China is a force to be reckoned with but is this great growth sustainable?
It is now conventional knowledge that China’s economy has undergone rapid and remarkable development, since the inception of the reform era in 1978. In turn, China has experienced approximately 10% GDP growth per annum.[1] However, such accelerated economic growth can no longer be sustained as recognised by scholars and the Chinese Communist Party (CCP) alike. Instead, the People’s Republic of China (PRC) acknowledges its slower growth as a ‘new normal’ and the necessity to embrace a different economic model.[2] One which relies less on investment and exporting and rather a model that utilises innovation to drive its economic growth. This is evidenced by the recent launch of President Xi Jinping’s ambitious innovative initiatives such as “One Belt, One Road” and “Made in China 2025”. Nonetheless, this paper posits that China’s slowing growth is not the issue in question, rather more pessimistically this study examines China’s likely trajectory toward a financial crisis subsequently positioning itself at the epicentre of the next Global Financial Crisis (GFC). We claim that the unsustainability of its current model is the result of overdevelopment in its financial sector leading to what we can observe as financialization.[3] Although not yet matching highly financialised economies such as the United States, it has become apparent that various phenomena of financialization are clearly observable in China.[4]
This paper suggests that the expansionary monetary policy implemented to counter the 2008 GFC and thus stimulate the Chinese economy is similarly being re-introduced in light of the current Covid-19 global pandemic. Arguably, the fiscal policy has fuelled the financial system specifically leading to a real estate bubble, the volatile stock market, and the shady banking sector. As a result, the negative interaction between the aforementioned sectors will contribute to China’s impending financial crisis. Overarchingly, we claim that the financialization of the Chinese economy will be its Achilles heel.[5] The forecasted financial crisis illustrates why such research has never been more necessary. The deep economic linkages between China and the global economy, particularly its key trading partners, illustrates the need for precautionary warnings to policymakers, so that they may consider the risks to all national incomes and government revenues.[6]
(Un-)Sustainability
The notion of sustainability is intended to encapsulate the understanding that for future generations, the Earth will have the equitable capacity to support their livelihoods as it did for previous generations.[7] Formally, the most celebrated and applied notion of sustainability is provided by the World Commission on Environment and Development (the Brundtland Commission) in 1987: “development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs”.[8] Thus, in an economic sense and for the purposes of this paper, a sustainable development model can be considered as a path that pursues and achieves a non-declining per capita over a period of time.[9]
In short, overarchingly academia suggests that China’s era of ‘above-normal’ growth is coming to a close.[10] The International Monetary Fund claims that China has reached an inflection point whereby its growth model will lead the economy into either the middle-income trap or cause a financial crisis.[11] A variety of literary suggestions attempt to interpret China’s unsustainable trajectory, centring specific factors such as the challenges posed by the environment, China’s industrial policies and state-owned enterprises, its rule of law and corruption levels, demographic problems, and the state’s incomplete transition to a market economy.[12] These factors should be examined in greater detail elsewhere, as to varying degrees, these are also likely to be contributing. However, in accordance with scholar Bello’s claim, we find that financialization of the Chinese economy should be assumed to be its gravest threat, suggesting that its trajectory is leading to a financial crisis. Without immediate policy changes by China’s leadership, the current growth model will soon demonstrate a declining per capita income for its population, evidently an unsustainable approach to development.
Financialization and the Chinese State
While the 2008 GFC reinvigorated academic research regarding the correlations between financialization and economic growth and financial cycles, within a global pandemic context, now is a vital time to reintroduce the debate.[13] As governments produce similar policies as seen in their attempts to counter the 2008 GFC, it is integral to understand the role financialization may play in states economic growth trajectories. In a purely definitional sense, according to Krippner, financialization is the process in which profit is acquired through financial trading rather than through trade or production. Importantly, this demonstrates the funnelling of resources to the financial economy, rather than the real economy.[14]
It is important to recognise that the finance-growth nexus is greatly contested within the literature, with both theoretical and empirical competing claims. On the one hand, the World Bank and famously scholars such as King and Levine assert that a well-functioning financial system has the capacity to exert long-run economic growth, through influencing investment outcomes, technological innovation, and savings rates.[15] Thus, arguing that finance is integral to economic growth. Conversely, economists such as Epstein, Minsky, and Bello have stressed the unstable nature of overdevelopment in the financial sector with immensely damaging effects on a countries economic growth and distribution.[16] Specifically, examining Post-Keynesian models and inflation targeting regimes their results indicate that expansive finance-led economies are likely to amass financial imbalances, that being largely rising dept-capital or debt-income ratios.[17] This could cause such economies to not only experience reduced economic growth but lead to a financial crisis.
