Is China Heading for a Crash or a Meltdown? (2010+) [<]

Very early in the 21st century China faced significant economic, financial, environmental, demographic and political constraints. Crisis scenarios could be identified though avoiding them was possible (see above). In response to the 2008 Global Financial Crisis (GFC) China faced significant economic disruption and difficulties in identifying future strategies (eg because export-dependent growth no longer seemed reliable). Changes were made that made little sense in terms of Western economic principles. Rural groups in north China gained influence relative to the commercial south and reportedly favoured military over economic tactics to boost China's power  And there was serious internal political discord that put the regime at risk.

In July 2010 a Chinese ratings agency (Dagong Global Credit) gave China a higher credit rating than the US - which is the opposite of the position taken by Western-based ratings agencies [1]. This follows complaints by Beijing that Western ratings agencies fail to give China full recognition of its economic strength [1], because of an ideological bias in favour of the West [1]. This presumably implied that the Chinese rating agency bid not accept financial criteria (which are central to Western economic decision making but much less important in East Asia - see evidence) as the major basis for a credit rating.

In the face of severe difficulties facing both Europe and the USA as a consequence of the GFC there was also a perception that those difficulties would mark the end of 500 years of Western global predominance (eg see In China's Orbit, 2010). Similar views have been expressed by other observers.

In August 2011, as a consequence of a sovereign debt crisis in Europe (involving risks to quite large economies, ie Spain and Italy) and difficulties in containing US government debts led to the loss of its AAA credit rating, there were again pronouncements about this signally the future global dominance of China. However the issues were far more complex than commentators who failed to consider the origins of major international financial imbalances seemed to realize.  Such commentators' typical implication (ie that China's main risk from the US credit downgrade) was losses on its $US holdings was grossly simplistic - see It's Serious for China.

An Australian expert on 'Asia' has periodically argued for raising Australia's standards to meet the higher levels of aspiration and excellence that exist in 'Asia', on the assumption (apparently shared by a prominent Australian political leader) that the Western institutions and methods that have been dominant over the past 2 centuries will no longer be relevant (see Learning From, Rather than About, Asia).  However such suggestions about the superiority of Chinese traditions are not accompanied by any clear explanation of what those traditions are (presumably because clarity of understanding is incompatible with those traditions) or of the incompatibility between the authoritarianism that those traditions imply and the liberal values that have underpinned Western societies.

In March 2013 a 'Chinese' view of future international relations based on peaceful development was expressed by China's ambassador to Australia - an aspiration that was both noble and replete with uncertainties (see Creating a New International on China's Terms).

However the issues involved in postulating China's future global predominance seem more complex than such views indicated (see Ending the West's Global Predominance?).

For example: One point of particular importance is the expectation that 'Asian / Chinese' capital would be able to finance development elsewhere or meet the needs for borrowing by heavily indebted governments elsewhere. because ‘Asian capital’ is not able to be provided on the basis of the balance sheets of financial institutions, but rather draws upon cash flows generated by high-turnover production with limited regard to profitability and enforcing a high rate of national savings. As the domestic demand deficits and international imbalances this strategy requires were getting close to disrupting global economic growth, ‘Asian capital’ would cease to be available to anyone (because, if the strong cash flows abate, there would be no basis for providing capital).

Rather than being economically strong China seems to face the risk of a severe financial crisis due to unwise investment, and in the longer term structural difficulties affecting its social, economic and political systems appear to create the risk of an implosion. And at the same time China's attempt to Create a New International 'Confucian' Financial, Economic and Political Order (which would allow its unaccountable elites to rule as the center of a 'middle / coordinating / organizing kingdom' like that from which Asia was administered prior to Western expansion) may not actually work or be widely accepted. After all Mao's cultural revolution involved an attempt to drive Confucian influences from China because they were seen to have been oppressive (even though Mao's alternative authoritarianism was no better).

An Investment-driven Bubble?

In 2010 it was first being argued that China could be headed for trouble because of wasteful spending to counteract the effects of the GFC - which was seen to have generated a property bubble much worse than that in the US.

Disruptive events ('black swans') such as 911 and the global financial meltdown can send history in totally unforeseen directions - yet these events don't seem to have disrupted shift in locus of global wealth for Atlantic countries to Asia Pacific - noting China's ability to sustain 10% pa growth. If China's economy becomes bigger than US, because of China's large population it would still be relatively poor. However increasing wealth brings military power, political leverage and diplomatic influence - perhaps allowing China to 'rule the world'. Beijing's handling of GFC supports such projections. But some now see a 'black swan' in China's future. To avoid social unrest, China has directed a torrent of money to state owned enterprises and local governments - and used this to fund wasteful projects. This has created a real estate bubble much greater than in US. A deep and sustained recession could have severe political and strategic costs to China (Friedberg A., 'Black swan haunting China's future', The Australian, 21/7/10)

China faces major challenges in reinventing its economy. Beijing model seems to be succeeding (ie maintaining about 10% pa growth) just as policy-makers in US / Europe seem to have run out of ideas. Complacency about China's model (Beijing consensus of state-controlled capitalism versus Washington consensus of free-market capitalism). Yet China faces many constraints on sustainable growth, eg heavy local government debts; property bubbles; rising labour costs; changing demographics; high energy consumption / pollution associated with growth; a need for tax reforms. China recently noted strong growth in foreign investment - but didn't mention that domestic sharemarket is not doing well. While there are short term uncertainties facing China, it has consistently show the ability to overcome constrains. Requirements now seem to include: restructure economy to emphasise consumption; revamp social welfare; reform taxes to fund local governments; and extend private property rights (Ryan C. 'The China model gets a workout', AFR, 17-18/7/10)

China's growth could be faltering - as a result of external supply disruptions and internal tightening, though the notion of a hard landing was dismissed.  However some see China's economy as like US in 1929 (with massive wealth disparities; rapid industrialisation and displacement of labour; opaque / misleading financial / economic data; massive borrowing by rising 'middle class'; bubbles in housing / infrastructure investment; accelerating and uncontrolled rise in disintermediated credit; expected transfer of growth to domestic demand; and wage / price spiral). China is seen to have lost control - as desire to placate masses with growth has created inflation that will lead to social unrest. It risks a deflationary collapse. Others seem China and emerging economies caught in price / wage spiral that can't be controlled through traditional monetary, fiscal and legislative control - because of wage inflation. Faith in China driving growth will be lost - and the world will be left with deflationary adjustments starting in US and then Europe [1].

An asset bubble is China's main short-term obstacle to economic growth - though a hard landing may have been prevented [1]

A large bail-out local government because of bad debts incurred by provincial banks may be needed [1]

There is near universal agreement that developing economies , led by China, will growth at double the rate of developed economies. China has set the pace for the past 2 decades, and most fast-growing developing economies have adapted China's export-led development model. But China's model has meant that is a net exporter of capital, not an importer. It has funded internal investment with high savings and low household consumption. Foreign direct investment has been allowed with strict conditions involving technology transfers that allowed rapid productivity growth. Portfolio investment has been controlled and limited. Thus financial proxies have emerged as the way of riding China boom (eg Australia's financial markets). Asia's future is bright, but the no-brainer of Asian portfolio investment may be over. Controlling inflation is proving difficult. Electricity rationing was introduced, and then scrapped. China's one-child policy is rapidly reducing pool of rural labour migrating to cities - and this could shift earnings from companies to employees [1]

The bailout of local governments in China will be equivalent to 150% of the TARP program required in the US - and thus that China has 150% of the 2008 financial crisis ahead of it [1]

There are signs that China property bubble is starting to deflate. China's economic growth could slow rapidly and adversely affect global economy. Real estate is foundation of China's rapid growth for two decades, and is crucial to construction / steel / cement industries. It is also favoured investment in China, because of poor bank interest rates, and critical to local authority budgets (as property sales fund infrastructure spending). Property construction in China was 13% of GDP in 2010, twice the level of 1990s. Many other countries have come to depend on this. Some cities have 20 months inventory of unsold properties, and suffer declining prices. Ordinary citizens can no longer afford to buy properties. In 2006 average apartment cost 32 years average salaries, but this is now 57 years [1]

China's post-crisis economy is built on 10,000 local government investment platforms which are in turn based on unsustainable rivers of debt. China has had competing needs for slow credit growth to contain inflation / asset prices and resource misallocation, and short term pressure to complete infrastructure and develop real estate. New credit had to keep flowing to meet repayment obligations on old bad loans. China has responded to the need to slow credit growth by blocking credit to private sector. Municipal owned companies accumulated $2.1tr debts (35% of GDP) - with 75% of this over the past 2 years. This may be unsustainable, but not be resolved for a long time because China does not really have a banking system - as the banks that hold local government debt are just arms of Communist party enterprise - and they can be topped up by other parts of this cashed-up enterprise at any time. Also local governments are finding new ways to raise capital - through bonds.  China's local debt is however a systemic problem - as there are limits to which households can be gouged, and thus likely political constraints. Land is current constraint - as used for loan collateral and this requires ever increasing land values (and coercion to hold down compensation payments from the dispossessed). The battle for land is where China's economic and political crises intersect [1]

 Problem loans from China's 2009 stimulus are about to hit China's banking system - and could require a rescue effort (about 7% of GDP) that is bigger than US TARP program. Government encouraged banks to lead to prevent recession in 2009 and a significant percentage of this went to local government borrowers, of whom 25-30% went bad. Also China established asset management companies (AMCs) in 1999 to absorb and dispose of bank bad debts. However they have not done so quickly, and rather than winding down they have continued to carry forward bad loans. Absorbing the new bad debts would compound problems in their balance sheets. Much of China's debts are held off balance sheet - ie nominally debts are only 20% of GDP, but actual total is about 80% of GDP. A large part of China's economic miracle has been built on ill-considered lending and accounting slight-of-hand [1]

There is increasing concern about China's debt levels. Local government debts are stated to be 27% of China's GDP (but may actually be 42%), and 20-30% of these loans are at high risk of souring. Defaults are emerging. The central government will need to assume responsibility for this - and most analysts see central government debt as 70% of GDP. However if contingent liabilities are also included the figure would be 150% of GDP. The bigger problem could be high levels of debt in economy - as many SOEs are now highly diversified, especially in areas where cheap capital gives them advantages (eg real estate and high tech). Chinese companies have incentives to borrow heavily and bulk up (eg better executive remuneration and political connections). China's investment driven growth model may be leading to unsustainable increase in debt. There is now a need to reduce growth dramatically or risk even worse increases in debt levels - though at least another two years of high-investment driven growth are likely [1].

 China may need a recession - though its leaders and international investors would not want this. There has been growing concern about debts of China's local governments - that spent heavily as part of response to GFC. Borrowings were estimated at 27% of GDP - but are probably more. Few loans are reported as non-performing - but as much debt was incurred with little regard to repayment, a great deal could turn sour. China is unlikely to face a debt crisis. Most loans are owed by one state-owned entity to another - so government carries any losses.  China's eagerness to keep joblessness at bay papers over the hole in the balance sheets of local governments - and this prevents banks operating on commercial terms. Corruption and fraud is not exposed. Problems with China's high speed rail network raise questions about whether spending was prioritised over quality control. China needs a recessionary bust to clear the way for a new boom  [1]

China is facing a hard landing (because of excessive credit growth and attempts to control the consequences). Moreover, as Europe and US experience economic problems, China will not be able to again boost spending to boost its domestic economy - and demand from economies that supply it with inputs [1]

China's private sector was born in Wenzhou (and entrepreneurs flourished). But problems arise. The city spearheaded China's manufacturing. But the trust based financing structures that replaced banks and fuelled its binge are collapsing - given slowing exports. The city has many problems. The cities financial-industrial model is unraveling. Wenzhou is defined by one-industry clusters, and never depended on foreign investment (as China's other boom cities do). 2m of the cities population live offshore, and are the basis of trade links. Wenzhou capitalised on non-bank financing, where relationships matter more than collateral. Traditional methods for channeling money to friends and family were massively expanded. But lending has ceased, because of risks [1]

In late 2011 a report (whose reliability can not be confirmed) quoted a Chinese source (who appeared critical of China's regime and was supposed to be commenting in private) as suggesting that China faces very severe fiscal and economic problems (Chinese TV Host Says Regime Nearly Bankrupt)

There seems to be a discrepancy between China's official 8.9% pa growth rate in the final quarter of 2011, and other (real economy) data indicating negative growth [1]

61% of global investors surveyed in December 2011 expected that China would experience a banking crisis because of misallocation of resources (as well as serious political and economic instability) in less than 5 years. Only 10% expected that China would escape trouble [1]

China is seen as likely to be the last country to experience the effects of financial / economic crisis, because of its massive surge in investment. But it is also likely to be the last to experience recovery. The dominant role of SOE's in the post results in wastage of resources. Huge profits are earned because their monopoly power is exploited. Economic vitality is being stifled and wealth is concentrating in the hands of a few [1].

China has not rebalanced towards consumption in 2011, and debt continues to rise quickly. This will not lead to a crisis, as it would simply be rolled onto government balance sheet. Financial Times reported that China has allowed banks to roll over loans to local governments. China's response to GFC allowed banks to lend $1.7tr to local governments (25% of GDP). As principal is not repayable, banks are now extending the loan terms. China has growing amounts of unrepayable debt - and most will wind up on government's balance sheet. Some suggest that the problem is only one of structure (ie using bank loans rather than bonds), but debt is debt. The problem was not perceived because of opaque financial system. The problem can only be solved by eliminating loss-making investments, yet China's growth is kept high by borrowing, misallocating the proceeds and allowing debts to rise. Household income is too low to be used to subsidize debts - so government will need to provide the transfers (eg by privatising assets or absorbing debt). Japan chose the latter. Now its debt is escalating, and there are risks of capital flight, high borrowing costs, falling currency / stocks and central bank needing to pump cash into local banks. Japan's government borrows more than it raises in taxes and has $10+tr debts. China can choose to absorb debts, and it would take many years before doing this becomes unsustainable. China is likely to have much slower growth and rapidly rising debt for most of the next decade - because privatising assets is hard. World Bank suggestions about doing so (in the context of pointing out the difficulty of China's economic transition) have encountered resistance. Increasing SOE dividends to the state would not solve the problem, as total SOE profitability is less than 1/5 to 1/8 of direct and indirect subsidies transferred from households [1].

China's headline GDP growth has been 8-10% of GDP. However this has been driven by new lending averaging 30-40% of GDP - of which 20-25% is likely to prove to be non-performing. Thus losses of 6-10% of GDP arguably need to be deducted from China's nominal growth. So China's real growth is much lower [1]

China's economy has slowed since mid-2011 - with electricity consumption growth down; a property bubble; local government debt overhang; and eurozone crisis. Despite reported strong 2011 growth, stock-market is down - indicating waste and limited value adding. China hasn't moved from quantity expansion on supply side and government investments / exports on demand side. Waste has escalated. This increases inflation. Banks have increased liquidity to sectors other than property, which will prevent the liquidation of inventors needed for a bottom. Chinese businesses face high / arbitrary taxes - with 45% of labour costs going to government, and low employee wages. Most demand is government-driven. China needs to boost competitiveness. It has now reached average $5000 per capita income, but is one of the last Asian countries to do so. While China's growth has been strong over the past 3 decades, it has few strong companies. Competitors elsewhere in Asia do much better. Multinational companies have all structured their operation to take advantage of China's cheap labour while protecting their own technologies / know-how. No other country has developed with such dependence on foreign companies. China's industrial policy has failed [1]

Xianfang Ren (IHS Global Insight) suggests that land sales account for 30% of central government tax revenues and 70% for local government. Property construction accounts for 10% of jobs directly and 20% indirectly. Residential property investment (12% of GDP) is above to 9% usual maximum for developing economies. Though minimum down payment is 30%, house prices are 16-18 times incomes in major cities. Financial system has much greater real estate exposure than it seems (especially weak are real estate trusts and non-bank lending). Small developers are cash flow constrained and will need to reveal defaults quickly. China's demographic crunch has arrived - percentage of children and elderly has reached minimum (28%). urbanisation has passed 50% when growth in developed economies starts to slow. Edmund Phelps suggests that China can no longer increase productivity enough by importing western technology. Productivity growth will be like that in west in 10 years, but at much lower levels. China can bail out banking system (given deposits, government revenues, sale of state assets, and foreign reserves) - unless it is simultaneously hit by external shock (as Japan was). [1]

In May 2012 there were signs (especially in M1 deposits, electricity output, lack of orders in shipyards, housing starts) that China is headed for a hard landing in late 2012 [1]

China seems to be facing a deflationary collapse. Prices have been falling; China faces a fast aging population and has excess factories. Credit has grown explosively . Loans doubled to 200% of GDP between 2006 and 2011. This is double the rate of loan growth (50%) before Japanese and US problems. There is near universal assumption that China can set off fresh credit boom, but loan take-up has been falling rapidly. China has, however, a lot of scope for fiscal largess (which the West lacks). If China experiences deep downturn and seeks to flood the world with cheap goods, the world could suffer a deflationary downturn [1]

In July 2012 it was suggested that China (and surrounding economies) are facing a severe recession - and that China has abandoned plans to reform its economy (ie to switch from unsustainable investment towards domestic demand) and is preparing large stimulus measures which will create further problems for its banking system [1]

In September 2012 it was noted that funding state pensions is becoming a major challenge for China given: its fast aging population as a result of the one child policy adopted in the 1970s; a corresponding decline in the working population; reduced willingness / ability of children to support aging parents; and expectations that China's growing wealth will be more equitably shared [1]

Private sector credit was seen to be laying the groundwork for a new financial crisis in Asia (especially Hong Kong, China, Vietnam) - according to Capital Economics. The credit explosion in Hong Kong, for example, was seen to be similar to the situation in Ireland before its financial crisis. Vietnam's property bubble seems to be bursting [1]

In China's non-bank lending now exceeds that by China's banks. A 'shadow banking' system now offers high returns to investors through very risky lending - and this is again feeding a red-hot property market (and creating risks of a crisis like that in the West) despite official efforts last year to cool the property markets by tightening credit.  The government turns a blind eye to this (and merely seeks to limit risk in banks) because it is desperate for growth to be maintained [1]

GMO (Edward Chandler and Mike Monnelly) argue that China's economy depends on ever larger quantities of credit - and looks like a bubble. This is like Indonesia at end of Suharto regime and Japan in late 1980s. Markets however can't get enough of China. GMO suggests China's credit / GDP ratio rose 60% to 190% between 2007 and 2012. This is more than Japan in late 1980s and US prior to Lehrman Brothers collapse. This could be a problem if credit market freezes - eg when there is a major default in Asian high-yield bond market. This is most likely in wealth management products. This shadow banking system emerged as Chinese savers tired of negative interest rates. Dumb money chasing yield is a formula for for band investments. These funds direct investment to real estate and companies that big four banks won't touch as they are seen to be too risky. If Chinese lost confidence in the shadow banking system there could be a full blown crisis. Some defaults have already occurred, and some trusts use new money to pay out earlier investors - which chairman of the Bank of China describes as a Ponzi scheme. Many of the products resemble the collateralized debt obligations that were sold prior to GFC. Products are sold as low risk, even though components are very risky. While the Chinese government might stand behind the trust, the economic effect of a crisis could be significant [1]

China's rapid growth may have created the largest housing bubble in history. State driven growth has focused on real estate and construction - creating cities with no one in them [1]

