China economy slows prompting infrastructure stimulus before US tariffs

Reuters

• China’s economy has started to slow dramatically, even
  before US tariffs have had a chance to make an impact.
• The government scrambling to boost growth, and walking
  back some of the measures it took to rein in debt and credit
  creation.
• This means it is once again encouraging infrastructure
  investment — one of biggest drivers of  China’s debt
  bubble in the first place.
• Beijing knows this is risky, and an analyst at Societe
  Generale says that by 2019 it could lead to the full return of
  shadow government borrowing and/or shadow banking.

The Chinese economy has yet to feel the pain of US trade
hostility, but it is slowing dramatically, to the alarm of
government officials.

That means the government must once again stare down the Catch-22
of modern Chinese economics. Should it continue to crack down on
easy credit and shadow financing to fight the massive debt bubble
that’s been building since the global financial crisis, or should
it loosen the reins in order to keep the economy growing at
around 6.5% regardless of any instability tariffs might bring?

This situation is coming to bare on Beijing hard and fast.
Bloomberg reports that President Donald Trump could place $200
billion worth of tariffs on Chinese goods
as early as next week.

And even without this pressure, Chinese economic data has been

trending down all summer, and the government is looking for
ways to stop the bleeding. That may mean returning to some old
habits. As Societe Generale economist Wei Yao wrote in recent
note to clients, “China has had no economic recovery that
wasn’t preceded by infrastructure stimulus” in the past 10
years.

The problem with that is that a lot of infrastructure
spending was funded by shadow banking and local government
financing that was either implicitly or explicitly backed by
Beijing. It was one of the main drivers in growing China’s debt
bubble to the point that the government had to crack down.

Foreign governments,
economists,
financiers, and nongovernmental organizations like the

International Monetary Fund all joined the chorus of people
telling China to tighten its credit and slowly deflate its debt
bubble years ago.

But infrastructure spending has always worked when China
needed a growth injection, and in increasingly uncertain times,
what’s a country to do? 

According to Yao the government’s crackdown on
infrastructure investment — which has fallen from
growing 18.5% in 2017 to just 5.3% so far in 2018 — is the
main factor in China’s economic slowdown, just as it was a huge
factor in its upswing.

From Yao’s note:

“Infrastructure funding has suffered severely due to two
lines of laudable deleveraging efforts – a clean-up of shadow
government borrowing and a deleveraging campaign targeted at
shadow banking activities.

We estimate that the combined impact is responsible for
half of the year-to-date slowdown, and the rest could be
explained by slower issuance of special local government bonds
(LGBs), which also had a lot to do with tightening liquidity
conditions in the bond market caused by financial deleveraging
measures.”

Until around May this wasn’t a problem. China’s economy was
looking stable in 2018. For the first time since
2014, it rolled into the new year without incident. There was no
stock market crash, no currency issue — nothing. The world
thought the bubble was being deflated, and that — as China’s
leaders have always said — things were under control.

Societe Generale

But as the year wore on that stability wore out. Now the Chinese
yuan is falling and its
stock markets are convulsing. Company earnings are hurting
thanks, in part, to a lack of easy credit.

The entire world expected any tightening of credit to bring some
instability. 

But the other edge of that sword is that China’s so-called
National Team of economists, officials and technocrats in China
are also expected to step up when things get too weird. And so
they have. That is why the Ministry of Finance is advocating
another go at infrastructure spending,
this time with private funds involved.

But no one knows exactly where that help begins, and where it
ends. Especially not in the face of a US trade war.

Yao has noted a “dramatic” speed up in the issuance of local
government bonds that fund infrastructure projects in recent
weeks — one that could push infrastructure investment growth up
to 10% in the second half of the year. However, this won’t be
enough to stabilize the economy if the housing market slows, as
she expects it will, in 2019.

That’s when the government may be tempted to bring back the
shadow financing of infrastructure investment to keep growth
around its 6.5% target.

“All in all, we think that the Chinese government will have to
make a most difficult decision in 2019: to deleverage or not?”
she wrote. “If it makes what we think is the right decision for
the long term – to deleverage – then a sharper slowdown is almost
certain next year. Based on the signs so far, this scenario looks
increasingly likely.”