China: the Known Unknown. Ryan Greenaway-McGrevy looks at propping up the sharemarket, provincial debt, capital leakage, 'real' GDP, the labour market, dissent, Dilbert and more

Today’s Top 10 is a guest post from Ryan Greenaway-McGrevy who is a senior lecturer at the University of Auckland. Prior to this he was a research economist in the Office of the Chief Statistician at the Bureau of Economic Analysis (BEA) in Washington DC.

In this week’s Top 10 he looks at China. The recent mini-meltdown in the Shanghai stockmarket is a timely reminder that 30% of our exports go to an economy that often escapes the headlines. But what do we know about the state of the Chinese economy? Chinese economic data is notoriously unreliable. This week’s Top 10 gives us a summary of some of the signals we are receiving.

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See all previous Top 10s here.

1. What is the Government doing to prop up stock prices?
Heather Timmons and Lily Kuo over at Quartz give us a timeline of the interventions that we know of:

Here’s a complete list of the stimulus attempts that have been made public over the past week or so:

June 27: A surprise 25 basis point interest rate cut and lowering of the reserves banks need to keep when they lend to companies.

June 29: Regulators say pension funds can invest 30% of their net assets (equivalent to more than $100 billion) in equities for the first time.

July 1: China’s securities regulator relaxes rules on margin financing, or trading stocks with borrowed money.

July 3: China’s central bank extends a 250 billion RMB ($40 billion), six-month loan to state owned banks to “encourage banks to increase support” to weak parts of the economy.

July 4: 21 brokerages, led by Citic Securities, say they will invest $19.3 billion in a new blue-chip fund to stabilize the market, and vow not to sell any of their own proprietary equity holdings.

July 5: 28 firms planning IPOs on the Shanghai and Shenzhen market say they will postpone them and start refunding investors’ capital.

July 5: China’s central bank says it will inject an undisclosed amount of capital into China Securities Finance Corp (CSF)., a state-owned company that makes margin loans to brokers.

July 6: Executives from mutual funds pledge to support the markets with their own capital.

July 8: Regulators banned company shareholders with stakes of more than 5% from selling for the next six months. China’s central bank said it would further support the margin lending provider CSF through interbank lending, bond issuance, and collateral backed financing and re-lending. China’s securities regulator also said it would increase purchases of small-cap stocks.

July 9: China’s banking regulator, the CBRC, said banks can now loan money to companies using stock as collateral, and ease margin requirements for wealth management customers.

Much of this reads as if the Government is doubling-down on stock prices soaring. In other words, they are trying to fuel a bubble, not slowly deflate it. That last intervention has the potential to be particularly damaging. Let’s take a closer look at it.

2. The Chinese Banking regulator has permitted banks to loan money to companies using their stock as collateral.
This is really is dysfunctional banking.  Sigrún Davíðsdóttir over at a Fistful of Euros looks at how this worked out for the Iceland banking sector. Here is my favourite quote:

Asking a foreign banker in London if this was a general practice that banks lent clients to buy the bank’s share with the bank’s own shares as the only collateral he said he knew of this Icelandic practice: “It’s so insane that I don’t even know if it’s legal or not. No bankers in their right mind would consider it.”

You see, I was pulling my punches when I called it “dysfunctional”. This form of collateral can quickly lead to prices spiraling downwards. Sigrún Davíðsdóttir talks us through what happened in Iceland:

Apart from weakening the banks’ equity the lending against own shares turned into a major headache for the Icelandic banks already in 2007 with the drying up of credit markets. The share price of the banks started falling, forcing the banks to make margin calls.

Under normal circumstances the banks would have taken the shares, liquidated them and pocketed the money to cover the losses. But by accepting own shares as collateral the banks had created anything but normal circumstances.

These circumstances were further aggravated with cross-ownership and close connections between holding companies and the banks. Thus, the collateralised shares, banking shares or not, created a highly poisonous circumstances where the banks could not follow normal business practices: by liquidating the shares the price would have fallen further – this really was a spiral straight to hell.

