China’s suspect economic data

Financial harm

Properly speculation ties immediately to banks. The financial system was unsound before the crisis. Pre-crisis estimates of government aid to banks ranged up to $650 billion. And this solved only the easy problem. Banks still routinely made, then hid, non-commercial loans. In September 2009, the Ministry of Finance itself did the same on a vast scale, rescheduling a $36 billion bond held by giant China Construction Bank (CCB), which accounted for half its net assets. Cinda Asset Management sold the bond to help absorb CCB’s bad debts, then survived on handouts from China’s central bank. CCB can claim adequate capital but only due to yet more government assistance. The largest state bank, Industrial and Commercial Bank of China, holds $46 billion in bonds of the same type.

Enter the $586 billion stimulus program. Provinces were to spend two-thirds, but many wanted far more. A few weeks after the stimulus was announced, provincial spending plans reached $1.47 trillion. By law, local governments cannot report budget deficits, so the stimulus had to come largely through banks. Official data have local government debt in 2009 alone rising 70 per cent to $1.08 trillion, or over 20 per cent of GDP. In comparison, 20 per cent of American GDP is $2.8 trillion - two years of current federal deficits. Beijing attacked local borrowing, but more still occurred in the first half of this year. Just a partial government audit found seven provinces with larger debt than annual revenue.

Finally, since 2007, banks have transferred loans to investment trusts, moving them off their own balance sheets. Transfers were banned at the end of June 2010, but an estimated $300 billion in assets were moved in the preceding nine months alone. Banks do not hide excellent assets, and the ultimate rate of failure for transferred assets may be high.

Lack of transparency clouds the question of system solvency, but there are hints. In early spring - before the damage was finished, much less tallied - the four largest listed banks needed $70 billion in fresh capital. Chinese banks chiefly raise money, through rights offerings or subordinated debt, from other Chinese banks. For the past decade, smaller banks grew faster than the large listed banks. Faster lending in a slower economy generally makes for weaker balance sheets. And larger banks have received far more government aid. The large listed banks may be turning to even shakier allies for help.

More ominous is that the government, too, seeks funds. Many government bank stakes are held in an entity known as Central Huijin, which will assist with banks’ needed fundraising. But Central Huijin has to raise capital to buy bonds and stock from its charges. The main purchasers of its bonds will be banks themselves. The central government is turning for capital to a system turning to the central government for capital.

Silver lining?

To be clear, there is no imminent crisis. Bad debts will accrue this year and next. They should appear on bank books in 2011 and 2012, and the inevitable bailout will start no later than 2014. The wisdom of the stimulus cannot be fully judged until then.

For now, a slower economy suffering financial strain may turn Beijing towards enhancing prosperity with less state spending. More open investment and trade offer exactly that. While foreign attention is focused on the exchange rate and trade trends, China has finally moved a bit towards internationalising the RMB. A trial program to use RMB in trade was greatly expanded. The trade program is quite substantial, but it can achieve little without a means of investing held RMB. Such a means is now under consideration.

It is thus conceivable that the autumn meetings of the US-China Joint Commission on Commerce and Trade could actually be fruitful. Longstanding American calls for balance of payments reform might be heeded. For its part, the US should pledge an end to simultaneous application of countervailing and anti-dumping duties on Chinese goods or to make investment regulations more transparent.