The recent actions of the Chinese government suggest a temporary avoidance of a major stock market crisis. To achieve this, the People’s Bank of China has made direct stock purchases on the Shanghai Stock Exchange. But what kind of illusion is this?
This move reflects a desperate strategy that merely postpones deeper issues. The financial and economic landscape in China remains troubling. Similar to the stock market, the country’s economic fundamentals are also misaligned.
Beijing’s strategy of extensive credit expansion has encouraged Chinese corporations to accumulate staggering amounts of debt, which now stands at an alarming $16.1 trillion. This figure represents the largest corporate debt burden in the world, and it appears to be unsustainable.
Companies in China are experiencing an unsettling reality where debt levels are rising even as profits decline. Attempting to increase production to counteract profit losses only compounds the dilemma. Businesses cannot offset diminishing profitability through increased volume.
The structural economic challenges are exacerbated by the prevalence of state-owned enterprises, which are notoriously inefficient. Yet, these firms are continuously sustained, allowing them to draw on credit despite incurring losses.
Buyer of Last Resort
According to a study by Thomson Reuters, “Corporate China’s debts have reached 160 percent of GDP, which is double that of the United States and has sharply deteriorated over the past five years.” Additionally, Standard & Poor’s forecasts that this debt mountain could escalate by 77 percent to $28.8 trillion within the next five years.
Beijing’s interventions in the corporate credit space seem primarily focused on maintaining economic growth, which is projected to hit a 25-year low this year. The government has cut interest rates four times since November, lowered reserve requirements for banks, and eliminated lending limits on their deposits. Although there is a desire to direct more of this credit towards smaller and innovative firms, these measures are somewhat blunt and ineffective.
“When the credit taps are opened, there’s a heightened risk that the funds will flow to ‘problematic’ companies or entities,” noted Louis Kuijs, RBS chief economist for Greater China. He pointed out that while policy easing has lowered short-term interest costs, lending for stock speculation has surged, offering little evidence that these loans are fostering genuine investment in the real economy—where long-term borrowing costs are still prohibitively high and banks hesitate to take risks.
This situation paints a stark picture of the chaos that has resulted from short-sighted policies aimed at stimulating the economy. The stock market, rather than functioning as a mechanism for efficient capital allocation, has become akin to a game of chance fueled by easy credit.
Recently, the Shanghai Composite Index was pushed to its limits, becoming increasingly volatile. Consequently, the People’s Bank of China has found itself serving as the buyer of last resort.
China’s Exercise in Futility
The emergency measures undertaken by China to stabilize its stock market represent an ultimately futile endeavor. As corporate profits continue to decline, maintaining inflated stock values will grow increasingly challenging. The likelihood of bankruptcies, bailouts, and market upheavals is on the rise.
These issues extend beyond China’s borders; other regions, including the United States, Europe, and Japan, have also resorted to injecting credit into their economies for growth. The Bank of Japan, for instance, has engaged in direct stock purchases as well.
Similar economic distortions are accumulating globally, potentially foreshadowing a challenging adjustment period ahead. Recently, Raghuram Rajan, governor of the Reserve Bank of India, cautioned the London Business School that the monetary strategies of developed nations could be creating parallels to the conditions leading to the Great Depression.
“I am concerned that we are slipping into issues reminiscent of the 1930s in our efforts to stimulate growth,” Rajan stated. “This is not merely a concern for developed nations or emerging markets anymore; it is a global issue.”
Notably, Rajan accurately predicted the financial crisis of 2007-2008, indicating that his current warnings should not be taken lightly.
Sincerely,
MN Gordon
for Economic Prism