So what do you do when prices begin the downward spiral? Reuters reports that many of the Chinese companies that have had had their stocks suspended from trading borrowed using their own shares as collateral.

3. Why is the Government so concerned about the stock market coming back down?
After all, the recent 30% drop occurred after an increase of 150% over the previous year. Evan Osnos at the New Yorker suggests that the regime has to keep the prices high because it urged the public to buy, and keep buying:

On April 21st, People’s Daily, the newspaper that the Chinese Communist Party calls its “throat and tongue,” published an online commentary exhorting the masses to place their trust, and savings, in the stock market. Even though share prices had soared by more than eighty per cent in less than four months, this was “merely the start of a bull market,” since blue-chip stocks remained “undervalued,” the author, Wang Ruoyu, explained. Like a CNBC stock picker, Wang mocked fears of a bubble—“What’s a bubble? Tulips and Bitcoins are bubbles”—and assured readers that continued gains would enjoy the full “support from China’s grand development strategy and economic reforms.” 

So this is about the credibility of the regime. This is appears to be an old habit:

The public had reason to believe. Official and quasi-official Chinese pronouncements carry the ring of prophesy. In the heyday of socialism, the Party forecasted the size of the following year’s harvests and the quantity of steel production, and the final numbers were rarely permitted to deviate much from the predictions. More recently, the Party has offered annual targets for economic growth that almost always bear out, no matter what sort of creative policy, or accounting, steps are required. 

After the exhortation to buy more stocks, apparently the graphic below started doing the rounds within China’s online community.

“ChineseBullMarket” by Licensed under Fair use via Wikipedia –

4. Debt at the provincial level ballooned to crisis levels in 2015.
The Ministry of Finance and the Bank of China reacted by having state-controlled banks purchase the debt under very unfavorable terms. This is a default by another name. Christopher Balding comments:

Let’s run a simple thought experiment.  Assume a government is drowning in debt.  They can’t raise the money to pay off the debt coming due.  The interest rates are too high and the maturities too short.  Revenues are falling and the banks are reluctant to continue extending credit to the government.  The situation looks dim.

The government and central bank, however, come up with an idea to solve the problem.  The government imposes a debt swap on the banks where they unilaterally turn short term high interest debt into low interest long term debt.  Though there is no write down in the face value of the debt, there would be a reasonable case given the coercion and change of terms, to ask whether this was a debt default.  There has been no change in asset or borrower quality but rather a unilateral rewriting of the debt contract using coercion.  Not wanting to miss out, the central bank offers to accept this troubled debt as collateral should the banks want cash instead, effectively monetizing the bad debt.

This scenario isn’t about Greece but about the debt swap imposed by the Chinese government in partnership with the PBOC on lenders holding local government debt.  While no one is saying this is a default, if this same scenario played out in Greece, there would be arguments over whether this constituted a default. 

But it seems the bailout was not enough to help local government. Here is Balding again:

Friday night the Chinese central government through the Ministry of Finance, along with the PBOC and CBRC, jointly announced a policy intended to further aid local governments.  In the words of the Financial Times, the regulation:

“…told financial institutions to keep lending to local government projects even if borrowers are unable to make principal or interest payments on existing loans….(the regulation)explicitly banned financial institutions from cutting off or delaying funding to any local government projects started before the end of last year and said that any projects that are unable to repay existing loans should have their debt renegotiated and extended.”

Let me say that again just so it sinks in: banks were told to keep lending money even if the borrowers are unable to make principal or interest payments on existing loans and banks are forbidden from cutting, denying, or delaying loans.  While country policy makers around the world have unofficially encouraged excessively loose credit policies and lenders may take such policies in individual cases, I have never heard of a similar countrywide or bank wide policy anywhere.  (If anyone knows of a comparable case please let me know).

5. Despite capital controls, capital is leaking out of China.
What do you do when the Government won’t let you buy US dollars to invest overseas, but it will let you buy US dollars in order to purchase goods and raw materials?