Zhou Xiaochuan (China's central bank governor) has been one of the few voices advocating genuine economic reform in China. He has been calling for a reduction in capital and opportunities available to SOEs and warning about the threat posed by the hundreds of $bns of loans to local governments to invest in property markets since 2009 (which continue to pose a systemic threat) [1]

China's premier warned 6 years ago that its economy was unstable, unbalanced, uncoordinated and unsustainable. And since then China has continued with the economic model that led to that concern (ie heavy reliance on investment in roads, factories and infrastructure). After the GFC such investment was further stimulated by fiscal spending and credit creation (which is now 4 times greater annually than in 2007). China's public / private debt now exceeds $200% of GDP - which is unprecedented for any developing country . This is not seen as a cause for concern - though attempts to understand the origin of financial crises suggest that this is false. The rate of increase in debt (particularly private debt) matters more than total debt. BIS found that 6% pa growth in debt higher than the rate a decade earlier implies major risk. In China this difference is now 12%. IMF found that if private debt grows faster than GDP for 3-5 years financial distress is likely. China's private debt has grown faster than GDP since 2008 - and has risen to 180% of GDP. China is assumed to be immune to risk because it owes little to foreigners - yet studies of the 79 financial crises in major economies over 140 years show that crises are just as likely in countries reliant on domestic savings. Also while Asian countries with high savings and few foreign liabilities did avoid crises after credit booms, growth fell sharply. Thus China is likely to experience rapid growth slowdown. To 2007 China created $1 of growth for $1 of debt - but now requires $3 of credit - which is what happens at late stage of a credit binge. China's exports and manufacturing are slowing while money flows into real-estate speculation. A more stable growth model requires promoting consumption. However while consumption has grown at 8% pa ((faster than in other miracle economies and as fast as possible) consumption is still falling relative to GDP because investment has grown faster. Thus China must cut back investment to rebalance and accept slower growth [1]

Fears that China could experience a hard economic landing have been renewed - because of skyrocketing property prices, mounting credit and GDP growth slowdown. China's economy is seen to parallel symptoms that led to 2008 financial crisis [1]

There has been increased speculation of a financial crisis in China. Nomura has suggested that China looks like US before sub-prime mortgage meltdown. The problem is seen in massive amount of credit that is extended off bank balance sheets (by contracting with less regulated financial vehicles or by property developers raising credit through friends). Such activity is opaque and largely fuelling speculation. Most comment has focused on how exposed China's banks are and whether government can recapitalize them. But the more important point is that off-balance-sheet activity is a good thing in China - because China's banking system does its job very poorly. Savers receive negligible returns, and banks direct money to SOEs - the least efficient firms. While off-balance-sheet activity generates risks, this is part of a process for fixing defects in the existing system [1]

One of China's top auditors has stopped approving local government requests to increase their debt levels, and warns that China faces a financial crisis bigger than that in the US and Europe unless debt levels are brought under control [1]

Possible responses to these challenges have been suggested to lie in gradual appreciation of emerging economy currencies and increased reliance on domestic demand. This seems to underestimate the difficulties of achieving such as transition - see Avoiding a Hard Landing in China .

Other Perceived Structural Problems

China's problems are arguably more fundamental than the immediate risks associated with wasteful spending and property bubbles in response to the GFC.

China has long had to struggle against economic, environmental, demographic and political constraints as suggested above (eg economic imbalances; wasteful investment; blunt economic management tools; pollution; limited soil and water resources; a soon-to-be rapidly aging population and need for massive state aged-care spending as a result of the 'one child' policy ; wealth imbalances; and frequent protests about official actions and corruption).

However in recent years observers have drawn attention to other structural problems, such as:

• a fragile and distorted financial system;
• lack of innovation / creativity;
• the dependence of local government finance on maintaining a property bubble;
• inflation being generated by an undervalued exchange rate;
• failure to actually increase domestic demand though rising wages are undermining China's industrial competitiveness;
• an inadequate education system;
• breaks in social harmony - as income inequality was rising rapidly and was well above the level that would normally indicate a risk of social instability;
• falling demand for construction (for which huge capacity exists) as income shifts to households;
• over-reliance on investment;
• the parallels between Japan's and China's property / investment bubbles;
• a potential precipitous decline in working age population after 2020 [1] - a problem is likely to compound China's export-dependence in an environment in which the import demand from the aging populations in developed economies is likely to be weak;
• the inability of China's political system to respond fast enough to achieve major adjustments needed to sustain growth;
• possible capital flight.

 Observers' comments on structural problem's China faces ....

In September 2010, questions were being asked about China's financial system.

There is concern that Chinese banks may be involved in a pyramid-style capital structure after domestic arm of China's main sovereign wealth fund raised $8bn through bond sale (to recapitalise China's state owned banks) and those banks were the biggest buyers of the bonds [1]

Moody's has expressed concern that China is powering its economic growth by raising the gearing of its banking system in ways that could leave the country exposed if outlook darkens. CIC borrowed $8bn to recapitalise three state-owned banks using debt, rather than genuine equity. There is concern about the opacity of China's banks [1]

In late 2010, a prominent Chinese academic also suggested that China faced serious structural risks.

 China's growth model is unsustainable and sudden slowdown is likely without radical economic and political reform - according to prominent academic and former member of People's Bank of China's monetary policy committee (Yu Yongding) writing in state controlled China Daily. Threats were seen in: social tensions; pollution; lack of public services; over-reliance on exports and investment (particularly in real estate). This comes at a time when many expect China to overtake US eventually - though there is current concern about rising inflation.. A transition in power to younger people is likely in 2012, and Yu's article reflects debate preceding this. Yu expressed concern about lack of innovation / creativity; inefficient use of capital (with investment over 50%) resulting in too many luxurious buildings. Yu also called for political reform - to break the alliance between politics and business. China's institutions require meritocratic government, but this is being eroded by sycophancy and cynicism. If China can't end current 'capitalism of the rich and powerful', then social tensions will lead to serious backlash. This investment is about    [1]

In early 2011, it was argued that China faced great difficulties in rebalancing its economy despite the announced intention of its neo-Confucian bureaucracy (ie the so-called 'Communist' Party) to achieve this.

China's premier spoke of rebalancing China's economy. But the role of the state in China's growth is a major problem. China is too reliant on unsustainably high levels of fixed investment to maintain growth. Fixed asset investment has risen 20-40% pa for the past decade - and this is not justified by urbanisation which grows only 1-1.5% pa. Such investment is about 55% of GDP - much above the 25-30% of GDP in Japan and Korea at a similar stage in their development. Bank lending has risen rapidly, and over the past 14 months Beijing has tried to restrain this. 3/4 of credit goes to SOEs through thousands of local bank branches. This creates obstacles to rebalancing. Local governments can't borrow - so they create state-owned commercial entities which invest in property market, rezone land (often illegally) to make this profitable and then sell. 50% of local government revenues come from property - so government tax revenues depend on perpetuating property bubble. Thus officials only pay lip service to central directives to curb lending. Also local officials (who have influence in banks) favour SOE dominance as it allows them to dispense patronage. Economic and social elites are Party's main supporters. Though returns from SOEs are poor, funding them is vital. Non-performing loans on books of China's banks could be 70% of GDP. Bias towards SOEs gives them 15-20% increases in revenues annually - but means that household income only increases 1-3% pa. This is why domestic consumption is weak (30% of GDP, the smallest level in any major economy). China can't reform its unbalanced and unsustainable economic model until the Party releases its grip on economic power  (Lee J. 'Party needs to loosen its grip', AFR, 9/3/11)

Australian Treasury warned about risks to global recovery associated with inflationary pressures in emerging economies. China and others in Asia are trying to quell inflation without doing anything about the accelerant of their undervalued exchange rates. Countries that tie their currencies to $US are importing monetary policy designed for an economy with low inflation and where private demand is weak. This is creating conditions like those prior to Asian financial crisis. Inflation is significant in China despite the fact that wages incomes are still falling as a percentage of GDP [1]

China has experienced an economic miracle, but three contradictions are emerging. China's leaders hope to slow growth and thwart inflation while raising wages and benefiting the masses. However wages have falling share of overall income, and gap between rich and poor is widening. There are many retail stores, but people look without buying. Wages are rising - but this seems to be diluting the competitiveness of manufacturers. There is thus a need to migrate to more sophisticated manufacture's and services. However this requires a better education system (as current one suffers from Soviet style management of science, and is shunned by China's elites). Second, China wants to internationalize the yuan - so that in a future economic crisis it could borrow in its own currency (as US does) - but this won't be possible unless economy is subjected to global markets. Low interest rates in China are driving asset bubbles - because people have no alternative investments. Third there is distrust between people and elites (eg Internet restrictions, wealth imbalances) [1]

Social management is the new buzz phrase in China's propaganda. Increasing public protests show why this is needed. The cracks in China's economic miracle are starting to show. China's president has called for social management to ensure harmony and stability. This is a belated rationale for crackdowns on most public critics. China has a 'Great Firewall' and an army of cyber-warriors - but this threatens to be overwhelmed by a home grown system like Twitter. Social management has led to efforts to silence lawyers, agitators, writers, artists. Beijing was worried by unrest in Middle East, and reacted harshly - but this may prove counter-productive. The origin of discontent is often in injustice - yet the role of lawyers in China is limited. The Communist Party prevents some matters being considered by the courts, and prescribes findings in others. The harmony China seeks has been hard to find [1]

The Bank of China issued a secret memo tightening the way mandatory reserve requirements for banks are calculated. This is an attempt to curb run-away lending by thousands of state-owned bank branches (which has boosted investment in China and commodity prices). However it is unlikely to be effective in the short term - because local banks are hooked on such lending and (with economic weakness in developed economies) it is hard to maintain growth without high levels of investment. Because of the bias towards SOE, China's private sector has shrunk - so there is ever more reliance on SOEs to create jobs - and building things is mainly all they know how to do. China's reliance on fixed investment guarantees that it will eventually have a hard landing [1]

The President of the World Bank argued in September 2011 that there are structural problems in the world economy which make monetary and fiscal policy solutions to economic growth constraints inadequate, and that significant changes to China's economic growth model (which has been based on exports and domestic investment) would be needed as a result [1]

In late 2011, a parallel between the bursting of Japan's 1980s investment bubble and China's current situation was suggested [though without mention of the cultural features that have arguably have given rise to this].

In China, industrialization as always, combines, progress with problems - though China differs in scale and cultural and entrepreneurial history.  China has many: large cities; rich people; university graduates; mobile phones; TV stations; patent filings (though no respect for others intellectual property); declining infant mortality; high speed trains (based on others technology, now localised); and outbound tourists. China's renaissance is as much cultural as economic, Chinese people are entrepreneurial, creative, energetic - who have been contained for centuries by domestic dynasties or foreign occupation. But prosperity brings problems - such as overconfidence - and the business cycle reflects this. China is not different except in scale, Australia's dependence on it and in the source of debts. Western business-cycles are consumption led, yet China's are investment driven. There are untold projects (eg cities built for a million people) that can never earn a return. The loan for one project costing $185m was guaranteed against land valued at $1.5m acre - the same as land values in richest parts of US where household incomes are $250,000 pa though in China the average was only $2,300 pa. 10,000 special purpose vehicles have been set up by China's local governments for such projects over the past 10 years - and $US2.2tr invested in them, of which 1/3 is estimated to be unrepayable. Central authorities tried to stop this, so local authorities established corporations to handle the transactions. Two of China's largest banks are estimated to have problem local government loans that amount to 30% of their book value, as well bad debts emerging from exploding corporate bond market. Since WWII consumers have driven growth in most Western economies. China has no consumer society. Rather it is an investment society. Consumption has fallen from 50% of GDP in 1980 to 35% . Investment has taken a reverse trend (ie from 35% of GDP to 50%). US consumption / investment figures are 71% and 15% respectively. This is why coal / iron ore / concrete prices has boomed. Since 2007 67% of increase in China's GDP has come from investment (the reverse of US situation). US bailed out the banks, while China embarked on massive government-driven investment program. US GDP stagnated, while China's increased 30% over the period. Michael Pettis (Peking University) argues that high levels of municipal debt are symptoms of underlying problems (ie repressing price signals, distorted investment incentives and heavy reliance on investment to achieve growth). In history this always tend to push growth too high and become unsustainable. However China can now only get growth with ever riskier increases in debt - and this must eventually be stopped resulting in many years of poor economic performance. Developing countries can initially find many profitable investments, but this eventually becomes harder - and when momentum takes over the system loses its ability to discriminate between profitable and loss-making investments. Strong GDP growth masks this problem until the bubble bursts. Japan's experience in 1980s and since illustrates the problem. To early 1990s Japan's GDP increased rapidly as share of global GDP (from 7% in 1970, 10% in 1980 and 17% in 1990) - but since then it has reversed (to 9% of global GDP). China is more likely to experience a Japanese style lost decade than Europe of the US.  Japan produced attractive, low cost products to achieve huge trade surpluses - using cheap labour and low exchange rates. The resulting surpluses caused concern to trading partners, and were used to invest / modernise. Ordinary Japanese paid for this (via low wages; a declining GDP share; low interest rates; escalating property values; and expensive imports). This is the model, not a by-product of the model . Eventually land values collapsed. poor investment decisions were exposed, and Japanese banks faced bankruptcy - and the economy entered recession from which it has yet to fully emerge. Peter Hartcher (in The Ministry) argues that though Japanese companies understand about return on capital, they would spend cash without worrying about the return.  In 1988 Japan's real estate boom paused, and speculators who were used to ever-increasing prices felt problems. But banks continued lending - and the boom continued. China did the same in the 1990s - and offloaded bad debts into state-run asset management companies. This allowed banks to claim 1.8% bad debt ratio in 2009. In 2002 one yuan of GDP needed 0.17 yuan of debt. Now it needs 0.30 yuan. Banks are forced to fund suspect government projects at excessively low rates, so bad debts will be high. China's banks are now facing a liquidity crisis - though this is invisible because the bad stuff has been taken off balance sheets. China seems likely to follow Japan. Edward Chancellor (in China's Red Flags) argued that China had all the features common to bubbles over the past 300 years. Half of China's millionaires reportedly want to emigrate - because of fears about future stability. The crisis may be a few years away, but investment-led growth must end. Government-induced slowdown is already occurring. But a shift to consumption-led growth is not on the horizon. Property values will continue falling. China's rulers have implied social contract with people since 1989 - sacrificing political freedom in return for economic gains. This may now crack. For China to change its economy, political and economic power must be devolved, yet elites don't readily give up power. ('The Coming China Crash', Intelligent Investor, December 2011)

In early 2012 a crisis was seen to be arising because: (a) high levels of investment are needed to sustain growth, though this also generates inflation; and (b) China's political system is not able to respond rapidly to the major adjustments that are required to maintain growth.

Concerns arise about China's economy (property deflation, weaker exports to Europe, cut-back on infrastructure investment). Since GFC China's economy has been driven by investment. High capacity has been created, which external demand won't support. There is a recognised need to shift to domestic demand, but China's system is geared to direct resources away from households towards investment. This would need to reverse rapidly - but more likely outcome is fall in investment. China's official economic statistics are not reliable (as shown in 2009 when 6.5% pa growth was reported yet 'real economy' data (eg electricity consumption) was contracting). Now all sectors seem to be contracting yet this is not officially reported, Most people see 5% pa GDP growth as 'hard landing' - and it seems to be current reality. If China built again everything it did in 2011 and everything else was unchanged, its GDP would fall 2% (to about 4.5%). Fiscal / monetary policy options are constrained. There is a need to grow over bad debts. Credit in system is fully occupied on existing projects, and POBC is wary about increasing credit because of inflation risks. Money supply expanded 2/3 over recent years, and was invested. Thus fiscal policy is now being considered. But China's nominal low debts (30% of GDP) is understated because of contingent liabilities (ie for debts of state institutions). This makes debt / GDP 100-200% already. It is likely that government spending will be increased and it will be revealed that past monetary stimulus was just disguised fiscal spending - as bad debts have to be covered. Spending will increase, but investment boom can't be maintained. Bubble probably can't be re-ignited. Diverting resources to consumption might help - but there is also a possibility that money just leaves the country. Capital leaving is now tending to offset China's current account surplus. If China's growth slows, devaluation will be sought - but this could provoke international reaction. If exchange rate is not adjusted, then inflation in China will increase. If exchange rates rise then producers bear the burden, whereas inflation hits households. Exporters are now being hit by rising costs in China. Some tried to adjust by getting into financial dealings, and again got burned. China's economic pattern is unsustainable given export / investment dependence. Leadership changes at present make adjustment impossible - as no one can afford to upset powerful constituencies. New leader will then take a long time putting protégés into key positions before radical changes can be implemented. Economy will require action much faster. Elements of hard landing are already occurring. Fiscal stimulus will help for a little while. But in mid 2012 hard decisions will be needed. A lot of debt needs to be rolled over. Tension between investment driving growth and driving inflation has reached a crisis point - given problem of bad debt. Bad debt is going to absorb credit. 300-400m Chinese are on internet, and complaining. Officials are concerned about social stability. Any hint of organised protests would result in crackdown.  But social media has changed the game - as everything that happens in shared / spread. Government is struggling to cope. Some favour social media as letting government know about community concerns. (Robini N and Chovanec P., 'China: How much stress can the system take?', Economonitor, 8/2/12)

CPDS note: Both of the above sources contained hints of possible capital flight from China. Similar suggestions appeared in Cash Exiting China (Duy T., EconoMonitor, 31/5/12; Frangos A etal 'In Reversal, Cash leaks out of China', WSJ, 15/10/12), and the rapid escalation of gold purchases by individuals in China (see Lee J. China's twitchy gold bugs, BusinessSpectator, 17/2/12) might also have similar implications.