Since the Global Financial Crisis 2007-2009, finance has become an integral element of China’s economic system.[18] The CCP formally announced at the Third Plenary Session of the 18th National Congress of the Chinese Communist Party in 2013 that markets played a ‘decisive role’ in allocating resources and enhancing growth in the Chinese economy, this notion was reaffirmed in 2017 at the 19th Congress.[19] The leadership have demonstrated that finance will play the leading role in China’s development and subsequently the financial sector has grown rapidly in recent years. Perhaps this could be attributed to the Chinese government’s countermeasures to the 2008 financial recession, predominantly its expansionary monetary policy.[20]
This introduced two primary tools to stimulate the economy 1) increasing the total money supply facilitated by a US$564 billion fiscal stimulus package, and 2) credit expansion under low-interest rates and as a result of national and local government policies.[21] Although the expansionary monetary policy boosted China’s post-recession GDP, this growth is not represented in the production of commodities and thus the real economy. Rather we can observe that these measures facilitated the channelling of resources into the financial sector. As evidenced by the fact that between 2003-2006 and 2014-2017, the ratio of market- to bank-based output increased from 0.2 to 1.09 and the average total value of stocks that were traded rose from 27.2% to 193.2% of GDP.[22] Consequently, the financial sector’s contribution to GDP growth between 2007 and 2015 nearly doubled from 5% to 9%.[23]
More recently, at the May 22 rescheduled National People’s Congress, China published its Government Work Report. This primarily presents a fiscal policy that is largely a re-imagining of its post-GFC expansionary monetary policy in order to revive its economy following the fallout of Covid-19. The detailing of a US$667bn infrastructure-centred stimulus package in order to stimulate the economy following the fall out of the coronavirus outbreak surpasses the US$564bn package released in December 2008.[24] Specifically, the government announced that it will issue US$140billion in special treasury bonds to support businesses and has encouraged banks to increase their finance lending to businesses by more than 40%.[25] Arguably, this enhanced expansionary monetary policy will refuel an already highly financialised economy which we can observe in the following:
Real Estate Bubble
The real estate sector is one of the most important markets for China, with the real estate market and its related industries contributing to 1/3 of China’s GDP and 20% of the national demand for loans.[26] At present, China is directly in the midst of a real estate bubble. From 2010, for small enterprises and housing for households, credit requirements were abolished entirely. Additionally, between 2011 and 2014, Tier 1 cities such as Beijing, Shanghai and Shenzen significantly reduced endowments on housing tax and housing credit requirements.[27] In turn, the real estate market began attracting a large proportion of the wealthy and middle-class population with excess liquidity, drastically speeding up speculation.[28]
In 2015, this became particularly evident in Tier 1 cities whereby mass speculation caused the price of real estate to rise by 20.2% in Beijing and 23.7% in Shanghai.[29] Although authorities have identified the rapid rise in real estate investment, measures to ‘pop’ the bubble have been slow and purposely insufficient. Major cities have imposed measures such as increasing down-payment requirements, banning the resale of property for a period of time, restricting the number of properties an individual can purchase, and tightening mortgage restrictions. Primarily the ineffective nature of these regulations is based on the leaderships presumption that real deflation of the ‘bubble’ could negatively affect real estate associated industries particularly the construction sector and its subsequent supply chain. This would include steel, iron, cement, and other building materials. The findings of this analysis contribute to our understanding of the dire real estate bubble in China and illustrate the potential association between a real estate crisis transitioning into a financial crisis.[30] In turn, China’s present situation should be considered both alarming and a warning for Chinese policymakers.
China’s Stock Market
China is now the second-largest equity market following the United States. However, excessive volatility still occurs regularly, with benchmark indices jumping typically 10% in hours. Further evidenced by a single trading day in June 2015, which marked a $700billion loss of value wiped off of Chinese stocks.[31] As Xiaochuan, the former PBOC governor explained, “the quality of the stock market still has some problems such as the transparency, the supervision, the maturity of the investors and whether they know what they are doing”.[32] Following the financial repression, the interest rates on deposits were low which as previously mentioned pushed many investors into real-estate speculation. However, with a very obvious ‘bubble’ in that sector and thus increasing uncertainty some investors shifted to China’s relatively un-regulated stock market in search of higher returns.