Import and export over or under invoicing is another means of disguising flow in the restricted sector to look like flow in the unrestricted sector to move capital between countries.  A sample transaction turns a $5m export into $10m to move $5m in capital into China. First, the exporting company issues a $10m invoice, declares $10 export to customs, and ship goods to importing company in another country. Second, the importing company declare $5 of import to customs, pays $5 for the good which is the real value of the goods trade. Third, the capital inflow of $5m will be remitted together with the payment for goods received of $5m, and be accepted by the Chinese company as $10m.

While some capital is also flowing in to the country, it appears that much more is flowing out. How can we tell? Balding again:

The easiest way to know this is happening is to compare official Chinese import and export data to the import and export data of its trade partners.  In other words, if China declares $10m in exports to Australia but Australia only reports $5m in imports from China, we consider that a significant discrepancy.  Differences are to be expected in trade data but they are typically and should be quite small.

But how much is flowing out?

From 2012-2014 the total export over invoicing discrepancy between China and its top five trade partners was approximately $40billion USD.  While that may sound like a lot, give the enormous amount of trade with the top five partners over three years, this is little more than a rounding error averaging about $13b a year.  However, import over invoicing, which moves capital out of China, has grown rapidly in the past few years.  From 2012 to 2014, the import over invoiced discrepancy amounted to $525 billion rising every year from a low of $148 billion in 2012.  Import over invoicing for the top five trade partners of China represents approximately 30% of the value of imports. 

So the net outflow of capital is accelerating. It is concerning if Chinese investors increasingly feel their money is better invested overseas. It certainly is not a vote of confidence.

Nor is the outflow economically insignificant: China’s trade surplus for 2014 was $382 billion. Because economists often rely on official trade statistics to estimate Chinese foreign investment, import over-invoicing suggest that these estimates will significantly understate the true amount of Chinese-owned capital sloshing through global asset markets.

But there is perhaps a silver lining: If official net exports are understated, then official GDP is understated.

While these net figures suggest that import over-invoicing is more prevalent than export over-invoicing, the latter is also occurring …

6. Despite capital controls, capital is leaking into China.
The Shanghai Interbank Rate (SHIBOR) is much higher than US, European or Japanese interest rates. If there were no capital restrictions, money would be flowing in, much like it does to New Zealand to take advantage of our high interest rates.

Again, fake invoicing is being used to get around this. The paper by Christopher Balding (you guessed it) and Zhang Xiao outlines how cooper reserves sitting in warehouses are used for this purpose. Balding explains how it works:

To move capital but disguise the FX transaction as trade rather than capital movement, firms have found an enterprising way around this.  A firm will enter into a sham transaction to export, for use in our paper copper, a product with a clear market price.  The firm will then secure foreign currency trade financing, typically in a currency fixed against the RMB like the USD or HKD with low borrowing rates and potentially additional leverage, convert back into RMB and bring the currency back into the country under the guise of goods trade.  They will then invest in typically high credit quality short term products and then unwind the trade and the end of the term for the copper holding.

But is this economically significant? It appears so.

Given that by our official estimates, China now holds nearly 40% of the global copper stock in warehouses, which excludes ongoing consumption, this is not an insignificant finding.  It is also worth noting that some estimates, have Chinese copper stock responsible for an even higher share of global copper stock holdings.

And here is the Financial Times reporting:

Some Chinese executives estimate that as much as 70 per cent of China’s imports of refined copper were used to obtain financing rather than for consumption.

Balding and Zhang don’t tell us how this may be distorting world copper prices. The global price may have been inflated not because it is being put to good use in building infrastructure, but because Chinese firms need a way to get around the controls.

Copper Price per metric Ton.

Graphic Citiation: “Copper Price History USD” by BonerUploaded by Gonzonator at en.wikipedia – Transferred from en.wikipedia by SreeBotOriginal caption: “Data extracted from”. Licensed under Public Domain via Wikimedia Commons –


7. Real GDP is almost certainly not growing at 7%, as the official figures indicate.
But you knew that already, and so do the Chinese leaders.