China's leadership was seen to be very worried about the future in December 2011 - even though many other countries are worried about China's competition. Their focus is on internal problems (eg dependence on high growth driven by exports to maintain social tranquillity; resistance to currency manipulation; inequality; the need for shifting to domestic demand; inflation and housing bubble; political transition in near future; pollution; aging population; protests; international isolation; [1]

Constraints are emerging on the expansion of China's international influence in support of its expanding economic roles [1]

More analysts are starting to understand constraints on China's growth model. It is predicted that: (a) China will be the last country to emerge from GFC - because those problems resulted from great trade and capital imbalances to which contributed with a massive savings rate which it has continued increasing, rather than reducing; (b) China's consumption will stagnate / decline until existing growth model (which depends on transfers from households to subsidise growth) is abandoned; (c) financial repression is the heart of China's problem; (d) investment is being misallocated on a massive scale, as a fundamental feature of the economic system; (e) debt is rising at an unsustainable pace, and this can't continue; (f) attempts to deal with debt problems will fail because the debt problem is systemic; (g) while privatisation is a forbidden topic, it will soon start to be considered; (h) a fundamental political split is likely between those demanding reform of China's growth model and those who want to maintain control of resources; (i) China's government debt will continue to escalate; (j) China's average GDP growth for 2010-20 could be 3% pa; (k) if China rebalances successfully growth in household income will be similar to GDP growth; and (l) non-food commodity prices will collapse over the next 3-4 years because these have been critically dependent on Chinese investment [1]

The IMF published Is China Over-investing and Does it Matter which argues that China is over-investing - as this accounts for over 50% of GDP and is most unusual relative to other countries. Households and SMEs have been forced to subsidise growth at a cost of 4% of GDP (or perhaps 5-9%) - and this explains collapse in household share of GDP. China has to eliminate that subsidy (and thus abandon its current growth model) if it hopes to get household / consumption shares of GDP to increase. China's investment has to fall by 10-20% of GDP, and this will adversely affect those who have benefited from over-investment. Moreover bringing the investment share of GDP down is very difficult [1] 

Obstacles to China's efforts to use its currency as the basis for international trade were suggested to arise because: (a) China still has a more-or-less fixed exchange rate with $US; (b) there is not much use for yuan outside China (and thus little point in holding the currency); and (c) all lucrative sectors in China are reserved for SOEs (except export-oriented manufacturing and participation in JVs to allow technology transfer into China). Until China opens its markets there is no good reason to hold yuan [1]

Japan shows the risks that China faces in shifting to a lower-growth model. China expects its growth to slow over the coming decade. This can be seen as either a reflection of the 'middle income trap' or of catching up with advanced economies. Indicators of this include: slowdown in infrastructure investment; falling returns on investment due to overcapacity; labour supply growth has fallen sharply; urbanisation is decelerating; and risks are growing in local government / real estate finance. A case can also be made for a more optimistic view - because China's income levels are currently much lower than when such transitions occurred elsewhere. However China is much bigger than other economies, so the world can provide it with relatively less opportunities, and its growth has often been seen as 'unbalanced, unco-ordinated and unsustainable'. High dependence on investment creates the biggest problem. A growth slowdown could be associated with a collapse of investment from 50% of GDP to 30% - and, if rapid, this would lead to depression. Real estate investment has led to a large rise in credit - and in risks of bad debts (leading to a more fragile financial system - especially because of growth of 'shadow banking' system). There may not be a decline in household savings to accompany falling investment. China hopes to manage the transition smoothly - but Japan showed that it may not succeed [1]

China's claims of strong export-led economic recovery (ie 19.8% year on year to the end of February 2013) appear dubious because of a discrepancy between China's claims of exports to Hong Kong (($US94.9bn) and Hong Kong's data on imports from China ($US58.7bn) [1]

China's 30 year economic miracle may be near exhaustion.  China's prime minister has asked the State Council to clamp down on excesses of the regions - as local government finances are out of control. China's growth could be at a safe 7%. Vested interests in state industries are seeking to prevent this. Catchup growth in the western hinterland has more years to run, but overall growth may be below 7%. There has been doubt about China's statistics. National Bureau of Statistics now says that regional data overstates GDP by 10% - because of growth-claim incentives facing officials. Some expect China's future growth to be much lower - eg because of population aging - and perhaps not much more than renewed US. Thus charts showing China tearing past US may be wrong. The 2008 banking crash was a nasty shock to US financial system but not to its creative enterprise. It was however a crippling blow to Europe and a subtle blow to China in many ways. US Council of Foreign relations (Richard Haass) sees US as doing well in many areas. It has a large debt hangover - but so does as state banks let rip during downturn. Total credit has jumped from $9tr to $23tr over the past 4 years. US has moved in the opposite direction with loan-to-deposit ratio around 0.7 - the biggest safety margin in 30 years. US Treasury debt has jumped - in ways normally seen in wars from which recovery has been possible in the past. China is facing 'middle income trap' which have affected many rising economies. China needs to shift from state-driven industrialization and cheap exports to free markets. Innovation at the technological frontier is incompatible with government planning.  However even if this change is made, population aging will significantly reduce China's growth. Surplus workers will be replaced by a shortage - as happened to Japan 20 years ago. More credit can keep the game going for a time - but this just increases the risks. The 'China Dream' of a post-American empire has a dated feel  [1]

Rather than reducing China's reliance on investment, detailed figures for last year show that investment increased as a percentage of China's economy in 2012 [1]

A credit rating agency suggests that China's shadow banking system is out of control as borrowers struggle to roll over short term debts. The scale of credit was so great that China could struggle to grow its way out of these excesses as it had been able to do in the past. Credit-driven growth is falling apart - and could feed into aver-capacity and potentially a Japanese-style deflation. The shadow banking system lacks transparency (in terms of who borrowers / lenders are, and quality of assets). The official non-performing loan rate of 1% means nothing as irregular lending makes up half of new credit and bad assets can be offloaded through the system [1]

There seems to be a contradiction between China's intention in November 2013 to announce sweeping economic reforms at Party's Third Plenum (involving an assault on SOEs and Party patronage machinery) and simultaneous reinforcement of a one-party, one-ideology authoritarian state. This contradicts core finding of DRC- World Bank report which suggested that China could not jump to next stage of economic development (and would languish in 'middle income trap' unless it embraced modern 'free thinking. Countries need to increase productivity through innovation. China is running out of cheap labour, faces severe demographic change, has picked easy economic options (cheap labour / investment led growth / catch-up growth) [1]

China is facing a new economic crisis - namely family business succession. China's economy is not dominated by SOEs as many believ. Private enterprise accounts for about 2/3 of China's economy - up from zero decades ago when private business was outlawed. Most such enterprises started 3 decades ago - and now simultaneously face succession issues. This is happening at the same time that China's privately controlled manufacturing has to move away from its low-wage labour intensive methods. Also there are major cultural differences between first generation business owners and their children. The first generation had little and limited education. 88% of their children have degrees and 52%studied overseas. The latter often clash with their parents over corporate management. The children favour advanced Western management systems - and parents believe that this is incompatible with the reality of doing business in China. Western educated children don't like dealing with government officials, which is vital in the Chinese business world. There is concern that they have been influenced by foreign culture / beliefs. In the US people have beliefs (eg in Christianity). While China has Buddhism, few people really believe it in their heart [1] 

In 2015 it was noted that the richest man in US politics (with almost $500m in family wealth) would only rank 166th in China [1]

Moreover the limitations that Western observers perceive in China's political and economic systems are only part of the story (eg see China can't be properly understood in terms of Western economics). The structural problems that China faces are escalating because of factors that require reasonable Asia-literacy to appreciate. For example: 

• East Asian systems of socio-political-economy have created and depended on favourable international financial imbalances (ie on the willingness and ability of trading partners to sustain ongoing current account deficits and ever rising debts) - see China may not have the solution, but it seems to have a problem.

Similar points are explored in China can't fix the global currency crisis without economic disaster (and in Another 'sting' driving Japan's urgency?). China lacks the ability to sufficiently reduce these imbalances that: (a) played, and continue to play, a central role in global financial instabilities; and (b) if uncorrected must eventually make global economic growth unsustainable. Those imbalance will soon lead to a decline in external demand and thus create crises for non-capitalistic financial systems when / if reliance on domestic demand creates a requirement to borrow externally.   The possibility of total failure of China's financial system is explored below (see China's Super-Ponzi-like Financial System and Preparing for a Con?);

• assumptions that seem to be made by China about the economic benefits of large scale industrial / infrastructure investment with limited regard to profitable use of capital in specific investments (ie benefits associated with synergies and side effects) appear likely to be false - and likely to generate a financial crisis because of the massive levels of sovereign debt that that assumption has apparently caused to be accumulated .

A source which the present writer suspects is based on realistic briefings about China's economic tactics suggests that there is an assumption underpinning large scale investment with limited regard to profitability in specific projects can have net overall benefits eg because:

• those investments can generate synergies / side effects; and
• providing cheap capital facilitates the rapid growth of capital-intensive production.

Synergies / side effects can be real and economically valuable. The present writer's 'take' on this is outlined in Fixing Economics (2012) and A Case for Innovative Leadership (2009+). These suggest that accelerating the development of industry clusters / economic systems as a whole can generate additional economic benefits - while Developing a Regional Industry Cluster (2000) suggests methods whereby this could be achieved in a democratic / capitalistic environment without eliminating the need for productive use of capital in relation to specific investments).

However without the latter constraint there is doubt that the economic benefits will compensate for the steady build-up of debts / bad bank balance sheets that is likely to occur in parallel because:

• it is difficult to know the productive value of such potential synergies / side effects - and thus how much build up of bad debts this may justify;
• where nationalistic / mercantilist goals (eg building economic / military power) are a significant element in any process, the costs could well greatly exceed any economic spin-offs;
• the individual interests of those participating in a process intended to promote community-level overall benefit cannot be entirely excluded - so the process can not be guaranteed to be unbiased - no matter how much 'self-criticism' the neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  may try to impose on its members;
• there is a limit to which any organisation / organism can deal with complex issues. There are in nature many large organisms and many complex organisms. But there do not seem to be very large / very complex organisms - because the problem of managing complexity becomes overwhelming.

Furthermore while a high savings rate and abundant capital can achieve rapid growth in the production of capital intensive goods, most growth in developed economies comes from the deployment of knowledge. There are limits to growth merely from increasing inputs of labour and capital - and unless those limits can be passed an economy risks being caught in the (so called) 'low income trap. And the reported shift in China's education system towards encouraging just-do-it compliance (rather than abstract understanding) through starting with rote learning of Chinese classics strongly suggests that knowledge intensive economic development is not envisaged (see Competing Thought Cultures).

• there is an incompatibility between the social equality aspirations of China's nominal Communism and the Confucian-style social-hierarchy that was vital for the methods for rapid economic modernisation that Japan had demonstrated and which it has been suggested: (a) were pioneered by Japan's military in Manchuria in the 1930s; and (b) China's post-Mao leaders were persuaded to adapt as 'socialism with Chinese characteristics' in the late 1970s. That incompatibility has the potential to lead to serious political tensions and perhaps even to a civil war.

China's history has been littered with civil wars. As noted above it has been argued that these civil wars featured contests between 'commercial factions' in southern China and rural / spiritual / militaristic factions that dominate in northern China – which resulted usually in the southern ‘commercial’ interests being driven out to become the Chinese Diaspora across SE Asia.

Tensions between such factions can be seen to have played a role in China's more recent history. 

Confucian-style hierarchy had been targeted for elimination by Mao's cultural revolution as Chinese 'Communism' favoured social equality, but was (apparently secretly) reintroduced after Mao's death by factions whose power base was southern China (Shanghai) who have arguably been the architects of China's modernisation using a variety of the neo-Confucian systems that were the basis of Japan's post-WWII economic miracle - see also Communism versus Confucianism: The Continuing Contest in China). The role that an elite neo-Confucian bureaucracy had taken in Japan was taken by the so-called 'Communist' Party itself - presumably because under Mao the Confucian bureaucracy had been successfully demonised as oppressing the masses.

Tensions were exacerbated by the massive personal wealth that many at the top of the socio-political hierarchy took the opportunity to acquire for themselves and their families (noting that the average wealth of the top 60 (2%) of the National People's Congress is reportedly $US1.4bn [1]).

This ultimately produced deep divisions within China's so-called Communist Party (illustrated by the Bo Xilia case mentioned above) apparently between: (a) the south China / commercial neo-Confucian factions who have provided the engine of China's rapid modernisation through a non-capitalistic / mercantilist / financially-repressive market economy built on relationships within an hierarchical and autocratic social elite; and (b) the 'redder' elements who favour social equality, but would not seek or be able to maintain a market economy (Political Change and Potential Instability: The Continuing Saga ).

In this context it is worth noting that (after China's system had been seen to be unbalanced and unsustainable) China was promoting both: (a) economic / financial liberalisation; and (b) potentially incompatible changes in China’s education system which would create a community that complies with social elites but would not be successful in a liberalized economic environment (see Financial and Educational Reform in China: Headed in Opposite Directions?).

Given China’s likely financial, economic, social, environmental and political tensions another revolution in China (revolting against the so-called-Communist-but-actually-Confucian factions in power) is neither impossible nor certain.

Even if the immediate threats to China’s political and economic stability are suppressed, these issues won’t go away, and anything that disrupts the social inequalities that have been essential to China’s post-1970s' neo-Confucian system of socio-political-economy is likely to disrupt China's ability to have a competitive market-oriented economy. Thus the vague 'China dream' endorsed in 2013 by the secretary of China's so-called Communist Party (Xi Jinping), which apparently included reducing the extremes of wealth that those with so-called Communist Party connections had achieved probably has major economic implication;

• the China-centred neo-Confucian international order that seems likely to be envisaged (which could from one viewpoint be viewed as a realization of Japan's 1930's aspirations for a 'Greater East Asian Co-prosperity Sphere') is incompatible with the demands now being placed on China to take the prominent role in global leadership within prevailing Western-style international institutions that is needed because East Asia's economic methods have partly incapacitated traditional global leadership. The Chinese state (which seems to be geared to mobilizing China's people for nationalistic endeavours to obtain vengeance for what China suffered from the time of the Opium Wars in the mid-19th century and as a result of Japan's actions from late-19th to mid-20th centuries) is structurally limited in its ability to operate in a Western-style international arena. The purpose of providing information under Confucian traditions is to induce others (eg students, subordinates, outsiders) to do things that would benefit one's ethnic community, rather than to enable them to understand. Thus diplomatic dialogue can not involve a serious attempt to resolve problems (see The Limits to Dialogue and Time May not be on China's Side). The latter also notes the difficulties being experienced in promoting ethical behaviour, and the uncertainty of resolving such problems by re-emphasising Confucianism;
• various other structural arrangements seem incompatible with the competing pressures that China is facing from the external world, and from its own people (eg apparent erosion of grass roots confidence in China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  and of the willingness of China's people to sacrifice for national gains; an education system that primarily prepares people to operate within a social hierarchy rather than to take independent initiative; poor domestic investment options; and vengeful domestic nationalism that is incompatible with providing the constructive international leadership that others now hope to see).  Many owners of China's 'private' businesses are retiring, and their university / overseas educated children have been influenced by foreign ideas - including doing business in ways that are incompatible with the state-orchestrated way in which business has been done in China (see above)

These structural difficulties are primarily a by-product of the neo-Confucian methods that were used to accelerate economic modernisation in China (as in Japan and elsewhere in East Asia) - and it is not at all clear that those problems can be resolved by the continued use of the methods that gave rise to them.

The supportive reactions of a Chinese American to suggestions similar to those outlined above may be noted.

Proposals for Reform i / Financial Obstacles / Increasing Aggressiveness (2012)

Proposals for fundamental economic and political reform that were being advanced to China's leadership from late 2012 in relations to these challenges included:

• curbing the power of state firms; increased emphasis on market in setting interest and exchange rates; and tax reforms (as local governments do most spending while central government gains most revenue. Emphasis is being placed on developing a national consensus on reforms, rather than reliance on Beijing sources [1];
• political reform and a greater emphasis on law-based governance without adopting a Western-style democratic style of government. Greater emphasis would be placed on 'how the Communist Party exercises leadership and governance to ensure that it leads the people in effectively governing the country' [This constituted an endorsement of neo-Confucian style leadership / governance]. Emphasis was also given to boosting China's: maritime power; social ethics; socialist market economy; and domestic demand within a framework of 'socialism with Chinese characteristics' [ie a neo-Confucian system of socio-political economy]  [1].
• proposals from a Central Economic Work Conference for short and long term measures to enable stable growth. Continued socialist market reforms were indicated and (for the first time) clearly stated plans for reform, to overcome suspicions that government was not serious about reform. [1]
• proposals for sweeping reforms to avert an economic crisis were being prepared for consideration by the Communist Party Congress by Liu He (Central Leading Group on Financial and Economic Affairs). This included proposals for: changes to financial system that directs cheap finance to SOEs but not to households; financial deregulation; fiscal reforms (related to central government transfers and effective property and consumption taxes); land transfer / usage systems; urbanisation; reducing income inequality; cutting red tape; and imposing market prices on coal, oil and other resources. No consideration was however being given to the sorts of institutions needed for transparent markets [1]

However, as the rest of the world stagnates economically because of failure to deal with international financial imbalances (see Too Hard for the G20?), China (like Japan) has seemed likely to lose the strong cash flows from exports that are needed to allow strong domestic growth without having to borrow in international financial markets. If this happened the balance sheet of its institutions would be called into question - and this could expose the 'Ponzi-like' character of its economy.

Diverting China's exports to emerging economies (as China has seemed to be seeking to do since late 2010) can not avoid this problem as many emerging economies (like China) can apparently only avoid financial crises by preventing current account deficits through export-led growth dependent on (mainly) US consumers (see Leadership by Emerging Economies?).

China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  has perhaps created an economy on the basis of a financial system that has many of the characteristics of a Ponzi scheme (ie one dependent on ongoing injection of new cash to delay exposure of problems in an undertaking's balance sheet that result from not earning enough to cover the ever increasing amounts owed to those whose savings were invested).

It is possible (though not certain) that the increased aggressiveness that China displayed from late 2012 was a reaction to the difficulties of its situation (as suggested in Friction between China and Japan: The End of the Asian 'Century'?). And, though the situation is anything but transparent, other late 2012 indicators of China's intentions included:

• the lack of any clear intentions to implement political / economic reform in the membership of the new Politburo;
• the apparent intent of China's education system to produce a just-do-it population that would be compliant with elite guidance in matters of politics and the economy (see Competing Thought Cultures) - a goal that suited China's past economic tactics, but would be incompatible with significant political and economic reforms;  and
• early indications [1] of an intention to continue China's GFC era economic tactics (ie an emphasis on property development and infrastructure investment).

Arguably China's wild (and desperate?) spending and credit creation in response to the GFC merely amplified a fundamental feature in non-capitalistic neo-Confucian East Asian systems of socio-political-economy generally (ie the lack of attention to profitability in the use of savings) - and thus increased the risk of a financial crisis when trading partners find or decide that they can no longer continue increasing their debt levels indefinitely.

Preparing for a 'Financial Con'? (late 2013) [<]

As observers have long pointed out, China seems to face increasingly severe debt problems.

Brief outline of earlier examples (drawn from Investment Driven Bubble above).