Unfortunately, for many who choose to invest their wealth in the stock market, due to the wild fluctuations of stock prices, many have lost their fortunes. One of China’s leading reform economists, Wu Jinglian noted as early as 2001, that the stock exchanges in Shanghai and Shenzhen are corruption-ridden and could be characterised as “worse than casinos”.[33] When the Chinese stock market lists large losses, particularly incidences such as the Shanghai index plunging 40% in 2015, for some it is the loss of all their savings.[34] Not only is this in an economic sense a rising debt issue and thus an impending national crisis compounded by the lack of social-security networks but it is also a personal tragedy for some Chinese citizens. Although Forbes identified that China’s mainland equity market was up by 33% in 2019, making it one of the top-performing stock markets globally, this only further illustrates the rapid and incredibly fluctuating market in China.[35]
Shadow Banking & Negotiable Certificates of Deposit (NCDs)
The shadow banking sector plays an integral role in China’s money-creating system, which has illuminated numerous challenges to the management of China’s financial risk.[36] The shadow banks constitute a network of financial intermediaries who do not operate under the formal, government-regulated banking system.[37] Thus, shadow banks transactions are not evident on the balance sheets of China’s financial institutions.[38]
This sectors prominence is the result of the national credit systems monopoly, favouring particular industries for credit, specifically export-centred enterprises, state-owned enterprises and specific local governments.[39] In turn, this leads to a lack of available credit for the private sector. This void has been filled by shadow banks. Perhaps of most importance, under the recent Covid-19 stimulus package, as aforementioned the national banks have been encouraged to enhance financing to businesses by 40%.[40] Due to the monopoly and demand for credit, we should expect a rapid rise in private sector enterprises defaulting or turning to the shadow banking sector for support. The risk this poses is concerning. If a shadow banking crisis occurs, the non-performing loans within this shadow sector may be transferred to the formal banking sector, potentially toppling this too.[41] Arguably, what this suggests is that national credit regulations are necessary, particularly diversification of credit receiving industries in order to preserve as many sectors as possible in the current climate.
Additionally, Listerud and Sinclair identify a relatively new element that has been largely overlooked in Chinese economic literature, that of interbank lending in China: the introduction of NCDs in December 2013.[42] Typically, NCDs are bonds that are issued from one bank to another that a) have a minimum face value of US$100,000 and; b) require short-term payback.[43] This between bank process has provided a useful method for liberalising interest rates and providing banks with more flexibility to set their own interest rates.
Since their introduction, NCD usage has rapidly grown, making up approximately 17% of all Chinese bonds in July 2017 and by April 2018 NCDs were the fourth-largest type of bond in China following sovereign, local, and policy-bank bonds.[44] The interbank credit crisis in 2013 encouraged the People’s Bank of China (PBOC) and China Banking Regulatory Commission (CBRC) to reform regulations to ensure interbank loans did not surpass one-third of a bank’s liabilities.[45] Yet a loophole in regulations that were not amended until 2017, did not require NCDs to be listed as interbank loans on balance sheets. Ultimately NCDs were not tracked as stringently as other loans. In these three years, NCDs rose to prominence while avoiding banks debt caps and the PBOCs regulatory investigations. In some instances, when NCDs were finally incorporated into banks’ balance sheets, interbank lending ratios doubled.[46] This illustrates the serious risk that NCDs pose, that being the financialisation of these products on such a grand scale. They illustrate a transfer of decreasing amounts of money between institutions. Overarchingly, they present an illusion of profits while actually adding very little value to the real economy.[47]
On analysis, the expansionary monetary policy implemented in order to counter the 2008 GFC and its recent reintroduction, in light of the Covid-19 pandemic, played a key role in fuelling the financialization of the Chinese economy. As demonstrated this financialization has caused great financial instability within the financial system; namely the real estate, stock market and banking sectors. This paper projects that this instability will likely increase, surmounting in an overt crisis. In turn, depressing China’s long-run economic growth and proving the unsustainability of the current growth model. This has important implications, given the deep international economic linkages and the strong gyrations of global finance. China’s impending financial crisis is not just a domestic threat but also a grave threat to the world economy. Following this assessment, this paper argues that in order for such a crisis to be prevented the CCP must enact fundamental reforms and regulations upon the countries finance system.
