shows. Transactions in the capital fell the most among the four cities, by 51%, followed by Guangzhou (43%), Shenzhen (38%) and Shanghai (36%). [..] The property markets in second-tier cities – provincial capitals and the larger cities in each region – were also cooler in the first quarter than they were in the same period last year. The number of apartments sold was down 25%,
Construction and sales of real estate have been major drivers of Chinese domestic growth, the main way to get people to move their savings into tangible things. What was it, 90,000 developers of which only a third are expected to survive? And then sales are down 40%? Prices are next then. Not quite yet though:
… home prices in three of the four first-tier cities rose from the previous month. Home prices in Shanghai increased the most, by 0.99%. Beijing and Shenzhen also saw prices go up, by 0.93% and 0.77% respectively. The average price in Guangzhou fell by 0.29%.
But prices lag sales, of course. At some point people come to realize that they can’t sell for what they want, and must lower their asking prices. I’d say the Communist Party needs a real clever plan very soon, or there’ll be angry hordes at the gates of the Forbidden City. And I don’t see the tens of millions of Chinese homeowners being as gullible as Americans, and being tricked by the sleight of hand circle jerks the Fed plays. The essential issue is dead simple: can Beijing reinflate the insane housing bubble, and how long for?
