Twofish's Blog

November 17, 2009

Not such a mystery

Filed under: Uncategorized — twofish @ 11:01 am

http://blog-imfdirect.imf.org/2009/11/08/asia%E2%80%99s-corporate-saving-mystery/

It’s actually not a mystery why Chinese companies (and households) hoard cash. The problem is that they cannot be guaranteed bank loans when things go bad, so they end up with massive amounts of cash which they can spend if things go bad.

I really don’t understand why this is a bad thing. It’s not as if companies are literally piling away paper in vaults. When Chinese companies save, this goes into bank deposits which the banks can lend out for infrastructure improvements.

Personally, I think that given that macroeconomic theory is a mess, when macroeconomists say that China should save less and spend more, and that China is doing an obviously stupid thing by undertaking the policies that it has, then we really ought to question the assumptions of the macroeconomists.

The problem with discouraging savings is that it assumes that companies will always be able to get funding when they need it, so when funding breaks down, you have a major crisis in the United States that you really don’t have in China. When a company in the US loses bank financing, then it has to immediate lay off workers, whereas Chinese companies have enough cash to keep workers employed while the government figures out what to do and while stimulus starts going on line.

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5 Comments »

  1. What is best for the Chinese individually is not necessarily best for the world and may not even be best for China as a whole. There is a way to describe this but I cannot think of the term, but I’m betting you can.

    Comment by China Lawyer — November 19, 2009 @ 4:19 am

  2. Why should low-return investment (in financial terms), such as infrastructure projects, be done with private instead of public capital? The problem is that banks in China are serving a quasi-fiscal function, funding things that should be financed through public channels, even municipal bonds, instead of lending to areas that would provide far higher returns in the private sector. I don’t share your sense of disillusionment with economics. What has happened is that the Washington Consensus, call it policy orthodoxy, has finally been applied to the US and others, otherwise there would be no framework for understanding what has happened to date and what might likely happen in the future. The same holds true for China, and macro theory provides a lot of insight into the structural eventualities there as well. The banks cannot make bad loans, package them, and sell them to some other financial institution for very long without problems arising. This applied to real estate financing, and is happening as we speak in China in much lower-tech way. We cannot call what is happening in China securitization because the laws and regulations that would govern such an industry/market don’t really exist. So it is simply the selling of loans to a willing buyer, who is probably buying the loans with borrowed funds, creating a loop of fiction similar to the AMC bonds. This cannot go on indefinately because it is unsustainable, and when things are that way they never last. So no, China should not necessarily consume more, because it will need more coerced deposits in its financial institutions to sure up their funding base. And, by the way, Chinese firms are notorious for not paying people in the best of times, not to mention rough patches. I have been on the receiving end of this, and was able (better able than a migrant worker) to get through it because I save.

    Comment by Moumou — December 30, 2009 @ 5:13 am

  3. Moumou: The banks cannot make bad loans, package them, and sell them to some other financial institution for very long without problems arising.

    Of course but I think the issues here are the numbers. What is the fraction of bad loans? What is the bad thing happening? In the case of China (and for that matter the US) is that the bad loans get transferred to the government debt, which may not be such a bad thing if it keeps worse things from happening.

    Moumou: This cannot go on indefinately because it is unsustainable, and when things are that way they never last.

    *Nothing* can go on indefinitely. The question is when it will end and how, and that involves looking at the numbers. Something that is the case is that over the next forty years, China is going to get a productivity boost from moving from farm to city, and this is enough to justify some fiscal injection.

    Comment by twofish — January 3, 2010 @ 4:19 pm

  4. No, the issue is that bad loans are being sold by commercial banks to non-bank financial institutions. Lots of people in finance in Beijing know this, and if you do some math with bank asset balances, new loan growth and asset balances system wide, the numbers don’t add up to the tune of RMB 1 trillion. This is not using government funds; it is just using an AMC bond like scheme, except with non-government funds. Sure, I agree about the benefits from urbanization, and this will both require and warrant fiscal injection. But I think a structural problem is that China is playing the same financial games that Japan did – cross holding of financial risk, for example relying on bank to bank and insurance company purchases of subordinated debt to sure up weakening capital bases for much of 2009. Fiscal health is another matter, and is decent. But when financial institutions are still acting like quasi-fiscal entities, as they did during 2009, then assumed forward liabilities of the government start to look darker, and quickly. And a note on productivity – the output of a worker that goes from the fields to a factory increases by about 5x, assuming that they can get a job. This is a one time productivity gain. What happens after that is far less certain, especially because the next generation of urbanized people will have far lower levels of education than the first one. This is not good forproductivity. So give them more capital, and labor productivity increases, but these are not workers that are going to be running big machines; they will be diggers and low-end services workers. Not areas where productivity growth is strong. If long-term growth is a function of productivity and demographics at the highest level, then productivity growth will need to be very strong over time (lets call it TFP, and not simply look at worker output) to make up for the fact that the working age population will soon start to shrink. This is not guaranteed simply through urbanization.

    Comment by Moumou — January 5, 2010 @ 8:58 am

  5. At that point you ask what happens if real estate prices drop, and if you have a situation in which a real estate crash is going to cause non-bank holder of an asset to lose their money, this may not be a bad thing.

    Also urbanization *is* a one time productivity gain and what happens afterwards depends crucial on decisions that get made now that have long term ramifications. One reason I dislike a lot of panicky articles about how China is doomed next year, is that it avoids discussion things that will be serious problems in 2030, 2050 or 2100. There is not that much that can be done to change what happens in 2012 or 2015, but if people think about 2100, then even small changes now make big changes in the future.

    Also TFP will flatten over time, the big question is how the economy will react when it does.

    Comment by twofish — January 13, 2010 @ 1:46 am


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