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China’s Stimulus Quagmire

By Leland R. Miller | The Wall Street Journal | January 21, 2015 | 2 pages



Even with Monday’s 7.6% decline, China’s stock market is on a historic tear, having risen more than 50% over the past year. Yet much of this investor frenzy is based on three flawed premises: that China’s decelerating growth necessitates stimulus, that such stimulus will reduce borrowing costs for firms, and that lower borrowing costs will incentivize spending and ultimately jumpstart growth.

New data from my firm’s China Beige Book—the largest private study of China’s economy—belie each of those assumptions. Our data make it clear that China doesn’t desperately need to stimulate its economy, that its recent attempts to lower interest rates via stimulus have done the opposite, and that if Beijing opts for large-scale stimulus anyway, it won’t work as intended.

Market participants often seem to misunderstand what China’s slowdown means. While the economy has continued to decelerate broadly, important components—including profit performance and the labor market—have shown overall improvement since 2014’s second-quarter nadir. In the just-completed fourth quarter, China Beige Book data on sales, profits and job growth all looked a bit better, as they had in the third quarter. This is a tentative rebound, to be sure, but it is hardly the gloom and doom narrative that most commentators (glued to older data) have now accepted as gospel.

Recent “stimulus” measures, including November’s cut to the benchmark lending rate, haven’t reduced borrowing costs for firms. The opposite has happened. Since last year’s second quarter, according to our data, the cost of capital has risen across the board—for bank loans, shadow-bank loans and especially bonds.

Perhaps most frequently overlooked: Firms still don’t want to borrow. The share of firms applying for and receiving loans dropped again in the fourth quarter, to the lowest levels we have recorded since beginning to survey in the first quarter of 2012. Since then, the share of firms borrowing has now dropped by more than half.

Crucially, firms don’t want to spend either. In the fourth quarter, growth in capital expenditure ticked down for the fourth straight quarter, also notching our survey’s all-time low.

Even the fourth quarter’s best performers—services firms—are caught in the wave: In multiple regions this quarter, including those that house the critical cities of Shanghai, Guangdong and Chongqing, services firms saw improved revenue growth, yet the proportion that hiked capital expenditures dropped anyway, in some cases dramatically. If firms don’t want to spend, monetary stimulus is a lost cause.

Plummeting crude-oil prices are a reason for optimism, given that China is a huge net consumer of energy. Our data track a steady pattern of disinflation in the Chinese economy since the first quarter of 2013, with sales prices, wages and material-input costs all continuing to rise, but ever more slowly. With the impact of cheap oil yet to be felt, 2014’s disinflation could become outright deflation in 2015.

Producer deflation is much better for an economy than consumer deflation. But with the economy slowing, Japan undertaking record quantitative easing and the eurozone headed in that direction, any sort of deflationary headwind may make it awfully hard for Beijing to resist another large stimulus of its own.

Here we get to the critical takeaways for investors: China’s slowdown may create the illusion that China has little choice but to stimulate, but our data show otherwise. Yet even if such stimulus is ultimately enacted, it simply will not work as intended.

Firms haven’t been interested in borrowing or spending on new projects for a year now. It is possible that low enough interest rates could change their behavior but to date rates haven’t been pushed downward by easing measures.

Instead, what companies are most likely to do if more liquidity is injected into the system is jump deeper into the roaring stock market. Already some of the inflows into stocks have come from the floundering property sector that Beijing has tried to stabilize.

If more firms move capital into stocks, the result won’t be more growth but rather more out-of-control prices for equities. And the structural impediments that are slowing China down will remain untouched.

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