• to avoid social unrest China has directed a torrent of money to fund wasteful projects ;
• China's economy is like US in 1929. China has lost control. A desire to placate masses with growth has created inflation that will lead to social unrest;
• China faces an asset bubble and a need to bail out provincial banks' bad debts;
• the future bail-out of China's local governments will have 150% of the effect of post-2008 TARP bailouts in US;
• China's property bubble has been critical to economic growth (and to others' ability to share the benefits), but is starting to deflate;
• China's post-GFC economy is built on 10,000 local government investment platforms - and these rest on unsustainable debts. New credit has to be created to meet repayment obligations on old bad loans. China does not have a real banking system - as 'banks' are just arms of the neo-Confucian bureaucracy (ie the so-called 'Communist' Party) ;
• Local government debts are 27-42% of China's GDP - and 20-30% are at risk. Central government debts are 70% of GDP - 150% if contingent liabilities are considered, Chinese companies also have incentives to borrow heavily. Investment driven growth is leading to unsustainable debt levels;
• Local government debts cause increased concern. Few non-performing loans are reported, but loans were often taken without intent to repay. Most debts are owed between state-owned entities - so government carries losses;
• China won't be able to ease problems associated with excessive credit growth - because US / Europe also face problems and can't boost China's economy
• in 2011 it was suggested (with unknown reliability) that China is nearly bankrupt;
• 60% of global investors surveyed expected China to face a banking crisis due to misallocated resources;
• China is likely to be the last country to experience the effects of GFC - and the last to recover. Dominance of SOEs results in wasted resources. Huge profits are earned by exploiting monopoly power;
• China has not rebalanced towards consumption. China's GFC response involved allowing banks to lend 25% of GDP to local governments. Principle was not repayable. Banks are now extending loan terms. Opaque financial system conceals but does not eliminate the problem. Government needs to absorb losses by privatising assets or increasing debt. Japan did the latter - and is now in serious trouble;
• China's 8-10% GDP growth has been driven by new lending of 30-40% of GDP - of which 20-25% is likely to be non-performing.
• Loans in China doubled to 200% of GDP between 2006 and 2011 - double the rate of loan growth before Japanese and US problems;
• Private sector credit was seen in 2012 to be laying the basis for a new financial crisis in Asia (including China);
• non-bank lending now exceeds that by China's banks. This offers high returns through very risky loans - which feed a likely property bubble;
• China's economy depends on ever large quantities of credit - and looks like a bubble. Shadow banking system is causing problems. It directs loans to real estate that major banks find too risky. Some defaults have occurred with new money being used to pay this out - officially described as a Ponzi scheme;
• China's central bank governor has warned about systemic threats;
• China's premier warned some years ago that China's model was unsustainable - yet that model remains;
• One of China's top auditors warned that China faces bigger financial crisis than US unless debt levels are brought under control

Late 2013 examples

In September 2013 China showed improved economic growth - reversing a politically serious mid-year slowdown. This was the result of reverting to infrastructure led investment. Net asset investment was 56% of GDP. Many observers have been concerned about China's dependence on investment. China is repressing domestic demand to build state-directed infrastructure - much of which does not produce economic returns. Bad debts are being avoided only by taking on more debt to pay interest bills. In September 2013 China's total system credit growth was $230bn ($2.3tr for the year to date). This massive credit growth is causing an asset price boom. It has not deflated yet because of ever increasing credit growth. This is a Ponzi scheme. In 2013 China's credit growth is likely to be 35% of GDP - leading to mal-investment. There is no certainty when this will end, but problems are likely eventually. The price of money has been faked globally by reserve banks, and the $US-renminbi exchange rate manipulation has led to excessive construction and manufacturing capacity in China. [1]

Borrowing by all government levels in China is unprecedented and one of the world's highest. Overall government budget deficits were 9.7% of GDP last year. But despite this massive stimulus growth has slowed. China's loan growth has taken total to 200% of GDP - leaving little scope for further budget stimulus. Recent growth has been driven by heavy state-led industry. But money growth is now lagging indicating problems in 6 months time. China bought $70bn of foreign bonds last month to hold down the yuan. China does not seem to be able to overcome dependence on export-led growth promoted by artificially cheap currency [1]

A few years ago it was suggested that the credit dynamics of China's growth involved an unsustainable increase in debt - which would ultimately undermine the banking system. This was disputed on the grounds that: (a) debt was directed to investment - and was thus not necessarily rising faster than debt service capacity (a view that few now support); (b) China's debt doesn't matter (being funded domestically / guaranteed by government - and China dealt with debt problems successfully before); and because foreign exchange reserves are available to recapitalize banks. A recent article noted that China credit situation has parallels with US before GFC. However it then suggests that there is no problem because of China's massive savings rate and foreign reserves (which would allow government to recapitalize the banks). Because banks are government guaranteed and people have no savings options apart from banks, China won't face a system-wide bank run as long as guarantee remains credible. There thus won't be a Lehman-style crisis. But neither will there be the advantages of such a crisis (ie quick resolution of the problem - that is possible in countries with sound financial / political institutions).  Rather there could be a Japanese style rebalancing which has much higher economic cost. Foreign exchange reserves can't be source of refinancing for banks - because there are merely assets on a ledger that are balanced by liabilities (ie the renminbi that the China's government had to borrow locally to borrow foreign reserves - in order to prevent currency appreciation). It has long been rumoured that PBoC would be insolvent if its liabilities were correctly marked. If foreign exchange reserves were used to recapitalise banks, PBoC's assets would thus be reduced, while its liabilities remained unchanged. Bailing out banks is no different to transferring their debt to central government. Some have suggested that because China's debts are hidden - those debts don't matter. But hidden debt eventually matters (as Greek and Italian situations have recently shown). This is because those debts must continue to be serviced.  If the assets funded by debt don't create enough wealth and borrower does not default, then there must have been a transfer from some other entity. In China this has typically been the household sector - eg via very low interest rates. But such transfers are China's problem. If any entity covered by central government can't service its debt - the difference must be paid by someone else, and this reduces demand and thus slows economy. If such transfers continue to come from households, then households' ability to increase consumer demand will be low. However if the state seeks to cover the difference in other ways then it creates difficult political problems - in assigning costs to influential interest groups. Debt must be paid by someone - and China's rapidly rising credit implies that growth must be slower in future - and that rebalancing will be increasingly difficult [1]

China's banks are amongst the world's healthiest and most profitable according to their financial statements. But investors are not convinced. Bad debts account for less than 1% of loans - but price-to-book values have been falling reflecting concerns about declining credit quality. Credit quality trends are not trusted. Banks tend to extend, restructure or sell loans to borrowers - rather than admit that they have gone bad [1]

There has been concern about China's local debt problem - and China's National Audit Office has recently reported on this (though the results are not public). Local governments have used innovative financial structures to raise debt. Auditors have clashed with local governments about debt classification. China's local debt problem is guessed to be between 10-50 tr yuan. The last official pronouncement was 10.7 tr in 2010 before explosive growth of shadow banking system. Total lent to local financing vehicles is about 10tr (in early 2013). This is 30% up from end of 2009 - reflecting 4tr fiscal stimulus package. Much of this was funded by debt from China's banks to local governments. 36 provincial capitals were surveyed. They have 3.85tr collective debt - and for about 1/3 debt-to-GDP ratios are over 100%.  There are problems in that a lot of local debt will be due in 2014. China's local debt problem (40-60% of GDP) is serious - but won't cause a crisis because governments have adequate financial resources (given large foreign exchange reserves, income tax of 10 tr yuan pa (which increases rapidly), and domestic financing of China's debt [1]

China's local government debt reportedly reached 20 tr yuan ($US3.7tr) in late 2012 - having almost doubled over two years - and has kept rising. Beijing is increasingly concerned with such liabilities - and this has driven a credit crunch. Total debt (consumers, companies, governments) has reached $20.8 tr - more than double GDP. Local government accounts for 80% of all government spending - yet only receives 40% of revenues. Debts of central and local governments had totalled $4.5tr at the end of 2010. Some local governments have been found to be taking on new debts to repay old ones. Incomes for such bodies are below their debt service obligations - and they hope to cover the difference with land sales.  (Callick R., 'Mixed messages on mountain of debt confuse China's markets', Australian, 30/12/13)

A blast of money from China's central banks has not stemmed growing cash crunch - as liquidity dries up and struggling lenders hoard funds. One-week borrowing costs rose over 1%, and the crucial 3 months rate rose 80 points. Fitch ratings argues that China's wealth management products (a hidden second balance sheet of banks worth $2tr) is the biggest risk . 50% of all liabilities have to be rolled over every 3 months - and a further 25% every 6 months. If rates remain at current levels, weak funds could be caught as Lehman Bros was. Central bank is also trying to rein in dangerous credit surge. Hot money has been pouring into China following optimistic response to reforms promised in November [1]

In October 2013 it seemed possible that China was hoping to 'con' the world in relation to its financial position. For example, there were suggestions that:

•  financial liberalization in China would significantly boost the global economy because a 'wall of money' from wealthy Chinese would be available for external investment [1];
• China's banking system was being cleaned up in October 2013 by 'huge' (ie a total of $4bn) write offs [1].

This seemed like a potential 'con' because (for example):

• the 'wealth' of elites connected to China's neo-Confucian bureaucracy (ie the so-called 'Communist' Party) is simply a component of the 'wealth' of the Chinese state; and
• the 'huge' write offs by the China's major banks involved about $US4bn relative to the claimed increase in credit in China (a significant fraction of which was perceived to be suspect) of $US2300bn to that point in 2013. It was estimated  in 2011 that the rescue effort that China's banking system required would be about 7% of GDP [1]. In October 2013 China's GDP was estimated to be about $US8,000bn. If the time discrepancy is ignored this implies that China's banking system (effectively a branch of the so-called 'Communist' Party) requires something of the order of a $US560 bn  rescue package (not a $4bn write-off).

In July 2013 it was noted that China's economy has been and remains highly dependent on external support from global companies that are based in advanced economies.

China frightens the west, but there is a need to consider how west looks to China. Peter Nolan, Cambridge Uni, pointed out that China is not buying the world. The West is in China, not the other way around. The world economy is dominated by major (systems integration) companies rooted in advanced economies. Such companies can raise finance for large projects, invest in R&D, buy state-of-art IT and leading edge human resources. As they invest across borders, such companies lose national characteristics and become harder to tax and regulate. China's success has been built on its willingness to allow its workers to the world's producers. Significant percentages of China's output results from such companies. China has far more inward than outward foreign investment. China's firms are seldom involved in major international mergers / acquisitions. China has few globally significant companies. Thus China sees itself as heavily dependent on others' know-how.  [1]

 In October 2013 China's people were reported to be wondering why China had acquired so much US debt - a question that pointed directly towards the need for reform of China's financial system - see comment in (Why China had to Buy US Debt).

Or Maybe There is No Real Problem  [<]

On the other hand it has also been suggested that China has no real problem:

•  China does not really need to change because a lack of attention to profit in the use of capital confers economic advantages because: investment makes the economy more productive and thus generates positive side effects (including taxes); a broader view of the economy is taken which sees capital as only one component; and there are more protections than are generally understood [1]. See comment on this view in China: Sustaining Growth by Neglecting Profitability?

• China's financial system is sufficiently protected from the risk of crises because: (a) its banks are being used to fund what elsewhere would be government spending; and (b) any potential problems in its banks can be covered by the government which has low debt levels and large foreign exchange reserves

[Comment: this involves claiming that a poor balance sheet for a country as a whole can be ignored by claiming that this is a matter of sovereign risk, and that sovereign risk is not an issue for a country with large foreign exchange reserves. This certainly seems to be what has been assumed - yet: (a) this protection can only be available so long as it is not necessary to borrow in international markets - which requires trading partners who are willing and able to continue indefinitely with current account deficits and rising debt levels; and (b) poor balance sheets are likely to be a symptom of badly directed investment - see also China's financial challenges are not limited to its banks and Resulting Interchange with Yukon Huang ].

• major reforms may be made to align China's financial system with the liberal international financial system  [1 ]  [Comment: such a move would seem to face serious obstacles for reasons developed further in Financial and Educational Reform in China: Headed in Opposite Directions?  ]

• China's economic reform agendas will create a basis for sustainable growth

An economy that starts process of modern economic growth can never stand still. China has been undergoing change since 1978 decision to pursue market-oriented reform and integrate into international economy. Changes, that amount to a new growth model, are now being forced by labour scarcity; rising wages; changes in resource allocation / income distribution / environmental impacts; and rates of growth / savings / investment / international capital flows. From 2004 China's old model suffered from wages rising above productivity and from decline in working age population from 2012. The old model's involvement with large current account surpluses was of concern because of its possible role in 2008 GFC. Uninhibited investment growth was also approaching limits. income inequality was becoming a source of social tension. There was international concern about China's contribution to greenhouse gases buildup. Corruption was also seen as a source of instability. Thus China entered transition to advanced modern economy - with a declining share of GDP associated with investment; heavy investment in education; higher quality education; expansion of consumption / services; reforms needed for legal and institutional basis for advanced market economy; structural change to technologically sophisticated industry. These changes reduced the contribution to growth by labour and capital - and increased the effect of institutional improvements. this requires less use of fiscal and monetary expansion - and acceptance of moderate slowdown without Keynesian response. Higher priority is attached to environmental amenity; energy savings; reduced carbon intensity. Rising wages are reducing income inequality. Government payments for rural education, health, transport, communication and an income safety net have increased. Measured inequality has started to fall.  [1]

The reforms announced by China' Third Plenum involved: (a) top level backing; and (b) a full market system. Reform would rely on top-level design rather than 'crossing the river by feeling the stones'. The most important statement is tht wherever market mechanisms work to allocate resources government should not intervene. This transition is leading to slower growth and rebalancing. Higher wages cut into profit margins, investment returns and export competitiveness - but increase household income. External surpluses decline. But there were also proposals for financial liberalization. The effect on rest of world will be to reduce China's contribution to external growth and perhaps increase risk of inflation. Expectation of a China collapse should be viewed with caution. China's outward foreign investment will provide opportunities. The privileged position of monopoly SOEs is coming to an end. China will remain a strong market for food and resources - and increasingly for consumer goods. China will rise up economic ladder with increasing innovation.  By 2020 China should be a market economy, a high income economy, the world's biggest economy and a vibrant consumer market [1]

• while there is concern about possible defaults in China's bond market, this risk is minimized by the ownership structure of the companies that issued the bond (ie many are owned by the Chinese government) [1] [CPDS Comment: All segments of China are ultimately subsets of the Chinese state. The question that needs to be asked concerns the financial viability of the whole system. The Chinese state ultimately inherits bad debts associated with the banking system, local government and SOEs all of whom have problems]

Or Maybe There IS a real Problem (2014+) [<]

At the start of 2014 the prospect of a financial crisis in China (a consequence of the escalating debt problems outlined above) was finally gaining observers' attention as an economic threat.

China's local government debt ($3tr) is now seen as the biggest 'known unknown' threat to global financial markets. China's spiraling credit addiction is a major problem as it struggles to maintain growth and avoid a financial crisis. Local government debt has risen 70%. Local governments borrowed heavily to maintain China's growth after GFC by spending on special projects. They were unable to borrow from banks - so special investment vehicles were established. Many investments may not produce enough return to pay interest / principal. Local government debt is now about half of China's total $5tr public debt. Cutting lending would have severe economic impacts - but QE could be used to deal with the problem. US government debts are about $17tr. China's government needs to relax their grip on liquidity, tighten control on state banks and control shadow banking sector. China's biggest advantage is that US is now growing 4% pa [1]

China's financial system is in danger of being too big to bail out. Official bank lending has more than doubled since the GFC - growing twice as fast as economy. The shadow banking system is a bigger problem -as it allowed companies / individuals (often with political connections) to borrow from state-controlled banks at low interest rates and re-lend at higher rates to private businesses desperate for credit. Now Communist Party has sought sweeping financial reforms. Markets will play major role in directing economy. Interest rates will be liberalised, cross border investment welcomed and regional / bureaucratic protectionism curtailed. Modest changes are already causing turbulence. Central bank had to back off to avoid stress on banking system as vested interests objected to paying more for what had been cheap loans. Efforts are being made to raise interest rates to reduce credit expansion. Market-driven interest rates have soared twice - though not for long. Tightening will induce de-leveraging. A complex / loosely regulated network of financial go-betweens has sprung up to profit from repackaging / reselling China's new mountain of debt. These investment products (which pay higher interest rates) have become popular with ordinary investors. But such products can be risky. The final users of the money will not be able to earn enough in slowing economy to repay loans. There is an expectation that Chinese people could withdraw money from banks - out of concern for stability - and thus make it impossible for them to continue funding SOEs and politically connected individuals (even where such loans are to repay existing loans). China's banks have been profitable despite lending at low rates, because they paid even lower rates on deposits - and savers had few alternatives until recently.. Real estate prices are now stratospheric relative to incomes; sharemarkets are distrusted; and shadow banking businesses require periodic intervention. Total credit in China (though growing fast) remains slightly below that in the West relative to GDP - though the percentage of non-performing loans could be higher and China's poorly regulated financial system may be harder to bail out than others  [1]

China's banks are now set to seek overseas bond buyers to provide cash. They need to raise $370bn from share / bond sales over 5 years. With growing levels of bad debts they can no longer rely on share issues to raise capital [1] [Comment: Avoiding the need to borrow in international profit-focused seems vital to protecting against financial crises where profitability is not sought in the use of capital];

Soros argues that China has become the major source of global economic uncertainty. Its past growth model is unsustainable - and current policies contain profound contradictions. It has been necessary to emphasise growth over structural reforms - to avoid a deflationary downturn, Growth has been highly dependent on expanding credit. There will be a need for political reforms to overcome China's problems. There is a strong parallel between China's situation now and the US in 2007 - though a big difference is that in China the state has control over the financial and economic systems, while in the US financial markets are independent [1]

China's national audit office has released results of country-wide survey of government debts. Local government debt growth has averaged 20%. Total debts rose 3.9tr yuan ($US720bn) to 10.6tr yuan over past 3 years. . They also guaranteed 2.7tr in others debt, and must cover 4.3 tr yuan in other liabilities. Total local government liabilities are 19.6tr yuan - about 1/3 of GDP. Central government debt is 9.7tr yuan. Total government debt is about 54% of GDP. This total debt level is concerning - but not an immediate risk. The biggest problem is the rate of debt growth while China's growth slowed. Also some areas face much greater debt risks than others. Moreover  history shows that in a crisis current government debt levels can escalate rapidly [1]

[CPDS Comment: It is unrealistic not to include the liabilities of China's banking system and shadow banking system - which are extensions of the neo-Confucian bureaucracy (ie the so-called 'Communist' Party)  - as part of China's government debt. It has been noted that China's banks are used to undertake quasi-fiscal expenditure (ie undertake spending that elsewhere might be funded by government) and that the associated losses are not seen as a risk to the banks because government will cover the cost. Credit creation by the shadow banking system has also grown rapidly - and apparently often been associated with dubious investments.]