But, how much lower is the real growth rate? Official statistics put nominal growth at 5%, meaning that there is deflation in China, which is not a good sign if you are looking for robust growth. Corporate profits are flat, despite that fact that some companies have been profiting from the stock market boom. Official reports of electricity consumption growth are flat. It is ultimately impossible to tell, but I would guess that it is much below 7%.

Which naturally leads one to consider what the true level of real (i.e. inflation-adjusted) GDP is China may be. Based on discrepancies between different measures of inflation, Christopher Balding puts it at $1 trillion (in purchasing power parity terms), which equates to a reduction of 8-12%.  

Official Inflation in China

“China inflation” by Abluher – Own work. Licensed under CC BY-SA 4.0 via Wikimedia Commons –

8. A huge chunk of labour force is employed in the construction industry.
The IMF reckons 14% of the urban workforce is in construction, while property investment accounts for between 12.5% and 20% of output growth. Or perhaps that should be accounted for between 12.5% and 20% of growth, as these estimates are a year old. Construction is a notoriously volatile sector in any economy.

Gywnn Guilford at Quartz has more:

The beauty of any housing boom is that it needs lots of workers to build it. That employment fillip has served China’s leaders well. After the 2008 financial crisis threatened mass layoffs, they pushed banks to lend to property developers and infrastructure. It worked; by 2011, construction was creating more than half of new migrant worker jobs, according to Capital Economics.

That’s also part of why, even as China’s GDP growth slowed from 14.2% in 2007 to 7.5% last year, employment opportunities abound.

Given that the Chinese property market bubble has burst, one wonders how the huge amount of labour has or will be reallocated. Unfortunately, but perhaps not unsurprisingly, official unemployment data in China offers little insight.


9. Meanwhile, the Government has been cracking down on perceived dissent from its citizens.
Until recently, China’s online community was a vibrant agent of change, and change for the better. Read this excerpt about how an internet campaign lead to the trial of a corrupt official.

It started with a smile. In the summer of 2012 a Chinese government official was pictured grinning at the scene of a bus crash in Shaanxi Province. Web users, annoyed by his cheerful demeanour at the scene of a tragedy, began trawling through other images of the official and found something that many found unsettling. In picture after picture, people noticed that the civil servant was wearing a string of luxury watches, and people demanded to know how he could afford them on his modest salary. The outcry led to a jail sentence for the official, and kick-started a wave of similar scandals, many of which came to light on the Sina Weibo social network.

But perhaps the online campaigners were too successful. The Government has since cracked down on dissent:

The downward trend may have been helped by a law introduced in 2013 to prevent “rumours” spreading online. It means those posting allegations to Sina Weibo risk being jailed for up to three years if their messages are shared more than 500 times. Rather than leading to a raft of convictions, the effect of the law has been to encourage self censorship, says Tommy Wen, a journalist and blogger based in Beijing. 

It appears that the crackdown has affected one of the most vocal critics of the regime: Han Han. If you haven’t heard of Han Han, you’re probably not Chinese. You should know of him. He spoke truth to power. His scathing, angst-ridden critique of modern China Triple Door was a best seller.

Is the crackdown a signal? Does it tell us that things are in far worse state than the leadership is letting on?

Han Han 2.jpg

Han Han. Photo credit: laihiuyeung ryanne from hong kong derivative work: Stevenliuyi (talk) – Han_Han_at_Hong_Kong_Book_Fair_3.jpg

10. You can’t understand the economy of China without understanding the geopolitics of China.
Despite being written over three years ago, George Friedman’s account of the Chinese regime’s political strategy is timeless. Friedman believes the maintenance of domestic stability has always been the priority of successive Chinese regimes. The current government is no different. But it is achieving stability be a different means:

The current government has sought a more wealth-friendly means of achieving stability: buying popular loyalty with mass employment. Plans for industrial expansion are implemented with little thought to markets or margins; instead, maximum employment is the driving goal.

As we have seen, the Chinese government certainly appears to prop all markets in order to maintain stability – whether it be stock markets or labour markets. Indeed, it appears that stability is paramount, and this drives much of the ongoing state intervention that we observe. Let’s hope that the Government can keep China prosperous and stable.