Perverse Incentives, China And You

Detroit Publishing Co. “Loop the Loop at Coney Island, New York” 1903

The Automatic Earth

Since I wrote “The Taper And The China Credit Power Struggle Squeeze” on Dec 29, I have of course kept on reading up on China, and thinking about what I read. And I got to say, it keeps getting murkier and scarier at the same time. What I suggested in that article is that, although nobody I’ve seen talks about it, I’m convinced there’s a political struggle afoot in China that may shake the country to its foundations. And I don’t see how the western world would not be affected by that, possibly quite severely.

That is to say, while everyone still holds on to the notion that the Communist Party and the – central – People’s Bank of China (PBOC) have near absolute power over the Chinese economy, I think power over the shadow banking system has been relinquished. The size of that shadow banking system was estimated by JPMorgan at $5.86 trillion, or 69% of GDP, in May 2013, and that’s an in your face indication of what powers the “official” leadership still has.

There’s a lot of talk of Beijing and the PBOC curbing lending through the shadow banks, but if you count for over 2/3 of the economy, it’s an obvious choice to just stare them down. In the same vein, Beijing wants local governments to show responsibility for their debt, but that will only drive local officials even deeper into the shadow system. These officials first of all get judged on their accomplishments, such as the infrastructure they get built and the jobs that are created in their region, and they’re probably covering one hole with another already, so there’s no way back.

Which, incidentally, is one of the main reasons why a annual growth rate of 7% or more is so crucial for China: it allows for cover-ups of everything that’s gone awry. Local officials would rather pay loan shark interest rates than fess up to the mess they’ve made. All they’re looking for is opportunities to keep rolling over the debt. They’re not interested in paying it off, they’d rather use the cash to build another bridge or highrise, because that’s good politically.

Reuters reported on Monday that Beijing issued a whole new set of rules:

China issues fresh curbs on shadow banking

China’s cabinet has issued new rules to strengthen regulation of the shadow-bank lending that has helped fuel an explosion in debt levels since 2008, in the latest effort to address growing financial risks, sources told Reuters on Monday.

Another way to read this: a very, capital V, substantial part of China’s growth since 2008 has been financed by an explosion in debt levels. And that’s helped push up growth a lot. Which in 2013 at an estimated 7.6% was already the lowest since 1999.

The wide-ranging new rules issued by the State Council, China’s cabinet, say that shadow banking is a “beneficial” and “inevitable” consequence of financial development and provide an official definition of the term, according to a copy obtained by Reuters.

It’s interesting to note that Beijing finds it necessary to acknowledge shadow banking’s role in its economy by providing an “official definition”. And we all understand that if any boss you’re working for ever labels you “beneficial” and “inevitable”, and puts it on paper, you know you’re good, and you’re not about to be made redundant.

The regulations contain new restrictions on banks’ cooperation with trust companies, securities brokerages and other intermediaries with whom banks have cooperated in order to carry out off-balance sheet business.

Authorities also attempt to address the problem of banks’ exploiting regulatory loopholes by clarifying the responsibilities of various regulators, the People’s Bank of China, the China Banking Regulatory Commission, and the China Securities Regulatory Commission. The rules also address internet finance, micro-lending, and informal lending by friends and family members.

The Chinese government would love to get a clear picture of what goes on underground in its own economy, but it must have understood by now that it can no longer simply demand to be given the numbers. To get that picture, it’s at the mercy of the very people it seeks to regulate more strongly. And then it becomes a straightforward negotiation: if I give you this, what will you give me?

The government did try, though, with an official audit. Or was it just going through the motions? You have to wonder about all the numbers the audit reported, since there’s no telling what was left out. This is how Bloomberg put it over the weekend:

continue article at The Automatic Earth:

http://www.theautomaticearth.com/perverse-incentives-china/