The rise in shadow banking has been a major reason that China's debt has soared at a pace similar to the US and European nations before they crashed. Since 2008 domestic debt has ballooned to 216% of GDP from 128% and could climb to 271% by 2017 if not corrected - according to Fitch Ratings. 34% of local governments' debts came from non-bank sources [China to rain in shadow banking', The Australian, 8/1/14]

China has set up arrangements to address the bad debts of its financial institutions [1]

China does not really know the extent of local government debt - according to China Beige Book International. China's state auditor came out with a figure - but this could only have been a wild guess - as the data is simply not available [1]

China faces major problems with debt. A cash crunch is looming. Affordable credit is being rationed. Foreign buyers are obtaining nearly completed buildings at severe discounts from distressed developers. Shadow banking system rose from 20% to 30% of all lending over past year (though some say it could be 50%). Growth generated from each extra yuan of credit has collapsed from 1 to 0.25 over past 5 years. China is now trying to deleverage without economic collapse. Money supply is 120tr Yuan - but inadequate as velocity of money is very slow and interest rates are rising. China might manage the problem because all contracts can be re-negotiated. Stock market is not a real market - as it is wholly government controlled. But efforts to limit speculation cause more speculation. When China opens its capital account, there will be a rush of money offshore - and perhaps trigger disorderly fall in real estate prices. defaults by financial institutions are looming. China is riding a $24tr debt tiger that it can't control. Loans have risen from 120% of GDP to about 220-250% since GFC. This is unprecedented for a large state. There will not be a banking crash as financial system is an arm of the state. Its ending will be quite different [1]

[CPDS Comment: The 'difference' in the ending of China's debt crisis could be that it beings down the whole Chinese state, not just the financial system]

 Most analysts expect China's economy to continue to grow - but China has had rapidly rising debts. Only 5 developing countries have had similar credit booms and all have suffered credit crises and economic slowdowns. China's 'credit gap' - increase in private sector credit as proportion of economic output - has risen 71% to 240% over past 5 years. Over the past 50 years 33 countries with the top credit gaps (42% or more) - and 22 of these suffered severe credit crisis. Many believe China will be different. Rate of credit growth (not total level of debt) seems most significant - because this increases risk of wasteful investment. This seems to be China's problem. Five years ago $1 of debt generated $1 of economic growth - now this requires $4. One third of new debt goes to pay off old debt. China is seen to have protection against a debt crisis in the form of foreign exchange reserves and a current account surplus - but this is no protection against a domestic credit crisis.  Other countries with large reserves and current account surpluses (eg Taiwan and Japan) have suffered crises. China may avoid a credit crisis - but this is unlikely [1]

Trust and bond defaults are expected in China in 2014 given the number of debt-plagued companies near the edge. 1/3 of outstanding ($836bn) trust loans mature in 2014 - which many struggling firms rely on for capital. Construction / property companies are heavily dependent on debt-laden local governments. About half of local government debts ($17.9tr yuan in mid 2013 up 67% since 2010) comes due in 2014. Maintaining China's growth will be increasingly difficult. Other countries reliant on supplying inputs to China are feeling difficulties also ['China's leaders signal growing unease as overseas producers feel the pain', The Australian, 6/3/14]

China's exports fell 18% in February 2014 (rather than increasing 7.5% as expected) while imports rose more than expected. This led to expectations that China will be unable to achieve planned growth rate and to iron ore price falls. New bank loans in China fell by 50% in February [1]. It is possible that this fall in exports might reflect the ending of previously inflated data - as capital was slipped into China disguised as exports [1]

Very weak data from China and Japan led to a sharp sell-off in Asian markets and a significant decline in iron ore prices in March 2014. Lending through China's shadow banking system had ground to a halt in February 2014 (down from $160bn in January) - at about the same time that China experienced its first corporate default. It is very hard to engineer a soft landing for China as it accounts for half of the $30 tr increase in world debt over the past 5 years [1];

Falls in copper / iron ore / and China's currency values reflect more than poor trade numbers. The issues go to heart of China's banking system and the activities of hedge funds. Copper is more than a simple commodity for China's banks. It has been used as collaterale for bank loans to property developers - and thus became part of the banking system. China's banking system is stressed. Credit increase by $13tr to $15tr over past 5 years. Much of the funds (especially recently) have been borrowed in $us - - to take advantage of US QE. But this now gives Chinese banks exposure to falling yuan. Declining yuan thus has negatives for China rather than simply increasing trade competitiveness. Rapidly rising lending has been accompanied by strange bank lending deals (eg like copper based real estate funding). China's steel mills are under pressure because of falling steel prices - but were given letters of credit to fund iron ore purchases and this assisted in getting bank loans to keep steel mills afloat. This created artificial demand that boosted iron ore prices. Now falling iron ore prices place huge pressures on China's steel mills and banks. Hedge fund shorting has compounded the problem - by targeting copper and iron ore to further force prices down. This accentuates the problems facing those exposed to those commodities. China's government or central bank will need to fix this problem [1]

China's present government inherited a dangerously unbalanced economy - which had been sustained by government-sanctioned spending on construction. AS this starts to be unwound, cracks are appearing (eg in steel sector where loss-making producers had long been supported by government subsidies). Some are now likely to default - and government expects that such failures can be localised and not have system-wide consequences. But China's economy has been accustomed for years to huge quantities of government cash which have funded massive projects (eg empty cities and over-capacity property development). Without this stimulus, and given necessary tightening, bank lending will slow and substantial segments of real economy will be in difficulties. In some regions entire towns depend on industries that are no longer needed [1] -

China faces the biggest ever property default as credit curbs threaten to break the property boom and leave a string of ghost towns (now likely at 10 sites, not just the 2 previously well recognised). Developers are running out of cash. This is undermining land sales needed to provide local government revenues. China's residential property investment to GDP ratio reached 9.5% in 2012 higher than peaks in Japan and Korea and much higher than during sub-prime bubble in US [1]

Devaluation of the yuan threatens a wave of forced selling and increasing problems for those with $US debts. There is a fire sale of Hong Kong real estate by those desperate to raise cash in the face of liquidity squeeze in mainland China. The losses on structured products as yuan devalues could force further devaluation and losses [1]. Alternately devaluation of the yuan can be viewed as part of deliberate Chinese strategy to stem hot money flows into China which had over-heated property markets [1]

China seems to be headed for a 'hard landing'. It has had 30 years of strong growth. Until 2007 this was driven by exports and investment. Imbalances both external (current account surplus) and internal (high investment-GDP ratio and low consumption to GDP) have increased. These are seen as inherent feature of China's growth model related to three price distortions (ie for exchange rates, wages and interest rates). Great Recession of 2008-09 made export reliance harder because of weaker demand growth elsewhere and yuan appreciation / increasing wages which impeded competitiveness. Thus growth depended even more o investment - and external imbalances reduced sharply while internal imbalances worsened. The fall in China's trade surplus reflected commodity imports - usually at high prices - because investment surge was commodity intensive. Though government has committed to rebalancing, this has not yet occurred - perhaps because of insufficient effective reform. Fundamental features of China;'s growth model (eg financial repression) remain uncorrected. That model has reached its limits - as shown by China's steady slowdown since early 2001. This could lead to a Japanese-style 'hard landing'. Reasons for suspecting this are: historical rebalancing precedents (most countries with similar model to China's experienced sharp growth slowdown; China's characteristics are those of other countries that experienced slowdowns); overinvestment (some see 12-20% of GDP being over-investment; capacity utilization fell from 80% before crisis to 60% in 2012); unsustainable debt trends (investment surge was largely financed by debt); and a real estate bubble (situation is like Japan at start of 1990s, and investment option in China are limited to real estate). [1]

Is China different, or must its debt binge end in tears. While China won't have a meltdown, growth will slow. China's net exports fell from 8.8% of GDP in 2007 to 2.6% in 2011. This was offset by sharp rise in investment. The latter was associated with explosion of credit and debt. Social financing rose to 200% of GDP (up from 125% before GFC). Most increase has been outside traditional banking. Private sector credit is now as large (relative to GDP) as in US in 2007. China's growth has slowed to 7% pa. If this data applied to a company a bad outcome would be expected. However it has been argued that: China borrowed to fund investment; companies are the main borrowers; and China does not depend on foreign lenders; and yuan is not freely convertible. However others have had problems with excessive corporate investment, and a substantial amount of investment (eg 12-20% of GDP) may have been squandered. The other points are stronger. Yet credit can't grow faster that GDP in China forever. Debt accumulation is likely to end with a wimper, not a bang. Households and smaller enterprises have subsidised SOEs. These subsidies will have to increase - harming the economy, if growth is to continue. China faces major difficulties in arranging a transition [1]

China has the greatest construction boom / credit bubble in history. China's development since Deng has been based on monetary and credit inflation. In 2000 US had $27tr credit - and this rose to $59tr (ie at 7% pa). In 2000 China had $1tr credit but now it has $25tr. There is no real banking system in China - just bureaux that distribute credit from the top. There has never been any real pricing or honest accounting. There is no financial discipline based on contract law. China's GDP grew $10tr after 2000 - without anyone ever apparently making mistake / loss. China had 1.5 bn tons of steel capacity - but use for only half of that. This is also true for cement, ship-building, solar power, aluminium. It also has 70m empty apartments. Local governments have little income, but large debts supported by inflated land values. Coal mines face collapsing prices / revenues - but double digit interest rates on shadow banking loans collateralised by overvalued coal reserves. Shipyards have no orders, but vast debts collateralized by their idle construction bays. Speculators have collateralised massive copper / iron ore stockpiles at outdated prices. Onece asset values start falling, its pyramids of debt will stand exposed. Zhejiang Xingrun Real Estate may be the catalyst for collapse - though there are thousands of other possibilities.  It borrowed $562m of which $112m was at 30% interest. It proposed a redevelopment project - but was unable to proceed because it was bogged down in a lawsuit with residents. It continued rolling over loans. But private lenders no longer want such risky projects. There are calling in loans. And real estate values are declining . Its default will add to local government debts and thus to provincial debts [1]

Major Chinese banks claim admirably low non-performing loan levels - but no one takes the official figures seriously. A mini bank run in Zheijiang could be a sign of things to come [1]

Many observers now believe that China's property bubble is like Japan's in 1990 and that it is only a matter of time before it bursts [1]

Turnover in China's property market fell 45% year on year to May 2016 and 19% over the previous month. A fall in property turnover has often been an indicator of recession. There are 53m unoccupied properties in China. Property development has accounted for 16-25% of China's GDP [1] - as compared with 6% of the US's GDP prior to the GFC [1]

China has backed away from long term structural reform because of the need to respond to its slowing economy [1]

China has suffered from a debt addicted economic growth. Other countries who have had a rapid rise in credit (eg a 40-50% increase) over 5 years have suffered serious financial crises (eg Japan to 1990, Korea to 1998, US and UK to 2007). China's debt-expansion (at 87% since 2009) has been much greater. Corporate debt in China is now greater than in US. The average Chinese company has been seen to have worse cash flow and more debt that firms anywhere else. Other countries also have accumulated debt problems (eg Japan, US, various European countries). It is only a question of who will hit the wall first  [1].

The state-owned Bank of China has been accused of money laundering and not complying with foreign exchange controls. Clients allegedly were helped to 'launder money' (eg illicit money gained by corrupt officials and businesspeople). There is a dilemma facing China regulators. They are seeking to promote financial liberalization and outward investment. But at the same time there is an unprecedented crackdown on corruption - and many officials are fleeing China. China could be preparing to clamp down on the illegal outflow of capital [1]

Debt plays a major role in recent evolution of China's economy. Investors take debt issues more seriously than economists, Many analysts get China wrong because they fail to understand the distortions driving the economy (especially the creation of debt). Unbalanced growth may make sense initially - but this has to change at some point. Eventually the imbalances must be reversed - and in countries with centrally managed economies like China the imbalances can have become extreme. There are various ways in which China could rebalance away from reliance on rapidly rising debt - but they perhaps require 4-5% of national wealth being transferred from state to household sector annually and growth rates on 3-4% (not 7-8% as at present). Everyone now recognises China's debt as a problem. However some see that this is merely a matter of administrative changes to eliminate the distortions in shadow banking system. But the reality is that escalating debt has been a fundamental part of the way the economy worked. There has to be a massive transfer of wealth from state sector to households to change this. Some believe that China's debt problem can be solved by socializing it - ie transferring it from banks to state - and that as China's total is less than in Japan (where high debt levels have been managed) this should not be a fundamental problem. But Japan's government debt has been sustainable so far only because GDP growth and thus interest rates have been close to zero. Socializing China's debt (or transferring local government debt to central government) would reduce the risk of legal defaults - but do noting to resolve the actual problem of resolving the debt problem which requires assigning the costs. China has been misallocating investment for years (ie generating returns on investments much less than debt service costs) and, because there have been no debt write-off these implicit losses remain on balance sheets of China's banks. GDP has thus been over-estimated (perhaps by 20-30%) by not writing down these losses. Productivity numbers have also been biased upwards. Losses that are rolled over do not disappear - but has an adverse economic effect in some way. GDP growth only increases while increasing amounts of losses are being rolled over, and is reduced when they eventually are written off. The difference can be very significant in terms of reported GDP growth (eg increasing a desired 7% pa growth to a reports 10% pa while losses are rolled over, and reducing it to 4% pa when they are being written off). The problem would be worsened by distress costs during the write-off phase. Debt can only be resolved by assigning the losses. China has hidden losses in its banking system - and China's government has to decide how to assign them. China can't assign losses to households as it did previously by financial repression without suppressing domestic demand, generating social unrest and creating an escalating requirement for increases in debt. If losses are assigned to SMEs then the engine of China's future growth will be affected. Assigning losses to state sector would be difficult as China's elites profit from control of state sector assets - and will thus resist attempts to assign them losses. The losses in the balance sheets of China's institutions can't simply be ignored. They have to have an effect somewhere [1]

Chinese property buyers are not concerned about a property bubble. But prices are falling and some see major problem. The risk that China's banks / shadow banks face is not the same as in the US. Rather the risk is that property is used as collateral for everything else - as applied in Japan before its 1980s' boom collapsed. Property is 15% of China's GDP. Authorities have sought to constrain China's property boom - and the effects are now becoming obvious. Credit drives expansion of China's property market - and when this fades property is directly affected. Since 2008 China's money supply expanded three fold - with most going into property. Constraints on credit to developers requires then to cut prices which discourages buyers. Developers are seen as the weakest link in China's property market. The market could be supported by: easing of government restrictions; relatively low level of household debt; requirements for large deposits mean that loan / valuation ratios are low [1]

China is seen as likely to experience a full blown banking crisis. Authorities are understating the extent of bad loans on their books - and will face difficult choices when bank failures start . 20 years ago authorities responsibility for 30% of bad loans in the system - but now claim this is 1%. A Chinese 'Lehman Brothers effect' could result if small banks are allowed to fail [1]

In China almost all debt is government debt - and bankruptcies / corporate failures are rare. Will Beijing step away from this practice, or might it face a situation where government is unable to prevent a broad unraveling? A $500m investment vehicle recently faced default. China's government its four pillar banks to have a massive borrowing-lending spread. Private borrowers can't usually get funds from them - but must rely on alternative vehicles (the 'shadow banking' system). The investment vehicle had been set up by one of the giant state banks - and a 'white night' rescued it. This was an entity that had been set up as a 'bad bank' to hold the assets of the major bank in 1999. Authors of red Capitalism argue that this is a shell game - where assets move around as Beijing maintains a fiction that NPLs are 1%. Now the AMCs are being listed as the communist party struggles against financial losses of all kinds. Since 201 China's banking assets have grown to double those in US. To postpone NPL time Beijing can print money. This casts a shadow over the prospects of real financial reform. 15 years ago the prospects of reform seemed better. It is now necessary to belatedly build on that start [1]

China risks heading in the direction of Japan - a nation synonymous with decaying first world economies. Urgent action is needed by authorities to prevent economic stagnation. China's problems are more serious than those in Japan. There are strong signs that the housing cycle is tipping over. Japan experienced rapid growth in second half of 20th century to become world's second largest economy - but was derailed in early 1990s - and is now mired in high inflation, low growth and high government debt. China's government debt problem is even worse. China may go the way of Japan as bad debt accumulates rapidly and assets deflate in value. China's problems are similar to Japan's - ie unbalanced growth; government stimulus; over-capacity; and overwrought housing market and an under-capitalized financial system. However there are steps that China to take to improve its position [1] 

The People's Bank of China will inject liquidity into the five largest banks in what is seen as as a form of quantitative easing [1]

China's attempt to achieve financial reform is running up against the pressing need to maintain growth. Growth has slowed. Beijing has tried to avoid short term stimulus measures at the expense of longer term reform -- as banks, companies and local governments carry huge debts, China's central bank has long sought competition between state owned banks and to get more money into consumers' hands. People's Bank of China offered money to banks at discounted rate - so that it could go to commercial enterprises - but political connections still proved dominant. Unlike US Federal Reserve, China's central bank is not independent and for decades directed banks to provide politically approved activities. With growth stalled China's leaders have made it clear that priority should be given to stimulating growth - and it is hard to also seen financial market reforms. The central bank is concerned that new funds made available could stimulate demand for loans to support real estate. Policy makers are now trying to prevent property market becoming an economy-wide crisis [1]

China's financial sector was reasonably sound prior to GFC - but since then its has become the biggest threat to China and perhaps to the world economy. The cause of the problem was probably the adoption of rigid economic growth targets and incentives that encouraged over-performance [1]

China's industrial production has fallen to lowest level since 2008. Retail, investment and housing all point to a slowdown. Government has given $81bn to 5 major banks - but this will make little difference, Corporates (especially in mining, property and industrials) face grim future. China's corporates took on 5.4 times more leverage in first half of 2014 than they had before - restoring levels like those in 2006. This has largely been unintentional - as debt growth has been decelerating. Situation is unsustainable - and government insists it won't provide rescue with big stimulus. Chinese companies seem to be in terrible position as in 2008 and 2011 - and on both occasions growth decelerated. Defaults, credit events and failure by weak companies should be expected [1]

There is a need for close attention to China's banks, China has to cope with a slowing economy and cooling real estate markets. Government has made it easier for households / business to borrow. This won't address growing pile of bad debts. Debt can still be increased at the moment - but the rate of debt increase since GFC is alarming. Since GFC over half of China's GDP has been from debt financed investment. This led to historic rise in property values which is now slowing. If this reverses significantly China economy could be badly damaged [1]

Despite this other observers have argued that problems facing China can be ignored because China has demonstrated a superior ability to avoid the effects of potential financial / economic crises in the past.

This might however be invalid. China's society and economy had responded to centralized coordination through a quasi-bureaucratic neo-Confucian hierarchy centered on the so-called 'Communist' Party - just as Japan's had done at least until the 1980s (though in Japan's case it was the actual bureaucracy that had provided that coordination) - see Understanding East Asia's Neo-Confucian Systems of Socio-political Economy

However this was not a sustainable arrangement because centralised coordination through an elite hierarchy that is able to create credit for 'desirable' investments with limited or no regard for return on capital (see Evidence) is a formula for escalating and unserviceable debts. Japan grew rapidly in the second half of 20th century but then became mired in low inflation, low growth and significant government debt. China now has an even bigger debt problem

Moreover for such systems unsustainable debt levels create the risk of political collapse (not just a financial / economic crisis) because it is the governing elites themselves (eg the so-called 'Communist' Party or Japan's bureaucracy) rather than private entities that would lose control if huge quantities of debts have to be written off. When Japan's financial crisis followed the excess credit creation of the 1980s, bad debts were concealed to be written off slowly so that Japan's governing elites would not lose power. The result was decades of economic stagnation.

To minimize the risk of either economic stagnation or political collapse China arguably needs to reduce the role that affiliates of the neo-Confucian bureaucracy - the so-called 'Communist' Party (ie state banks and politically connected individuals) play in allocating / using capital and place greater reliance on independent profit-oriented decisions in a market context. Another justification for doing this would be to reduce the wealth inequalities that have resulted in China as many have exploited their positions in the economic hierarchy. The (possible) extent of the corruption (and its adverse economic effects) can be seen in 2014 suggestions (of unknown validity) that up to $4tr (almost half of China's 2014 $9tr GDP) have been corruptly moved offshore by Chinese officials since 2000.

However, if this were done, the view that China will successfully manage its current challenges because it has done well in the past would be invalid (because the key to moving forward would be to demolish past machinery)

Though not all are convinced (see indications), the possibility that real market reform was intended was supported by:

• suggestions by Chinese analysts (see above);
• a perception that China's president (Xi Jinping) has orchestrated an anti-corruption campaign across China. This has consolidated his power and resulted in jail sentences for his former political rival, Bo Xilia and for many other prominent officials [1] [CPDS Comment: another interpretation of these purges is that they have had the effect of eliminating those who might have sought a more truly 'communist' China - in which social elitism and gross wealth inequality is reduced. This certainly seemed to be the basis of Bo Xilia's populist campaigns - which appeared to favour a return to a variant of the Mao era and a primarily state-owned economy]
•  the reported flight from China by rich Chinese (most of whom presumably gained their wealth from connections with the Chinese state) in order to get their wealth out of the reach of a reformist Chinese state. One third of China's 'super-rich' were reported to have already left, while another 1/3 were said to be considering leaving [1] [CPDS Comment: another interpretation of a large-scale shift offshore by China's economic elite would be that this is intended to provide a means to orchestrating a global, rather than a purely domestic, Chinese economic empire];
• lending through China's shadow banking system ground to a halt in February 2014 (down from $160bn in January) - at about the same time that China experienced its first corporate default [1] an indication that government would no longer automatically bail out failed ventures;
• a China Development Forum in March 2014 heard acknowledgement of China's economic challenges (which included demographic constraints on labour force; rising financial risks; pollution; and water-availability constraints on resource-intensive growth) and proposed liberalizing reforms to provide a basis for China's future political and economic success (see details below).  [1] [CPDS Comment: The problem with such proposals is the same as it has always been - ie that 'liberal' arrangements seen incompatible with China's traditional culture - see also China's Credibility Problem ]

• there is a perception that China's efforts to promote the role of the yuan as a international / reserve currency is a sign of serous intent to establish a free-market financial system [1]. However this is not necessarily so.