References
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Brundtland Commission. Our Common Future. Oxford: Oxford University Press, 1987. ProQuest E-Library.
Chen, Yan, Ya Cai, and Chengli Zheng. “Efficiency of Chinese Real Estate Market Based on Complexity-Entropy Binary Causal Plane Method.” Complexity, (2020): 1-15. https://doi.org/10.1155/2020/2791352
Ellyatt, Holly. “Expect more market shocks in China as investors figure out what they’re doing, ex-central bank chief says.” CNBC, September 11, 2018. https://www.cnbc.com/2018/09/11/chinas-stock-market-is-still-immature-so- volatility-is-to-be-expected-former-pboc-governor-says.html
Jiang, Jason. “Beijing details $667bn infrastructure-focused stimulus package.” Splash247, May 22, 2020. https://splash247.com/beijing-details-667bn-infrastructure-focused- stimulus-package/
Listerud, Ann, and Maria Sinclair. “The Snake that ate itself: Financialisation of China’s Negotiable Certificates of deposit.” Center for Strategic and International Studies. Accessed May 13, 2020. https://www.csis.org/npfp/snake-ate-itself- financialization-chinas-negotiable- certificates-deposit
Morrison, Wayne. “China’s economic rise: history, trends, challenges, and implications for the United States.” Congressional Research Service. Last modified June 25, 2019. https://fas.org/sgp/crs/row/RL33534.pdf
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Noble, Josh. “FT Explainer: Why are China’s stock markets so volatile?” Financial Times, July 3, 2015. https://www.ft.com/content/e5af8da0-1fc7-11e5-aa5a-398b2169cf79
Pearce, David, and Giles Atkinson. “The concept of sustainable development: An evaluation of its usefulness ten years after Brundtland.” Swiss Journal of Economics and Statistics 134, no.3 (1998): 251-269. https://doi.org/10.1007/BF03353896
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Rapoza, Kenneth. “Is This Why China’s Stock Market is up so much in 2019?” Forbes, December 18, 2019. https://www.forbes.com/sites/kenrapoza/2019/12/18/is-this-why- chinas-stock-market-is-up-so-much-in-2019/#e29205c79d41
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[1] “The World Bank In China,” The World Bank, last modified December 13, 2019, https://www.worldbank.org/en/country/china/overview#1
[2] Wayne Morrison, “China’s economic rise: history, trends, challenges, and implications for the US,” Congressional Research Services, last modified June 25, 2019, https://fas.org/sgp/crs/row/RL33534.pdf
[3] Ann Listerud and Maria Sinclair, “The Snake that Ate itself: Financialization of China’s Negotiable Certificates of deposit,” Center for Strategic and International Studies, accessed May 13, 2020, https://www.csis.org/npfp/snake-ate-itself-financialization-chinas-negotiable-certificates-deposit
[4] Johannes Petry, “Financialization with Chinese characteristics? Exchanges, control and capital markets in authoritarian capitalism,” Journal of Economy and Society 49, no. 2 (2020): 214, https://doi.org/10.1080/03085147.2020.1718913
[5] Walden Bello, Paper Dragons: China and the next crash (London: Zed Books, 2019), chap. 1, 3, ProQuest Ebrary.
[6] Ivan Roberts and Brendan Russell, “Long-term Growth in China,” Reserve Bank of Australia, December 12, 2019, https://www.rba.gov.au/publications/bulletin/2019/dec/long-term-growth-in-china.html
[7] David Pearce and Giles Atkinson, “The concept of sustainable development: an evaluation of its usefulness ten years after Brundtland,” Swiss Journal of Economics and Statistics 134, no. 3 (1998): 251, https://doi.org/10.1007/BF03353896
[8] Brundtland Commission, Our Common Future (Oxford: Oxford University Press, 1987), 5, ProQuest Ebrary.
[9] Pearce and Atkinson, “The concept of sustainable development,” 251.
[10] Roberts and Russell, “Long-term Growth in China.”
