In an interesting article entitled Dark Side of the Lending Boom the author, Mr. Xie (see bio below) writes about the downside to China’s massive lending binge. Since December 2008, China’s banks have made loans of over Rmb 6 trillion but the author believes much of it has been used to fuel speculation rather than investment. As a result, commodity prices have surged and the Chinese economy has suffered. In the author’s words, The damage is already significant. If lending doesn’t cool, this force would transfer Chinese income to foreigners and trigger stagflation for a long time to come.
With demand dropping around the world, commodity prices have rocketed since March, the Reuters CRB commodity price index has risen by a third on the basis of Chinese buying, much of it speculative stockpiling. The author goes on to say Rio was on its knees at the turn of the year and grateful for the $19bn lifeline Chinalco threw it but surging Chinese iron ore purchases have tripled Rio’s share price and given the firm the opportunity to pay down its debts via a rights issue. Chinalco lost it’s once in a decade bargain basement buying opportunity because of buying, much of which was speculative.
In the author’s opinion there is little doubt by now that China’s bank lending since last December is driving speculative inventory demand for commodities. Chinese banks lend for commodity purchases with the underlying commodities as collateral. The lending is structured similar to a mortgage. The media report the surge in imports as evidence that China is recovering and with it so will the rest of the world but much of the buying has been playing the arbitrage between spot, forwards and warehousing costs. The demand for physical metal has made the prophecy of rising prices appear self fulfilling.
To what extent the author’s statements that Chinese companies are moving away from the real world and towards a virtual world is hard to judge. The point he is making is faced with this wall of money, companies have borrowed heavily but with stagnant export market they have often not invested in new capacity preferring to invest in raw materials such as commodities. Even state enterprises are lending on to smaller companies previously not able to borrow because of shaky balance sheets. Both corporations and individuals have invested massively in the stock market pushing share prices up 70% since last November.
The result is employment is not picking up. The government is spending massively to try to ensure students coming onto the job market find employment of some kind, China’s students have traditionally led opposition to authority and unemployment would likely be the catalyst in the current market.
He concludes by stating that only a structural shift away from export dominated investments and incentives towards raising the living standards for all Chinese and hence boosting domestic consumption will ensure China’s long term health. Interestingly his position is in line with Commerce Secretary Gary Locke who has called for China to allow the Yuan to freely float. Whether any notice will be taken in Beijing is extremely doubtful.
For the record Mr Xie is a graduate of Shanghai Tongji University and MIT in the USA. He was joint MD of Macquarie Bank Singapore’s Finance Dept and Morgan Stanley’s economist for Asia and Pacific Regions until 2006.