Are Yuan Reforms an Alternative to Market Liberalization? - email sent 27/3/14

Geoff Weir and Kathleen Walsh
Australian Centre for International Finance and Regulation

Re: Casey M J., China markets to take off with yuan reforms, The Australian, 27/3/14

There are possible problems with the suggestions ascribed to you in the above article:

“CHINA is poised to accelerate liberalisation of its capital and foreign exchange markets, a move that will turn the yuan into a major reserve currency within 10 years and catapult Chinese stock and bond markets into the ranks of the world’s two biggest, according to researchers from an Australian government-sponsored think tank.

A comprehensive report by Geoff Weir and Kathleen Walsh from Australia’s Centre for International Finance and Regulation argues that if new experiments with free-market finance in the Shanghai Free Trade Zone succeed, Beijing will expedite the opening up of China’s capital account.

Such a move, which would allow more or less unrestricted exchange of yuan for other currencies, has been flagged as a five-year goal by the Chinese Communist Party’s Central Committee.”

While there is little doubt that China would like to see the yuan become a recognised ‘reserve currency’ this would probably be regarded as an alternative to the adoption of a true free-market financial system because there are massive cultural obstacles to the adoption of such a system within China itself (see China's Credibility Problem). Moreover China is arguably facing a financial, economic and political meltdown unless it can convince the world that yuan are worth having irrespective of the true balance sheet of China’s banks and government. Where financial institutions do not take profitability seriously (see Evidence) the need to borrow internationally (which China’s declining current account surpluses suggest is imminent) is a formula for financial crises – unless one can borrow in a ‘reserve currency’ that one manufactures oneself.

The view of an experienced ‘China-watcher’ about one of the issues you reportedly mentioned is referenced in Not Everyone is Convinced that the Shanghai free-trade zone is serious.

I would be interested in your response to my speculations.

John Craig

Observers had both positive and negative perceptions of China's economic reform agenda.

China's premier presented his annual Work Report in March 2014. It referred to maintaining 7.5% pa growth and free trade negotiations with Australia. It also targeted international audiences with references to pollution / corruption reduction - and targeted China's political business elite in warning of break-up of government monopolies and corporatising financial services. In relation to concerns about a 'hard landing', China's government committed to reducing its deficit, spending cuts and a wider trading band for renminbi. Foreign trade would be increased, conditions for foreign investors improved and outbound investment streamlined. There was a wider blueprint for wide-ranging market and fiscal reforms as the foundation of deregulated and liberalised economy. Reforms related to marketisation, entrepreneurship and public finance were outlined at Third Plenum. These were converted to deregulation agenda involving abolition of government monopolies, opening state-controlled industries to private capital and banking sector corporatisation. private entrepreneurship is recognised as contributing to innovation / job creation. Private sector would gain better access to bank finance and protection of intellectual property. Markets for services and other areas would be opened to foreign participants. Most reforms are just on paper - though some are being trialled locally. They would be complemented by social welfare reforms (eg extending the right to live in cities). The problems of reform in China have long been known - but now there is a government plan that permits private entrepreneurship and a market-based fiscal system. This is like deregulation in Australia during Hawke / Keating years. However implementation is likely to be gradual. Chinese government's desire for a better market economy and better system of governance is now indicated. [1]

Everyone wants to hear of 'reform' in China. Those who rejected criticism of China's system now say that its system needs 'reform'. China's premier recently spoke more about maintaining growth than about 'reform'. Reforms mentioned included: closing idle factories; encouraging private investment; cutting red tape; encouraging consumption, rather than investment, driven growth. But these are not real reforms. What is the  'market-based reform' to which Chinese leaders are committed? Real reform requires: (a) encouraging real competition between firms / individuals; and (b) building institutions needed for fair and even transactions between economic entities and for 'creative destruction' of undeserving entities. One requirement to achieve merit-based competition would be winding back the special position of SOEs. However at present all that is being done is apply band-aids to problems created by SOE dominance. Raising the social safety net can not significantly encourage consumption. Rather this requires enabling millions of private firms to seek opportunities by reducing SOE role. However SOEs continue to be subsidies at expense of consumption. Interest rates are kept low to give SOEs cheap finance. Investment options are limited to state-owned banks. Creating private banks won't overcome the bias to financing SOEs which is implicit in their government guarantee. Profit is not the way market-worthiness of firms is judged in China. Many SOEs are profitable because of advantages given them - not because they are more efficient or provide better products. Also the advantages given SOEs mean that they can ignore measures intended to improve environmental situation. Chinese officials claim that institutional support for fair competition is proceeding. And urban residents now have more secure long-term lease rights. Contract law is generally enforced. However in important ways reform has ground to a halt.  When the state or SOEs are involved in disputes, problems arise because the state controls courts and tribunals. Millions of rural residents have had property siezed to allow developers to profit in property market. Land rights would be the best way to remedy rural poverty in China - yet government has to pour in huge subsidies to compensate for lack of land rights. To avoid the 'middle income trap' China needs real reform [1]

Japan was seen to be likely to overtake US economically in 1980s - but asset bubble burst. Plunging share / land prices led to banking crisis (with $US 950bn banking losses from 1992 to 2007). Japanese government spent $500bn on non-performing loans. China could be going the same way with non-performing loans. NPLs of 12 listed Chinese banks are (officially) $A67bn. China's banking regulator has demanded better performance. China seems better prepared than Japan to now avoid a crisis. Corporate debt is likely to fall over coming years, and credit growth has been constrained. Rate of private debt growth / GDP in China is below that in US, UK, Spain.  China's banks have strong balance sheets to withstand losses. In 1980s Japan's banking regulator did not take pre-emptive steps to curb credit expansion. China's homebuyers need to find 30% deposit (or 60% for second homes). Banking reguator has implemented Basel III capital framework. In early 2000s banks had 40% NPL rations - so government injected a lot of capital. This could happen again. Japan's government could not do this in 1980s. China's rapid growth rate is higher than in Japan - and this provides a buffer. None-the-less China's banking system will come under stress. [1]

China skeptics used to be regarded as curiosities even as late as 2010 -but since 2011 this view has been more widely considered. The focus is now less on China's double-digit growth model and more on what level of chronic slowdown it will suffer. Intellectuals can tend to get things wrong because they are 'slaves to fashion'. Hype about the China model has been led by: (a) those who could profit from that hype; (b) those who advocate engagement with China to ensure its peaceful rise; (c) intellectuals / malcontents who were seeking an alternative to Western-style capitalism - and hoped that the Beijing consensus would avoid the chaos, corruption and indecision that can affect developing countries. Those with no experience of China's system fantasized that an all-knowing / all-powerful political party can avoid short-termism, political disputes, factionalism and other democratic features; and (d) the Communist Party - which needed to have a good story to tell to attract foreign capital and resist pressure for property / intellectual property rights and a rule of law [1]

 'New normal' is used to describe China's slower (ie about 7% pa) annual growth. However there are significant structural change. China long pursued a mercantilist model that prized production over consumption. But consumption is now seen to exceed investment. Services now account for 46.7% of GDP growth. Ryan Rutkowski (Peterson institute for International Economics) cast doubt on these nominal Chinese figures. He suggests that rebalancing is occurring but more slowly than claimed.  [1] 

China's anti-corruption efforts have been seen to be directed against opponents of the ruling regime, and suspicions exist about those in senior roles in the regime (see below)

The way bad debts disappear in China raises troubling questions about China's plan for its financial system [1]

One possibility that occurred to the present writer was that reform could ultimately involve a break-up of SOE's enterprises (ie to bring to an end the Mao-era economic arrangements that Bo Xilia and his supporters seemed to have favoured) and to replace this with a 'market' economy driven by businesses with social links to the state rather than one driven by independent initiative - thus creating a 'non-capitalistic market economy' somewhat like that in Japan..

However if genuinely market-based methods of setting economic directions are required in future (ie those based on independent / private enterprise), China's economy will lack the discipline it has had in responding to the fairly-well-informed consensus developed by the quasi-bureaucratic economic hierarchy. Moreover:

• massive cultural changes would be required to enable a more liberalised financial system to operate - for reasons suggested (in the context of the 1997 Asia Financial Crisis) in The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems (1998) and in Understanding East Asia's Neo-Confucian Systems of Socio-political Economy (2009+);
• China's education system does not seem to be geared to creating a population with the cultural characteristics required to operate in a liberalised financial / economic environment (see Financial and Educational Reform in China: Headed in Opposite Directions?, 2013);
• the creation of a market economy does not necessarily indicate the end of internationally disruptive financial distortions. Japan was said in the 1990s to have a 'non-capitalistic' market economy (ie one in which capital was allocated to a 'market' involving state-linked enterprises with limited regard to financial returns, so that current account surpluses - and trading partners willing to sustain ever rising debts - were vital to avoid a financial crisis). Having a 'market economy' has not meant that those distortions have been eliminated in Japan's case (see evidence).

Structural Problems (above) draws attention to underlying obstacles to reforms to ease these outlined difficulties including: dependence on unsustainable international financial imbalances; over-optimistic assumptions about the economic benefits of large scale capital spending; and incompatibility between Chinese people's desire for social equality (which China had in the Mao era) and the neo-Confucian social hierarchy (centred on the so-called 'Communist' Party) that has been the basis of its centrally orchestrated economic 'miracle' since the late 1970s (and incompatibility that could even lead to another civil war).

An aside on QE: It can also be noted that quantitative easing (QE) to compensate for any decline in the availability of credit as financial institutions suffer the effects of widespread bad debts could be quite risky for China.  Under some circumstances 'printing money' to support state spending can generate hyper-inflation. One factor in containing this risk is presumably ensuring that QE merely compensates for declining credit from other sources. However another factor that has limited the potential for an inflationary outcome from QE in the US / Europe / Japan is that the pricing power of producers (and thus the potential for wage / price spirals like those that resulted from oil price shocks in the 1970s) has been contained by competition from cheap imports (especially from China). This obstacle to an inflationary outcome from QE would not apply to China. It can also be noted that QE does not provide a solution to structural problems in the financial system (eg the effect of international financial imbalances on the requirements for some countries to be willing and able to perpetually increase their debt levels in order to prevent global economic growth from stalling in the face of 'savings gluts' elsewhere). It merely allows debt levels to rise for longer without an immediate crisis, but is likely to lead to severe problems when interest rates subsequently rise to market levels.

Uncertainty  (2014) > >>  >>>

In mid 2014 it was argued that observers expecting China to liberalize economically or politically were misguided as what seemed to have been put in place by president Xi Jinping was a reversion to an ancient Chinese elite-guided style of regime (see The Resurgence of Ancient Authoritarianism in China).

In the latter the present writer argued that introducing this reform reflects the very weak position in which China and its leadership found themselves. China's economy was messy (property bubble, shadow banking) and highly dependent on nothing going wrong with a highly-uncertain global economy. The (so-called) 'Communist' Party confirmed its status as the top level coordinators in a (neo-Confucian) bureaucratic state - and sought to promote virtue to overcome problems associated with a past lack of ethical behaviour by 'Communist' Party elites. Anything that goes wrong is now clearly their fault. Many of the people who orchestrated the economy in the past (and who have vital knowledge) have been marginalized by anti-corruption push. The Bo Xilai challenge was the face of a growing reaction against the currently-dominant factions – who presumably have their power-base in the commercial south (Shanghai) and amongst the Chinese Diaspora. Opposition to this is significant (as much of China puts communal before commercial values – and a desire for social equality is strong). Regime is tolerated so long as economy advances. Opposition is underground / invisible – but could have unexpected manifestation at any time. China’s history is littered with civil wars – which have often seen the predecessors of current dominant factions thrown out of China. Maintaining domestic security is a major challenge.

In August 2014 it was argued (on the basis of research by US Conference Board) that China's recent reform agenda had not put it on a sustainable growth path and that it seemed to be headed for the 'middle income trap' that had affected economies such as Brazil and Malaysia. Productivity growth had gone into reverse for the first time since the end of the Cultural Revolution - a classic sign of the 'middle income trap'. Over-building / over-capacity / the advance of less efficient SOEs into private sector markets have been a drag on China's economy. Growth has relied increasingly on state-directed investment - which the incremental approach to reform had failed to achieve the necessary changes [1].

CPDS Comment: This conclusion is possible (eg because efforts to eliminate corruption from China's government have probably also eliminated many who with the best understanding of China's economy). However it also needs to be recognized that the criteria for economic 'success' that the US Conference Board perceives may not be the same as China's criteria

In September 2014 there were indications that China's administrators might have recognized the true difficulties China faced and intended to confront them - even though this would involve immediate pain. The actual implications of that 'solution' were not immediately obvious. Panic might be imminent.

China's leaders have ignored warnings of an incipient credit crunch - and seem determined to purge excesses from the financial system despite falling house prices and a deep industrial slowdown. Industrial production fell in August. Fixed asset investment fell to record lows. Despite a sharp deceleration Beijing seems calm. New credit has fallen 40% - and there has been a shadow banking system clampdown, A 'credit crunch' is being engineered by regulators. Nominal GDP now grows faster than credit. The property market suffers. Washing machine production has fallen 7.5% over the past year. China's central bank may have to step in to prevent over-kill. Premier Li Keqiang seems determined to implement deep reforms and wean economy off very high debt levels. The money supply was said to be being restructured rather than expanded. Reform will continue so long as growth is strong and unemployment low. China's workforce is shrinking and rural-urban migration is slowing rapidly. Catch-up growth options may be exhausted. Until recently each slowdown was met with fresh blast of new loans - creating increasing problems. Credit / GDP ratio has doubled over 5 years to 200-250%. The economic benefit of new credit has collapsed - and creating new credit was becoming dangerous. Communist Party's decision to constrain credit has global implications - as its $25tr banking system was already as big as US / Japanese banking systems combined. China's industrial slowdown explains why iron ore prices have crashed - and oil demand is below expectations. China's new discipline may not last. The problems in the construction industry are disguised by advance payments that are treated as cash flow. China may find it as hard to deflate a housing bubble as Japan and US did [1].

In late 2014 there were increased reasons for concern about China's economic sustainability (eg see Assessing China's Prospects).

• In October 2014 an attempt was made to solve the problems associated with China's local government debts - a move that would both:(a) improve future financial transparency; and (b) pass losses associated with poor investments by financial institutions, which had been seen as implicitly subject to some sort of government support, on to those who deposited funds with, or loaned money to, the financial institutions).

China's State Council issued directives to improve transparency, clarify debtors' responsibilities and reduce overall debt. China's local governments have direct debts, debt guarantees and partial responsibility for other liabilities that are about 1/3 of China's GDP - though some are concerned that these figures are understated. Reforms include: (a) allowing local governments to raise their own debt - rather than turning to local financing vehicles - and limiting this to funding infrastructure; (b) reducing moral hazard by making it clear that central government would not bail out local governments; and (c) clarification of who is responsible for debts (to clarify the blurred lines between government debt and corporate loans). Local governments will be unable to raise debt through corporate platforms - and companies can't shift debts to local government. Local governments must withdraw from all commercial real estate projects - and liquidate assets through market mechanisms [1]

CPDS Comment: What has been announced seems to involve the ultimate 'bail in' (ie passing losses associated with poor investments by financial institutions on to those who deposited funds with, or loaned money to, the financial institutions). It seems very likely that these measures will: (a) inflict substantial losses mainly on Chinese savers and companies (given the likely massive level of bad debts that will be written off and the refusal of China's government to accept any responsibility for what local authorities were encouraged to do to sustain China's post-GFC growth); (b) be possible only because of the repressive control that the Chinese state exerts over its people; (c) have the perhaps-serious impact on China's financial system / economy that has long seemed imminent; and (d) provide China's regime with an ability to blame  the adoption of liberal Western style financial reforms for triggering that outcome.

• it was suggested that China's risks of a financial crisis seemed to exceed that in the US that led to the GFC, and argued that, though Chinese leaders were smarter, China still faced a major challenge.

CPDS Comment: China's prospects can't realistically be understood without consideration of what is different about ways of thinking and doing things in East Asia - see Assessing China's Prospects.

• China's transition from its past growth drivers is likely to be very difficult, and that indicators of its actual economic growth suggested that this has fallen far more than official GDP data would indicated.

Germany and China are at the center of regional trade blocs. They both trade globally but also depend on their regions. German exports are 50% of GDP, compared with 24% for China (14% for US and 20% for Australia). Germany's primary market is Europe - and it has problems because European economies are struggling to grow. China has much more regional demand - but much of it is from people who lack the purchasing power to buy the goods China produces for export markets. China's reliance on low-cost exports and state-led infrastructure / housing investment are no longer viable. Domestic consumption / high value-added manufacturing / services are not yet of sufficient scale to offset risks of social and economic dislocation (as political legitimacy depends on creating jobs and rising material prosperity). Both Germany and China depend on sustaining strong exports. The Communist Party was shaped by rising unemployment in Shanghai in 1927. The GFC decimated China's low-end export sector - which had been maintained for too long by low wages and subsidies. Exports fell suddenly from 38% of GDP to 24% - and reliance had to be placed on state-led housing / infrastructure investment. The housing boom is now ending. China hopes to expand exports of higher value goods. China's real growth has slowed - and there are deflationary risks in housing / shadow banking system and overcapacity. China's official GDP figures are unreliable. An alternative (China Momentum Indicator) suggests that China's growth is now well below what GDP data suggests. [1]

• China seemed to be unable to escape from its dependence on a extraordinarily high rate of credit creation despite the declining economic impact of that credit.

