BY HE QINGLIAN, September 11, 2018 Updated: September 11, 2018
Lately, the P2P crash has fostered many predictions about China’s impending Minsky moment.
The “Minsky moment,” named for American economist Hyman Minsky, refers to the moment at which the value of assets collapses suddenly. In China today, the two main indicators identified by Minsky — increased debt and a rising leverage ratio, have manifested quite severely. China has doubtless entered the stages of developing financial crisis and a long deleveraging cycle that Minsky described. In this sense, the economists declaring that China is about to reach its Minsky moment have grounded their arguments in fact.
How China Can Delay Institutional Aspects of the Minsky Moment
Using Western concepts to examine China issues runs the risk of overlooking important institutional factors. Minsky’s made his statements while observing a market economy under the American democratic political system, but China is an incomplete market economy under the political control of a totalitarian autocracy. There are several salient differences between the two economic systems:
The U.S. market economy is based on private ownership, wherein the government merely acts as a regulator and market monitor. The government does not control the various resources such as oil or land, nor does it own multinational enterprises. It can only launch new economic policies in the form of stimulus or choose limit development in a particular area, such as Trump’s tax cuts to attract capital back to the United States. So the government itself does not participate in the market directly. The Chinese regime, by contrast, dominates the economy via public ownership and monopolizes resources including land, forests, minerals, and so on. It commands the state enterprises and all land ultimately belongs to it. Because it also formulates the regulations, the government effectively participates in the Chinese economy as both player and referee.
In Western countries, central banks are separate from the government and can independently formulate monetary policies. The task of controlling inflation is also completed by the central bank. Aside from the 2008 financial crisis, where the Federal Reserve was asked to cooperate with the government, the U.S. government generally does not interfere with the daily work of the Fed. The Fed mainly regulates the economy through controlling the rise and fall of interest rates. Meanwhile, the Chinese central bank has no autonomy and is totally subordinate to the Politburo Standing Committee of the Chinese Communist Party (CCP).
According to an insider quoted by the Wall Street Journal’s 2011 report, “Who Decides China’s Monetary Policy?” Chinese monetary policy is the result of a compromise between various bureaucratic institutions, enigmatic committees, and the omnipresent influence of the Communist Party. In this regard, no one official makes the decisions, which makes it almost impossible for major countries to coordinate economic policy with China. For instance, it is said that Zhou Xiaochuan, who has served three terms as governor of the Central Bank, is often excluded from the Politburo Standing Committee’s discussions of monetary policy due to his lack of political qualifications.
Owing to these essential differences, the Chinese regime enjoys the ability to manipulate and intervene in the economy to an extent far greater than that of Western governments. The downsides are obvious when we consider the many financial disasters waiting to happen: systemic risk in China’s financial sector; banks bearing mountains of bad debt, among which real estate loans and state-owned enterprise loans have the highest risk; the overwhelming local government debt that has triggered a tidal wave of defaults this year; and the default risk associated with the shadow banking system’s various financial platforms.
All of this can be attributed to the government’s continuous reliance on currency tools to hedge risks. The CCP’s ability to weather financial blows is far greater than that of Western countries for this reason. For example, after problems arise with old financial instruments, the regime can continuously introduce new currency mechanisms to stave off risks.
In recent years, due to its reliance on expanding internationally, the Chinese government has adopted strategies of “exchanging space for time” in the form of Belt and Road investments, establishing Africa as a second front in the Sino-U.S. trade war, and repositioning its economic strategic position. It also utilizes ploys to “exchange time for space,” that is, procrastination tactics — directing the P2P meltdown and so on, delaying the local debt crisis, and engineering fund diversions, although the capacity for such diversions is diminishing.
How Does China Hedge Risks as the Economy Declines?
