Chinese stocks jumped 1.1 percent Tuesday on hopes that the government will ramp up spending again to ward off an economic slump. Premier Wen Jiabao stoked expectations on Sunday with a statement that “more priority should be given to maintaining stable economic growth.” While it must be tempting to goose GDP once more, Wen and his colleagues should think twice about another round of stimulus.
There is no longer any doubt that China is facing a rough economic patch. Last month’s data showed almost zero growth in imports and electricity use. Industrial production grew just 4.3 percent on a month-on-month annualised basis. On a broad range of growth indicators, China has fallen to 2009 levels.
Three years ago, the government responded with one of the largest stimulus programmes the world has ever seen, totalling 15 percent of GDP. It included $580 billion in government spending, but the bulk was in the form of new bank lending, most of it for investment in infrastructure and industrial capacity. Some analysts estimate half of those loans will eventually go bad. Beijing can’t afford to do that again.
The counterargument is that Beijing merely needs to take its foot off the monetary brake that it has been using to fight inflation over the past year. Regulators engineered this slowdown to prevent a bubble in real estate and focus on higher-quality growth. Once banks are allowed to lend more freely, the argument goes, the real economy should take off again.
Only it isn’t working this time. The People’s Bank of China has loosened credit, but companies don’t want to borrow when they are already having trouble making profits. New bank loans contracted by 8 percent in April, and the percentage of long-term business loans in the banks’ asset portfolios is falling.
The lack of confidence is due to the overhang from the last blowout. All of that investment in industrial capacity and real estate is now coming on line. Companies and local governments are finding it difficult to make their new assets generate enough revenue to service the debt. Inventories are piling up, and China is seeing capital flight for the first time in decades.
In other words, much to the surprise of some investment bank analysts, China is not immune to the business cycle after all. It is overdue for a bout of creative destruction to clear out inefficient enterprises such as the builders of empty “ghost cities.”
The worry is that China has gone more than a decade without a painful slowdown. During that time, the government held down interest rates at artificially low levels to encourage investment. Such conditions often precede particularly long and painful contractions, a phenomenon the Depression-era economist Irving Fisher called debt deflation, otherwise known as a liquidity trap. One symptom is the lack of demand for credit that China is experiencing.
It’s possible that Beijing pulled the monetary punch bowl away in time. Yet in recent months we have learned that hidden debts in corners of the economy such as credit-guarantee companies and local government financing vehicles were huge, and the true extent of their liabilities is still not fully revealed. Now is not the time to try to reinflate the economy with more wasteful spending and investment. That would only ensure the trap is sprung at a later date, at an even higher cost.