China seems to have abandoned its policy of monetary tightening. It has cut interest rates to head off corporate crunch and increasing dangers of deflation. This seems like a return to old ways of credit-driven growth - a tactic that has passed its sell-by date. Falling inflation has caused the real cost of borrowing to rise from zero to 5.5% since 2011 (while non-financial companies face interest costs of 15% of GDP - up from 7.5%). Cutting rates is significant change from recent piecemeal injections of liquidity. It is being forced - but China won't be safe until its dependence on credit creation is constrained. Cuts were needed because of $250bn tightening associated with clampdown on shadow banking system over past 2 months. China is close to deflation - made worse by fall in Japanese Yen and quasi-peg to $US. It is importing contractionary forces when its housing boom is wilting. China requires 20% loan growth to keep economy going - but it has fallen to 15% and this is strangling economy. There is less GDP growth out of increasing credit - which says that loss-making assets are being rolled over. Bad loans are rising 50% p. The biggest problem lies with SOEs whose debts are about 100% of GDP - as compared with 50% of GDP for private corporate borrowing. Central bank has been trying to wean China off credit, but it may have been overruled by state council. China's debts are 250% of GDP which is unprecedented for a large developing economy. Some observers see the problems as manageable with no signs yet of real distress. The cuts to interest rates may not be as significant as some have suggested. China's labour force is declining by 3m pa (due to one-child policy) and this automatically tightens the labour market [1]

• China's economic dream is at an end

Economists suggest that China will become the world's largest economy. China's president has launched a 60 point plan to remake China's economy - and campaigned to cleanse the Communist Party of corruption. However in 2009 China's economy was growing 10% pa- but is now 7%. GDP statistics are only accurate in terms of direction - and this is now clearly down. China's economic miracle is ending. Success has depended on debt-powered housing bubble and corruption-laced spending. Many Chinese cities are surrounded by vast, empty apartment complexes. Real estate has been the main driver of China's growth for 20 years. Debt paid for the boom - with borrowings by governments, developers and many industries. The IMF has pointed out that only four countries have had as rapid a debt build-up as China (Brazil, Ireland, Spain and Sweden) - and all had debt crises in 3 years. China followed Japan and Korea in using exports to pull its people out of poverty - but China's immense scale is now its problem. It is the world's largest exporter - but can't get much more growth from this. Shifting to innovation will be hard - as its competitor nations encourage free thought and idiosyncratic beliefs.  Few engineering students in China seek to become entrepreneurs - about 1/7 the percentage in Stanford. Xi's reform agenda is standard fr China. But it is hard to make it happen. The government wants to reduce steel production in the province surrounding Beijing (where twice the steel production in US is located). It was decided to destroy blast furnaces - and this was publicly done. But those facilities has had long been out of production. China's steel production is on track for record this year [1]

• it was noted that debt guarantees between companies had been very useful in allowing small firms with limited collateral to borrow and fuel China's rapid debt expansion in recent years. But as China's economy slows this is now leading to cascading problems and potential regional crises - because some firms are failing and their guarantors are actually having to pay up at the same time that they themselves come under financial strain. China's reserve bank reduced interest rates to take pressure off SMEs [1]
• it appeared that China had wasted $US6.8tr over past four years (invested this amount ineffectively according the China's National Development and Reform Commission). This amounts to about half of all 2010-1013 investment. Low interest rates and government stimulus measures are seen to be the problem. China's deserted ghost-cities are a major manifestation of this. The problem is likely to continue as the PBoC has slashed interest rates. It is exacerbated by corruption amongst the countries autocratic elite [1]
• China is experiencing a stock market boom despite having excess capacity in 'everything'. Authorities are striving to contain it, but China's excess savings have nowhere else to go [1];
• China is likely to experience recession in the next year or so

China is struggling to maintain growth - given shadow banking, ghost cities, slumping property prices, a manufacturing slowdown and debt defaults. Home prices have fallen 7 months in a row. China's property market is the biggest domestic economic threat (and perhaps a global threat). A growing middle class is nice, but China needs strong export growth which is hard with a now expensive currency. China buys most of the world's iron ore - but now has huge stockpiles. China's efforts to rebalance its economy towards domestic consumption seems like a 'hard landing' from Australia's viewpoint. Jobs growth is the main driver of consumption - and this has been weak. Shadow banking has been a necessary part of China's growth (because the banking system is not working well) - but is weakening. In China, companies, individuals and government continue to leverage up to an extent never seen before - creating a massive credit bubble. A recession seems likely over the next year or two. China's housing bubble is unsustainable [1]

At the same time:

• it seemed possible (though not certain) that protests in Hong Kong about the erosion of political liberty associated with truly becoming just another part of China might be a 'canary on the coal mine' in relation to political stresses in China more widely - see China: No Turning Back Now???? .

• China was seen to be seeking to undermine G20 proposals for international cooperation in reducing corruption despite supporting such a proposal of it own, because the latter is part of a process of purging political opponents in China, while the global initiative would also make those associated with China's current regime exposed. It has been claimed (with unknown validity) that up to $4tr (ie almost half China's $9tr annual GDP in 2014) has been moved offshore by corrupt Chinese officials since 2000.

Global anti-corruption efforts have been dealt a blow as a hoped-for agreement through G20 is likely to be torpedoed by China. Proposal involved establishing a public ownership register to prevent people hiding their financial affairs. China's likely disruption of this is peculiar as it proposed the issue at the recent APEC summit. China's corruption busters have been applying pressure on countries such as US, Canada and Australia to help repatriate corrupt officials and their loot. China argues that 19,000 officials have made off with $123bn since mid 1990s. Global Financial Integrity (US-based) argues that $2.8tr was siphoned out between 2005 and 2011. AT APEC China got member states to agree to ACT-NET initiative to facilitate information sharing on corruption. This network would be headquartered in CCDI - the discipline watchdog of Communist Party (whose methods are notorious for involving torture and abuse). However the most favoured destination for corrupt officials (US, Canada and Australia) have no extradition treaties with China because its legal system is not trusted. While Australia should cooperate in anti-corruption measures, in China there is very fine line between anti-graft campaigns and political purges. China's anti-corruption campaign since late 2012 has been as much about preserving single-party rule as about eliminating corruption. All of the 48 most senior 'tigers' who have been caught in the anti-corruption process have humble backgrounds - none are 'princelings' (sons of senior party officials). Thus Xi Jinping's own faction has been spared, while rivals have been vanquished. The G20 proposals would help China's program. But it is believed that relatives of China's political elite have been stashing huge quantities of cash offshore. As much as $4tr may have left China since 2000 - mainly through opaque corporate methods. A corporate transparency regime would put China's top leaders at risk. [1]

• China was seen to face significant limitations on its ambition to become the dominant power in Asia. [CPDS Comment: China seemed to have ambitions that went well beyond becoming Asia's dominant power - see China as a Dominant Power]  

China may be Asia's economic powerhouse but a report by Paul Dibb and John Lee suggest that it won't become the region's dominant power. The factors that contribute to China's national power would be unlikely to provide it with an ability to become a region-dominating superpower. Problems arise from the nature of China's economy; a lack of close bilateral relationships; and weak military capacity. China has the economic hardware in place (and is an economic / military power).  China's economic growth rate is 7% pa - but declining productivity suggests that this rate of growth can't be maintained. In 2012 $5.50 of capital input produced only $1 of output. Experience shows that such low levels reflect massive inefficiency and are unsustainable. Also China can't shift from middle-income to high-income status (which a dominant state requires) unless it improves citizens' living standards. This would require much more government spending on social security / unemployment benefits / health care. Defense receives a large share of government spending (15% in 2014) but China can't be a super-power until it can take global-scale action. As a result of territorial disputes China has few friends in Asia. This limits its ability to wield influence / power in the region. China does not have the charismatic soft power that Asia dominant power would need [1]

• despite China's anti-corruption programs, China was assessed to be more corrupt in 2014 than in 2013 - under criteria used by Transparency International [1] [CPDS Comment: Transparency International's criteria seem to include a 'rule of law' which is not the way China is governed]

Ongoing Uncertainty 2015+  [>> ]

In 2015, China's started referring to its situation using the slogan: the 'New Normal'.

After the China Dream of a new dynasty, the Fox Hunt for corrupt cadres, the New Silk Road to connect China to the world comes the New Normal. This refers to persistence of leader Xi and his economic team. Slumping commodity prices are a major boost for China. The New Normal is also seen to apply to: refraining from criticizing the Communist Party; a new basis for university education - which involves more emphasis on ideological guidance; and China's shift towards consumption and services [1]

And the Chinese government increasingly sought 'religious' authority to ensure desired behavior by Chinese people. This was significant because: (a) the traditional role of Confucian bureaucracies in governing China on behalf of emperors included promoting appropriate behaviour in accordance with Confucian virtues; and (b) the authority of the state traditionally depended on the perception of the emperor's 'mantle of heaven' (ie that emperors had divine authority and the state would act virtuously). And the latter had been anything but China's recent experience (see The Dali Lam's Search for Moral Wisdom).  Examples of China's leaders' search for a moral / religious basis for authority include:

•  it was reported that China's education minister has vowed that 'western values' would never be allowed into that country's classrooms;

China's education minister has vowed that 'western values' will not be allowed into classrooms - as Communist Party seeks to consolidate its autocratic rule and resist demands for democracy and human rights. Anything that defames leaders or smears socialism should not be in universities. China has clamped down since President Xi took over in 2012. Many people have been detained / imprisoned for expressing views contrary to Party.  Teachers and professors in Beijing have been order to toe the Party line on history / geography / etc and not discuss democracy / human rights. Academic discussion of press freedom, civil society; elected government and constitutionalism is forbidden. President XI has sought more ideological guidance in schools / universities, and study of Marxism. Nationalism has been emphasised as a way for academics to keep themselves safe.  Even before this China's education system was highly ideological. The 'patriot education' curricular adopted after 1989 Tiananmen Square student uprising is still the basis of curricula. Paramilitary troops have been garrisoned on campuses since then. Internet censorship is now being tightened [1]

• China seemed to be seeking to establish a religious / moral basis for state authority.

• China's president Xi had endorsed Confucian virtues as the foundation of his approach to life, and those virtues were described as providing the social stability required for East Asia's past economic and political progress [1] - a view that seemed somewhat simplistic for reasons outlined in Merging Political Power and Religion Can Create Problems

• The Dali Lama suggested that his soul may not be reborn (as has been the Dali Lama tradition for hundreds of years) - while the Chinese Communist Party leaderships insists that it will. In 2011 the Dali Lama had ended the era in which Dali Lama's were both political and spiritual leaders in Tibet. He had also expressed fears that vested political interests could misuse the reincarnation system [1];

This tends to create a clash between the so-called 'Communist Party' and Christianity which: (a) can be seen as the ultimate Western 'value'; and (b) is now a significant influence and growing so rapidly (ie at 7% pa) that (if continued) 2/3 of Chinese people would be Christian by 2050.

China has historically tended to follow religions such as Buddhism and Taoism. But a recent study suggests that monotheistic religions (eg Islam and Christianity) are becoming significant. Buddhism dominates in south and SW regions. Protestants and Catholics have begun to occupy China's eastern regions while some western regions are mainly Muslim. Protestant Christianity has been the fastest growing religion - with around 100m Christian in China potentially rising to 160m by 2025 (with an ongoing 7%pa growth rate which could lead to 66.7% of China's population being Christian by 2050). This is leading to tension between Christians and the Communist Party. There are also tensions between China's authorities and its indigenous Muslim population - involving violence and restrictions [1]

In mid 2015 it was reported that China had substantially increased persecution of Christians and other believers as part of a broader war against dissent [1]. The emphasis on the welfare and capability of individuals that is by-product of Christianity is incompatible with the state-centered authoritarianism that China's regime seemed to be seeking to create (see Christian Persecution in China).

During 2015 and 2016 concerns about China's economic sustainability continued to mount (eg see in particular Context to China's Share Market Boom and Bust;  and China's Problem is Neo-Confucianism not Hypothetical 'State Capitalism'). >>

2015

• US analysts suggested that China was at risk of a financial crisis.

Bank of America warns that China faces the risk of a financial crisis associated with slowing growth and deflationary pressure to to defaults. A credit crunch is seen to be probable. Highly-leveraged companies are at risk form President Xi's attempt to eliminate moral hazard and reduce dependence on credit growth. Slow growth and excess debt could damage financial system. Few countries escape financial crises after after such rapid credit growth. Likely scenario involves: bad debt surge as growth slows; credit crunch in shadow banking system; and major bank recapitalization. Rescuing lenders cost China 15% of GDP in late 1990s. The problem is harder now. Loans have increased 100% of GDP over 5 years - which is twice the rate before Nikkei bubble burst in 1990. Total credit exceeds 250% of GDP (once shadow banking and offshore lending are included) - which is high for emerging economy without mature markets or layers of accumulated wealth. Explosive growth on Shanghai markets (up 350% in 3 months) is unrealistic. China has seen factory gate deflation for 33 months, and this is deepening. When producer price deflation last occurred, it took 6 years to reverse. And now there is nothing like China's access to WTO in 2001 to boost demand. Falling inflation reduces the real cost of borrowing. There has been a rapid increase since 2011. Hot money outflows raised the risk of devaluation - and will drain money from stock market and increase problems for those with $US debts. China's firms have borrowed $.12tr in external currencies. Rising $US has pulled yuan higher (because of soft peg) and it has revalued 60% against yen over two years. This reduces China's competitiveness. Hot money is now likely to leave China - perhaps leading to something like Asian financial crisis of 1997. China's capital account has been in deficit for last two quarters. China has a great deal of economic depth and is likely to muddle through [1] 

• options were suggested to deal with China's financial system problems by reform of its fiscal systems. In the past expenditure that should have been by government were funded inappropriately through bank lending to provincial and local government.

Banks are not the source of China's economic problems. The real problem is fiscal system. Local governments have 45% of tax revenues, but 85% of state spending. They have had to obtain funding (for social / infrastructure spending) through off-balance sheet sources (eg land sales / shadow banking). This results in bank lending that does not generate commercial returns. Such spending should have been funded by state budgets. Such debt piles up and is written off with other non-performing loans. China has plenty of productive capacity to grow over 7% pa, but there is inadequate demand to sustain this (eg because of Europe's weakness and the US's import-weak recovery). China's rate of investment will fall because of low returns and the need to deleverage. Household consumption won't increase much because its growth will be hampered by slowing wage rises. China needs to fix its fiscal system - and a plan to do this exists. This involves expanding tax revenues, and restructuring local government debts into long term bonds and eliminating loans related to land. Incentives for seeking off-budget revenue will fall.  State budget expenditures (which have been very low) will rise. This will allow government to be more transparent. Few outside China have recognized its ambitious fiscal agenda. Success is not assured [1]

• it was suggested (based on a parallel with what had happened in Switzerland) that China might be forced to abandon its currency's peg against the $US - and that the results could be disruptive

Currency pegs cause problems when they are out of kilter with economic reality. China announced that it would restrict margin lending to stop market speculation. The stock market fell significantly. China has problems because it linked its currency to $US since 1994. This accounts for China's trade surplus and $tr foreign exchange reserves. However to maintain pegged currency China needs to print yuan to swap for $USs. If this was not done, exporters would lose competitiveness. Thus there has been a huge amount of liquidity flowing into economy which can be inflationary. China sought to stifle this by issuing notes and bonds of varying maturities and increased bank's lending margins to restrict credit growth. But the 2008 crisis forced China to get banks to lend aggressively - thus creating a credit bubble.  China's new leadership in 2012 started trying to curb this - including purging many corrupt officials who had been profiting. The main effect of credit bubble as land boom - which is deflating. The stock market was an alternative - but now government is trying to stifle this. China might need to end currency peg to solve this problem. It is uncertain then whether yuan would go up and down. Because China has long sought to keep yuan down, revaluation seemed likely. But the damage done by the credit bubble could have the reverse effect [1]

• China was seen to be finding (as others had previously found) that it is impossible to deflate a credit bubble safely.

Money has been tightened for a year and there has been a shadow banking crackdown. China is headed for a debt-deflation crisis. It will be hard to overcome the effects of its $26tr credit boom. Factory gate inflation is -3.3%. China debt rose from 10% of GDP to $250% in 8 years - as compared with 50% of GDP debt growth in Japan prior to its lost decade. The unemployment situation is increasingly unhealthy. Home prices fell 4.3% in December. New committed construction is down 30% over 3 months. Property investment in China rose from 4% to 15% of GDP - the same as in Spain at the peak. Inventory overhang is 18 months. Property slump is turning into fiscal squeeze as land sales are 25% of local government revenue. Fiscal deficit would be 10% of GDP without land sales revenue. China is not alone in facing such problems as 15 central banks have eased money policy in 2015. China's link to $US is eroding thin profits of Chinese companies. A significant yuan devaluation would have big deflationary impact worldwide. China has been trying for two years to wean itself off credit. Yet this is proving hard to achieve [1]

• China's goal of boosting domestic consumption is limited by the lack of a large middle class that is capable of high levels of consumer spending [1]
• China was facing a major fiscal contraction

China's Politbureau is attacking the country's credit-driven growth. Real interest rates have increased. The Yuan has appreciated. Fiscal policy is tightening as big-spending local governments are constrained. This is leading to sliding global prices for commodities. China is seen to be facing a fiscal cliff. Budget deficits exceeded 10% of GDP. A budget squeeze has emerged as property slump continues - as revenues relate to property cycle. Property bubbles in China (and elsewhere in Asia) exceed those in US before 2008. There is a reliance on government bail-outs. Local governments have been prevented from raising money off balance sheet - potentially tightening fiscal policy 5.5% of GDP (similar to fiscal contraction imposed on Greece). Monetary policy can't be used to compensate for fiscal expansion - as its economic impact has collapsed. New lending now only rolls over existing debt. Total credit rose from 100% to 250% of GDP over 8 years. China is close to a deflationary trap.  Apparent monetary stimulus is merely offsetting the effect of tightening as central bank dips into foreign exchange reserves to strengthen currency. China's capital deficit in fourth quarter was $91bn. It is now a net seller of US Treasury securities. The PBOC is now in the reverse of its boom years position. Then it bought foreign assets and caused liquidity in China to surge. Now liquidity is draining away. China's shift from buying to selling bonds has been $40bn per month - outweighing the $15bn per month that Japan is buying. Asia is tapering $25bn per month - offsetting the effect of prospective QE in Europe. China needs devaluation - yet yuan is tied to soaring $US. China real growth rate is now less than 2% pa. Boosting growth requires devaluation. If half the big central banks resort to currency combat the world's deflationary impetus will escalate at a time when there is no monetary ammunition left to counter it [1]

• a new source of financial instability was seen to have been introduced through the development of asset-based securities [1]
• China sought advice from Japan about avoiding the sort of economic stagnation which Japan had suffered from 1990 because their economic systems were very similar

Chinese regulators are turning to Japan for lessons - to avoid taking the same path of recession / deflation that blighted Japan for the past 20 years. Tokyo's handling of the liberalization of capital flows over part 30 years is seen by China as leading to the bust of Japan's asset bubble in the early 1990s. Japan's and China's economies share similarities - so lessons should be valuable. Communication about this continued despite the chill in diplomatic ties from 2012. China is undertaking three reforms that Japan did (ie liberalizing interest rates / internationalizing currency / opening capital account). China sees Plaza Accord which approved a stronger yen and opened capital account in leading the Japan's lost decades. The stronger yen hit exports and prompter BoJ to ease monetary policy. However money from this and foreign capital flowed into stocks / property and other assets. China is applying these lessons. China is not taking measures that could heighten imbalances even when growth is slowing. Japan was said to have been unable to tighten monetary policy when bubbles were forming because of the effect this would have on US. Domestic policy considerations should dominate over international considerations. China has other problems that mirror Japan's (cooling property market / rising bad debts). China is like Japan in corporate reliance on bank loans / heavy banking regulation. China may copy Japan in bank consolidation. Exchanges between Japan and China on this are often informal. [1]