[11] The World Bank, China 2030: Building a Modern, Harmonious, and Creative Society (Washington: International Bank for Reconstruction and Development / Development Research Center of the State Council, the People’s Republic of China, 2013), 8, https://www.worldbank.org/content/dam/Worldbank/document/China-2030-complete.pdf
[12] Morrison, “China’s economic rise: history, trends, challenges, and implications for the US.”
[13] Bello, Paper Dragons: China and the next crash, 3.
[14] Ibid.
[15] Lixin Sun, “Quantifying the Effects of Financialization and Leverage in China,” The Chinese Economy 51, no. 3 (2018): 211, https://doi.org/10.1080/10971475.2017.1398363
[16] Sun, “Quantifying the Effects of Financialization and Leverage in China,” 211.
[17] Ibid.
[18] Petry, “Financialization with Chinese characteristics?” 214.
[19] Petry, “Financialization with Chinese characteristics?” 214.
[20] Trieu Nguyen, “China’s Growing Real Estate Bubble,” Mises Institute, last modified November 16, 2019, https://mises.org/wire/chinas-growing-real-estate-bubble
[21] Nguyen, “China’s Growing Real Estate Bubble.”
[22] Petry, “Financialization with Chinese characteristics?” 216.
[23] Ibid.
[24] Jason Jiang, “Beijing details $667bn infrastructure-focused stimulus package,” Splash247, May 22, 2020, https://splash247.com/beijing-details-667bn-infrastructure-focused-stimulus-package/
[25] Frank Tang, “China coronavirus stimulus: what measures have been used to combat the economic impact of Covid-19?” The Coronavirus Pandemic, May 8, 2020, https://www.scmp.com/economy/china-economy/article/3083268/china-coronavirus-stimulus-what-measures-have-been-used
[26] Yan Chen, Ya Cai, and Chengli Zheng, “Efficiency of Chinese Real Estate Market Based on Complexity-Entropy Binary Causal Plane Method,” Complexity, (2020): 1, https://doi.org/10.1155/2020/2791352
[27] Nguyen, “China’s Growing Real Estate Bubble.”
[28] Bello, Paper Dragons: China and the next crash, 10.
[29] Simon Zhao, Hongyu Zhang, Yanpeng Jiang, and Wenjun Pan, “How big is China’s real estate bubble and why hasn’t it burst yet?” Land Use Policy 64, (2017): 153, https://doi.org/10.1016/j.landusepol.2017.02.024
[30] Zhao, Zhang, Jiang, and Pan, “How big is China’s real estate bubble and why hasn’t it burst yet?”
[31] Josh Noble, “FT Explainer: Why are China’s stock markets so volatile?” Financial Times, July 3, 2015, https://www.ft.com/content/e5af8da0-1fc7-11e5-aa5a-398b2169cf79
[32] Holly Ellyatt, “Expect more market shocks in China as investors figure out what they’re doing, ex-central bank chief says,” CNBC, September 11, 2018, https://www.cnbc.com/2018/09/11/chinas-stock-market-is-still-immature-so-volatility-is-to-be-expected-former-pboc-governor-says.html
[33] Bello, Paper Dragons: China and the next crash, 15.
[34] Ibid.
[35] Kenneth Rapoza, “Is This Why China’s Stock Market is up so much in 2019?” Forbes, December 18, 2019, https://www.forbes.com/sites/kenrapoza/2019/12/18/is-this-why-chinas-stock-market-is-up-so-much-in-2019/#e29205c79d41
[36] Guofeng Sun, “China’s Shadow Banking: Bank’s Shadow and Traditional Shadow Banking,” BIS Working Papers, last modified November 8, 2019, https://www.bis.org/publ/work822.htm
[37] Bello, Paper Dragons: China and the next crash, 15.
[38] Ibid.
[39] Ibid.
[40] Tang, “China coronavirus stimulus: what measures have been used to combat the economic impact of Covid-19?”
[41] Bello, Paper Dragons: China and the next crash, 15.
[42] Listerud and Sinclair, “The Snake that Ate itself.”
[43] Ibid.
[44] Ibid.
[45] Listerud and Sinclair, “The Snake that Ate itself.”
[46] Cindy Wang, “China / Hong Kong Industry Focus: China Banking Sector,” DBS Vickers, April 16, 2018, https://assets.kpmg/content/dam/kpmg/cn/pdf/en/2019/06/the-future-of-banking.pdf
[47] Listerud and Sinclair, “The Snake that Ate itself.”