The Chinese regime must bear the burdens of its power. There are several financial crises that could explode at any time, such as the 60 trillion yuan (about $8.7 trillion) in local debt, the real estate bubble, and the peer-to-peer (P2P) lending crisis that has left millions of investors bereft of their savings. It is impossible to prevent them all; they are armed bombs that the CCP can only hope to detonate in a controlled manner. In the United States, the government does not have even this option — in the event of economic crisis, it can only provide relief in the aftermath. By relying on its unchecked powers of intervention, the CCP can assess the situation and pick the crisis that is least catastrophic. In this case, it let the P2P industry collapse and with it release some of the pressure weighing on the financial system.
There have been widely-shared reports these last few days of people committing suicide over their losses due to the P2P crash. This should not have come entirely as a surprise. In mid-June, chairman of the China Banking Regulatory Commission Guo Shuqing gave a speech at the Lujiazui financial forum. His proposal for hedging risks can be boiled down to the following: defuse financial bombs, carry out controlled demolitions, and conduct pressure tests. Guo issued a warning especially for P2P investors, telling them to be prepared to be prepared to lose the entirety of their principal for any investment with an estimated return of more than 10 percent.
With there being so many bombs, dismantling must be done step by step. Thus, the government kept two key considerations in mind when selecting P2P as the first of its “controlled demolitions.” First, the 1.3 trillion-yuan P2P loan industry is miniscule in comparison to China’s 252 trillion yuan in total banking sector assets. The collapse of P2P lending had a much smaller overall impact than if a different area were to be compromised. Second, although the number of “financial refugees” runs in the millions or tens of millions, the damages are not so serious as to pose a significant threat to the regime.
The CCP is very familiar with this approach and have applied it many times. For example, during the term of former premier Zhu Rongji, four major asset management companies were created to deal with bad debts, which were stripped, repackaged, and sold to foreign investment banks that desperately wanted to understand the operation of China’s financial system and enter the Chinese market. Under Wen Jiabao, the Chinese regime attracted foreign banks as strategic investors to restructure several bad-debt laden state-owned commercial banks through asset restructuring. The banking crises were mitigated successfully on both occasions.
Since the injection of 4 trillion yuan to save the market and hence becoming the world’s largest banknote machine in 2009, the Chinese government has depended on two “currency reservoirs” — the stock market and real estate, to hedge the oversupply of money. In 2015, the stock market plunged by 5.28 points and the market value decreased by 4 trillion yuan. On June 19, the Chinese stock market fell precipitously, and the market value evaporated by more than 2 trillion.
Since 2009, when China’s economy began to slow down, the government has assumed control over almost all bank loans. After multiple rounds of real estate speculation, most of the leverage accumulated in the previous periods were transferred to real estate buyers. The result was that several years of “real estate destocking” turned property owners and the government into a vested elite: should real estate prices fall, the CCP would have to deal with massive quantities of bad banking debt, as local governments, real estate developers, and property buyers are the main borrowers of capital from state-owned commercial banks. Property owners, meanwhile, fearing the depreciation of their assets, support government policies to maintain the real estate bubble. This year, for example, regional governments across China issued policies stipulating that no trades can be made within two years of obtaining a real estate license, with the intention of locking up real estate liquidity and allowing central banks to issue additional yuan.
Precisely because the United States and China are two completely different systems, the United States’ Lehman moment became a Minsky moment, while in China, all the conditions have matured, but the CCP has applied its innovative interventionist policies to manipulate the economy and allow it to maintain at various levels the spectacle of simultaneous inflation and austerity. Fields not supported by targeted loans have one after another had their capacity reduced, such as thermal power, electrolytic aluminum, construction materials, crude steel, and coal. Certain financial ailments that do not impact the overall situation have been allowed to run their course, such as the P2P lending crash. Therefore, China can likely postpone the Minsky moment for the foreseeable future. However, debts must eventually be repaid, and until then, the crisis will still exist.
He Qinglian is a prominent Chinese author and economist. Currently based in the United States, she authored “China’s Pitfalls,” which concerns corruption in China’s economic reform of the 1990s, and “The Fog of Censorship: Media Control in China,” which addresses the manipulation and restriction of the press. She regularly writes on contemporary Chinese social and economic issues.