For a long time when it came to Chinese loan creation, analysts would only look at the broadest reported aggregate: the so-called Total Social Financing. And, for a long time, it was sufficient – TSF showed that in under a decade, China had created over $20 trillion in new loans, vastly more than all the “developed market” QE, the proceeds of which were used to kickstart growth after the 2009 global depression, to fund the biggest capital misallocation bubble the world has ever seen and create trillions in nonperforming loans.
However, a problem emerged about a year ago, when it was revealed that not even China’s TSF statistic was sufficient to fully capture the grand total of total new loan creation in China. We profiled this three months ago in a post titled “China’s Debt Is Far Greater Than Anyone Thought“, where, according to Goldman, “a substantial amount of money was created last year, evidencing a very large supply of credit, to the tune of RMB 25tn (36% of 2015 GDP).” This massive number was 9% higher than the TSF data, which implied that “only” a quarter of China’s 2015 GDP was the result of new loans. As Goldman further noted, the “divergence from TSF has been particularly notable since Q2 last year after a major dovish shift in policy stance.”
In short, in addition to everything else, China has also been fabricating its loan creation data, and the broadest official monetary aggregate was undercutting the true new loan creation by approximately a third. The reason for this is simple: China does not want the world – or its own population – to realize just how reliant it is on creating loans out of thin air (and “collateralized” by increasingly more worthless assets), as it would lead to an even faster capital outflow by the local population sensing just how unstable the local banking system is.
Unfortunately for the Beijing politburo, there are ways to find the real number. This is how Goldman did it: the firm’s approach is not to directly quantify the amount of credit extended, because financial institutions (FIs) do not provide good clarity on the true nature of their assets and hence it is difficult to conclude how much of those are indeed credit to corporates and households. Rather, the firm looks at the mirror image of credit—i.e., “money”, which is a metric related to FIs’ funding side. The basic idea is that credit generation is essentially a money creation process, hence an effective gauge of “money” can give a good sense of the pace of credit. But as the officially reported broad money, M2, has been rendered less relevant by continued financial diversification, so Goldman construct our own money flow measure to fit our purpose.
- Quantify the money flow from households and corporates to various financial investments, including i) bank deposits from households and corporates and ii) non-deposit financial investment by households and corporates, including wealth management products (WMPs), investment funds, insurance schemes and collective trust products.
- Adjust the money flow measure above for factors that affect the quantity of money but are unrelated to credit generation; These include changes in net government financial balance, FX/RMB conversion by households and corporates, and cross-border RMB flow.
- Add entrusted loans (which are company-to-company lending and do not create money) to the adjusted money flow measure to make it comparable to the TSF concept.
The table below shows Goldman’s estimates for 2016 Q1-Q2, in addition to its estimates for 2011- 2015 discussed previously. In seasonally adjusted terms, our estimate of credit flow for the first half of 2016 is 35% of GDP.
Here is the good news: compared to late 2015, the record credit creation has slowed down fractionally, and the gap with the TSF total has shrunk. The smaller gap seems to be in line with recent reports that listed banks’ “investment receivables” expanded less rapidly in 2016 H1, and it might partly reflect the regulators’ tougher stance against shadow lending in recent months.
And now, the bad news: this “tougher stance” has not been nearly tough enough, because as the following chart shows on a 1-year moving average, nearly 40% of China’s “economic growth” is the result of new credit creation, or in other words, new loans.
What this really means, is that China’s debt/GDP, estimated most recently by the IIF at 300%…
… is now growing between 30% and 40% per year, when one accounts for the unaccounted for “shadow” credit conduits.
Here is how Goldman concludes this stunning observation:
The PBOC appears to have shifted to a less dovish, though still supportive, policy bias in the last few months. However, given the prospective headwinds from slower housing construction and tighter on-budget fiscal stance in the coming months, there remains a clear need to sustain a high level of infrastructure investment, which is credit intensive, to achieve the minimum 6.5% full-year growth target (see our recent comment here). This poses constraints on how much further the PBOC can keep reining in credit, in our view.
Translating Goldman, some time around 2019, China’s total Debt/GDP will be over 400%, an absolutely ridiculous number, and one which assured a banking, if not global, financial crisis. The only saving grace is that for the time being, the PBOC and Beijing have managed to sweep away China’s unfixable problems under the rug, with a series of amazing distractions and the effectively nationalization of the stock, bond and FX markets. Alas, this is also the basis for “recovery” in all other developed nations, which means that as of this moment, it is a race between the world’s central banks not who can devalue the fastest, but who can avoid losoing credibility first, and watch as these Keynesian mountains of debt, never before seen in the history of manking, come crashing down as JM Keynes “long run” finally catches up with everyone.