• China sought to make the yuan a global reserve currency - as one of the foundations of the IMF's SDRs [1] [ See CPDS comments in China Does not have a Normal 'Currency' ];
• Japan had grown at 10% pa for two decades in the 1980s - but since then has stagnated. China faces a similar risk. Economic growth is only possible by adding more labour, capital, productivity. Russia and Japan suffered malaise because growth had been driven because of expansion of inputs, rather than lifting productivity . China grew 162% from 2004 to 2014 - but 136% of this was due to more capital inputs. National corporate debt has risen from 147% of GDP to 250%. China's building programs have been wasteful. China doubled-down on Japan's strategy - and lacks means to escape middle-income trap. Dismantling China's state-dominated political economy is needed but difficult. China now has more people leaving than entering workforce - because of demographic issues. China's concealed bad debts are estimated as 70-140% of GDP. Unfunded pension liabilities could be 40% of GDP. [1]
• About 25% of China's economic growth of past 3 decades was due to its demographic structure - with a young workforce lifting output by gaining new jobs. The proportion of children and older people was low. However since 2010 China's working-age population peaked and its dependency ratio has been rising. The government's package of economic reforms have achieved little - because of entrenched interests. China must now raise productivity with a shrinking workforce. Ways to overcome this problem have been suggested to involve: ending one child policy; and strengthening market mechanisms [1]
• China has introduced a moderate form of QE to provide funding for debt-strapped local governments [1]
• In April 2014 it was suggested that China's economy is worse than admitted. Demand has fallen for first time.  Officially growth was 7%pa in first three months - yet power output was flat and imports were plunging. One estimate was that real domestic demand was falling 10% pa in first quarter [1]
• It was suggested that China's potential real estate crash might not happen [1];
• China's finance minister drew attention to China's 'middle income trap' risk. He referred to: wage rises outpacing productivity gains because of new labour laws; China's aging population; and high debt levels [1]
• China's economic reform policies were seen to have been successful in developing a large cluster of high tech and software firms in Hangzhou - a city on the east coast [1]
•  IMF has warned of danger to emerging economies from tightening by US Federal Reserve - and this has particular implications for China (see The New Big Short).
• China's financial support for Venezuela's regime in return for oil supplies is putting it at risk of significant losses [1];
• China appeared to provide net economic benefits to Australia through the terms of a Free Trade Agreement (see CPDS Comment)
• China has averted a deep economic slump by again expanding credit. Consumer confidence, output and home prices are improving. This has positive implications for world's commodity producers. To achieve this the debt swap plan (to clean up local government finances) has been expanded. This frees up borrowing for other purposes. Attempts at a controlled slowdown were abandoned - as this led to 'fiscal cliff'. Investment crashed - and the shock spread world-wide. China still faces severe deflationary pressures and industrial over-capacity. China seems to be in much the same position now as Japan was in the early 1990s. It was too late to escape the effect of a credit bubble - and necessary to turn on the fiscal taps to prevent a collapse in GDP [1]
• Shanghai share-market is either undergoing a correction or indicating major problems. Some believe that China has mastered the art of managing its economy and markets - through command and control tactics. And there is no doubt that governments can boost growth in various ways. However Japan's system was once seen to be superior to Western methods (given central bank discipline, interlocking corporate ownership, and a superior mercantile manufacturing economy). This ended on the last day of 1989. China now looks the same. Its manufacturing prowess is overstated. Its ability to manipulate / stimulate its economy is exhausted. Labour-cost advantages have eroded. Government is less friendly to those wishing to establish on-shore facilities.  China's debt-GDP burden (282%) is double that in US and even higher than in Japan [1]
• China's plan to resolve problems associated with excessive local government debt amounts to a bailout [1]
• It was being suggested that China's necessary transition to a new growth model was yet to be achieved

China's economic growth is expected to slow gradually. This implies that its government is seeking (with structural adjustments) to overcome financial vulnerabilities. Growth model is shifting from manufacturing to services, from investment to consumption and from exports to domestic spending. Credit growth has been slowed, shadow banking contained and local government borrowing limited - thus slowing real estate investment. China also seeks to avoid growth slowing too much. Large scale stimulus measures would conflict with efforts to make economy sustainable in long term. There is massive over-capacity in heavy industries. Slowing export growth and softening real estate prices are dampening economy. Thus One Belt, One Road scheme seeks to boost external demand for China's investment goods. Growth of services is also important - and this includes big financial sector. Many countries have failed to graduate to high income status - and many see China facing this risk. China is changing Current account surplus is falling. Consumption is rising. Income distribution is improving. This is mainly due to labour market changes. Liberalization of financial markets / land system / energy policy are also needed - as well as technological innovation and industrial upgrading. Garnaut argues that China's slowing growth masks weaknesses in its economic transformation - related to income distribution and the environment. Macroeconomic changes required for ongoing success remain to be achieved. Slowing growth reflects problems in the old growth model - rather than transition to new model. Since 2011 China has depended heavily on growth of capital stock while productivity growth has been slow. Future growth drivers have to involve innovation and productivity lifting change - and this remains to be achieved  [1] 

• Many have expressed concerns about China's economy. However China's stock market has achieved a 130% gain over past year despite lower growth, corporate profitability being squeezed and large increases in non-performing loans. Shanghai market posted 14.3% fall in July. But the turbulence in China may merely be growing pains in an economy that could turn around surprisingly [1]
• Shanghai stock index fell 7% - and PBOC cut interest rates. GDP growth in China is well below target. Despite nominal easing - real rates have been rising because yuan is tied to $US so inflation has fallen. Stock-market and real estate are obvious bubbles. The main effect of market crash would be on confidence.  Household balance sheets are theoretically strong - but country as a whole is bloated by debt - after years of economic stimulation. Property prices have increased 40% pa in major cities and over 50% of debt increase has been for real estate. China's monetary policy doesn't work because banks are over-exposed to property and won't invest elsewhere. Key question is whether China's banks can remain solvent given both property and share market crash [1]
• There was extensive debate about the implications of China's share market crash and the extreme measures that China's government took to respond to this.

Outline of Observer's Views

China's desperation to prevent a stock market crash has led it to go beyond increased central bank liquidity and regulatory inducements to allowing homes to be used as collateral for stock purchases. This could create another financial 'time bomb' in home ownership to complement those associated with its debt and stock bubbles. China needs stronger demand, not more market froth [1]

China is going to extremes to stop stocks crashing. Homes can now be used as collateral to buy stocks - even though they are hard to sell when assets crash. China is sowing the seeds of a third financial time bomb to match its debt / stock bubble. Stocks have fallen for 9 days. Iron ore prices have fallen - suggesting that growth is slowing more than government is letting on. China is making its financial system more fragile - the reverse of what is needed. [1]

China is not the first country to prop up a falling sharemarket - but its methods are extreme. The reasons are unclear. The market is down 30% - but still 80% higher than last year. The economic slowdown is stabilizing. Other assets are doing well. Property downturn is moderating. However China's intervention screamed panic. Short selling was banned. Pension funds pledged to buy more stocks. IPOs were blocked. Brokers used central bank cash to buy stock. The state media played cheer-leader. Some see government action reflecting fear of economic crash - but that is unlikely . Stockmarket has limited role in China. However many stocks were bought with debt - which was why it was hard to stop the fall. But this was only 1.5% of banking system assets. Most likely issue is politics - as government has indicated that it wants stocks to provide more corporate financing. And market fall dented leaderships' standing. Biggest concern about panicked policy response is what it says about government's economic agenda. Market forces had been expected to play a major role in allocating resources - but recent events show that China's government wants a decisive role in markets. Share market downturn shows that government can't indefinitely bend markets to its will [1]

When China's economy became larger than Japan's in 2010, it was presumed that China would become economically dominant in Asia. But it is now struggling to deal with over-valued sharemarket and property bubble. Many thus ask if China will suffer what Japan did in 1980s and 1990s. However China's problem is probably more severe.  China is near the end of reliance on exports and fixed investment - and is seeking to promote domestic consumption. In achieving this its authoritarian government supposedly does not have to sacrifice long term needs to political expediency. However the reality is different. The property bubble emerged because of too much Party intervention in response to GFC's impact on export markets.  Fixed investment had been 25% of GDP growth in the 1990s but became 90% in 2009. New credit increased $20tr from 2008 to 2013. And capital controls mean that firms and households can't easily take money out of China. They can't take advantage of best economic opportunities - as these are reserved for SOEs. The stock market became the main way to get a decent return. Government's problem with declining share values is that most listed companies are SOEs. So intervention is mainly about protecting value of SOEs. In Japan, when its economic malaise began, the country had already built solid institutions (ie rule of law, property rights, independent courts, a political system that did not depend on growth for stability).  [1] 

The key aspect of bursting of China's sharemarket bubble is that its elites have encountered 'creative destruction'. The Communist Party decided that it wanted to stop this. But capitalism doesn't work that way. China had wanted to maintain employment while shifting / reforming economy but increasing liquidity / credit. This seldom works. Local governments had been told to borrow to spend on infrastructure. Interest rates were below GDP growth for years. This is a formula for bubbles. China's sharemarket bubble burst on 12 June - just when markets success was being celebrated [1] [CPDS Comment: China's economy does not seem to include 'capitalism' (see Does Asia have Capitalism?). Markets are orchestrated by social elites, not the drivers of economic change]

China's stock market turmoil is seen by China's leaders as a threat to regime - and this explains measure used to counter market downturn. A multi $bn funds was set up by China's brokerages at government request to buy shares, and 'financial risk' was included in new national security laws. The latter discourages foreign investors (as it involves mandate for political manipulation of share market). 30% fall in Shanghai index was not a major threat to China's financial system. Share ownership is limited - and only late investors have yet lost money. The panisked response indicates a desire to shield Communist Party from criticism / social unrest by maintaining stability. Social stability has become main focus of bureaucracy - through coercion and concession. New national security law is a further expansion of already-massive security enterprise under Xi Jinping. If Shanghai index sells off despite government measures. Party's image could suffer more. Seeking security for the Party may however have undermined it.  [1] 

China became world's largest economy in PPP terms in 2014. It is Australia's largest export destination. China's slowdown is reducing Australia's terms of trade China's stock market rose 144% over a year and then fell 30% in 10 days. It is hard to tell the effect this will have on China's real economy. China only recently established financial markets. China's authorities have more capacity to intervene in those markets than others do (eg by directing SOEs; banning directors / large shareholders from selling; providing credit to brokers to buy shares). China avoided both the Asian financial crisis of 1999 and responded skillfully to 2008 GFC. China may be more cautious in pursuing market liberalism. The relationship between financial sector and real economy is different in China to that in advanced liberal economies [1]

China's sharemarket jumped after government banned big shareholders from selling; directly bought stocks through China's state margin lender (with central bank support); limited short selling). Adverse effects of crash will eventually be felt (eg corporate earnings / distortion of capital flows / market can't work normally). Potential losses will be transferred from investors to government [1] 

Market turmoil is testing China's commitment to opening financial markets as part of its economic transition. Turmoil may not affect China's real economy. No country has ever liberalised markets without adverse effects during transition [1]

Market crash will have little real economy effect - equity finance provides only 4% of investment capital. The biggest effect will be in terms of consumption and finance. This would compound problems related to declining exports and investment [1] 

China has tried to stop stockmarket slide - but the harder they try to more it looks like they are losing control. China's bond and currency markets have been hit by worries of contagion of slowing economy. China's investors are anxious - and their leaders face a crisis of confidence . Government has driven decades of strong growth - and kept economy strong during GFC. China has suffered rising debt levels and needs to reform economy away from government driven infrastructure investment. As economy and property market slowed, government focused on stock market. Recent decline has worried investors who are used to seeing government in control. The more authorities try to calm the market, the more the panic spreads. Also investors could be forced to reduce spending. 80% of all share investments had been made with borrowed money - and margin loans doubled to over $US 2 tr in the six months to June 2015. When investors started selling in mid-June, margin debt created a spiral down [1] 

China's stockmarket rout compounds global economic uncertainties. That market is unimportant in itself - but the crash and China's reaction is symptomatic of broader problems. The market has clearly been in speculative bubble for months. Until last November stocks had been weak while real estate boomed - then property prices flagged and (to boost confidence) authorities cut interest rates and increased access to margin loan (ie loans secured against shares). This attracted inexperienced investors - and their funds swamped the market. Valuations were unrealistic. China's authorities did nothing - perhaps hoping that heavily-indebted state enterprises might be able to refinance themselves by issuing new equity. However authorities also believed that had the means to easily cope with any problems.  Modest changes had cooled property markets. This assumption proved false - and authorities panicked.  This was not to prevent an economic problem - but to avoid political damage by imposing losses on 90m investors - for many of whom market speculation was their only way to accumulate wealth. The big problem with this is that government has signaled that it will transfer market losses to financial institutions. This will leave them with large losses. What was done shows that Xi's commitment to market forces is very limited. The fact that China is in transition adds to difficulties.  There are important precedents from other Asian precedents. All countries that grow over 7%pa suffer problems (political as well as economic) as growth slows when per capital incomes reach 10,000-15,000 pa. The effects on influential interests makes it hard to actually make the necessary transition. South Korea suffered repeated crises before changes were made. Japan suffered long period of stagnation. The main question is how China will handle this transition - ie away from housing / infrastructure investment. It must double its productivity growth (to 4% pa) but this would happen in economy based on command and control. Market liberalization is needed - but encounters strong opposing forces.  [1]

There has been a perceptible dampening of economic activity in China as a result of stock market downturn [1]

China's sharemarket problems reflect the fact that its growth drivers (high investment, exports, migration to the cities) are generating diminishing returns. China's economy is not only slowing but being profoundly transformed - and the parts that benefit Australia are being reduced (a fact that resource companies have not taken into account). China has 6m fewer migrant workers in cities than a year ago (as the rural population itself starts to decline). Migration had been one of the main drivers of China's economy - and as this slowed productivity growth fell to zero. The old growth model was based on large investments support by the shift of hundreds of millions from rural areas to cites. Slowing urbanization has reduced demand for housing and infrastructure - and for significant elements of old economic growth model. As labour became scare, wages started rising - and profits slipped. The migration change required an absolute reduction in investment - not just slower growth - and much faster growth in consumption spending. But this has not happened. This has been compounded by government's response to GFC - which was similar to, but larger than, its response to Asian financial crisis. China moved to arrest slide in property prices. The property slide was one reason for sharemarket bubble -as investors then had no real other choice. The government tried to intervene in that market. Until recently authorities said that market had a bright future. It is uncertain whether government efforts to stop slide will work, and what the effect could be on shadow banking system that holds much of the margin debt   [1] 

The amount of leverage in China's share market has halved over the past 2 weeks [1]

China's authorities panicked over stock market fall. Most analysts assume that the real economy impact will be slight. However there was a feeling of confidence in US when sharemarket peaked in 2007 - though recession had already started. There are indications of problems. Car sales fell 3% in June. Property transactions increased - but only in larger cities. Producer prices have fallen for 3 years. Consumer sentiment is weaker than implied by 7% pa growth - though many believe growth is only 4%. The unwinding of margin debt that built up over past year will have adverse effect. And government will lack credibility with elites who were encouraged to go down a ruinous path [1] 

China and Greece share a common problem in that no one trusts their economic data. Greece has long had a reputation for lying about its economic data. China recently claimed that growth was 7% yoy - even though imports were down 15%; gas sales were down 3.4% in June, excavator demand fell 34%; rail freight fell 12% and power consumption grew just 1.8% [1]

The most important consequence of stock market crash was a loss of credibility by China's leaders. The stockmarket boom had been encouraged to help shift China from an economy based on investment to one based on consumption - and the market crash highlighted their inability to do so [1]

China's rescue of its stock market cost $US800bn (about 10% of China's GDP) and has produced quite limited effects [1]

China's heavy stockmarket intervention will be difficult to unwind and will take a long time. However the way the Hong Kong government used foreign exchange reserves to do something similar at time of GFC and unwound this slowly is precedent to study [1]

China's stockmarket crash can be likened to that in US in 1929 - ie it went on for a long time. And China does not really have a 'market' (given the extent of government manipulation. Stock bubble grew out of China's ongoing credit crisis. It has a massive debt pyramid that was crashing. There was a huge amount of concealed bad debt - which China tried to deal with by selling shares to suckers. China's elites are getting money out of China as fast as possible - eg buying off-shore real estate. [1]

There has been concern about whether China's sharemarket fall could lead to something like failure of Lehman Bros in US. China kept growing after 2008 when global economy slowed through a massive investment program. Such debt-driven expansion seems to end up badly. But China is more likely to suffer stagnation like Japan than a Lehman style collapse - though the consequences for China's people will be worst than in Japan. China's stock exchange had become a major casino. After GFC devastated China's export potential, Communist Party initiated largest stimulus policy in history - with $US 15tr new capital first through state banks and then through unregulated shadow banks. China debt rose from 150% of GDP to 300% over past six years - a rate of growth faster than that in US before GFC. About 1/3 of new capital in first six years of stimulus went into new real estate - much of which remains unoccupied (and able to accommodate the next 20 years increases in urban populations). When China blocked property speculation because of fears about property bubble speculators shifted to stock market. By March 2015 4.5m new investor accounts were being established each week. The median PE ratio of China's stocks rose from 9 at the start of 2014 to 80.  However China won't suffer problems like US did because China's banking system is state controlled - and will be forced to lend even though credit risks are poor. But debt levels in China's economy are already so high that 1/3 of new borrowing is merely to pay of interest / principal on existing loans. Doing this was what led Japan into a moribund economy in 1990s. And China's situation is worse because it has an aging population, a fragile authoritarian political system and a failing economic growth model [1]

A 5% rise increase in China's sharemarket in the last trading hour strongly suggests that the government has resumed buying shares [1]

China has abandoned large scale share buying - and instead is focusing on punishing those who destabilized the market. For two months the 'national team' had spent $200bn trying to prop up the market. This was seen to have failed because too much information was allowed to become public. China now wants to punish those who took advantage of state bailout to make profits or obstructed government efforts to support market [1]

China's market rescue operation failed because: (a) those who were required to participate in China's 'national team' (ie prop up market) were torn between that goal and remaining profitable; (b) what they were doing became obvious and others 'gamed' the system - or became involved in insider trading; and (c) the lack of any coherent investment strategy [1]

China tried 40 different things to try to prevent stock market fall - and directly buying shares was the only one that worked [1]

Since stock market started melting in June 2015, China has tried increasingly desperate measures to halt the slide. The latest involves attempts to shift the blame onto perceived market manipulators. China's government has both promised to loosen its grip on the economy - and sought to maintain stability and thus confidence in government. The conflict this involves has made China the biggest threat to global economy. It is now widely accepted that China does not know how to handle markets [1]

China's approach to stock market woes has been to charge 200 people with spreading false rumours. China wants to embrace market reform - yet is only willing to tolerate this when market does what government wants. China's old growth model is broken - yet to achieve the desired new model, China's authorities have to give up the power that sustains their position [1]

CPDS Comment:  Context to China's Sharemarket Boom and Bust presents a scenario which would explain why China spent over 10% of its GDP to prevent the crash of a stockmarket which has very little economic importance. It involves taking account of not-well-known features of China's history and culture which imply that a major threat to China's whole system of government could exist. There are simpler scenarios - but these do not really explain why such huge resources were devoted to an apparently economically-marginal problem.

• Trade has been key to China's rapid growth over the past two decades. Now imports are down heavily and exports are only achieving marginal growth. This is being repeated elsewhere in Asia. Global trade is the life-blood of Asia and it is not growing fast. Some of the most open manufacturers are in trouble. Normally when US recovers its trade deficit increases. But this hasn't happened this time. Imports to US have been flat for a decade. This weak growth means that the Asian region will be very exposed when the US started raising interest rates in late 2015 [1]
• China seems to be headed for a financial crisis which will render vain its efforts to promote international China-centered economic projects and arrangements

China's 7% growth in June quarter of 2015 was a surprise as domestic demand had been stalling and the property boom had bust. Rates had been cut and credit made readily available. The stockmarket collapse was too late to affect June data. The collapse highlights potential overstatement of China's economy based on its reliance on debt. Stockmarket expansion was seen as demonstrating authorities money creation to build economy on debt - even as real spending / production / productivity / quality of life declines. $3.8tr expansion of share values was based on companies whose earnings are declining. Money from PBOC and MOF was channeled to brokers and smaller / weaker banks. Government's panic over share market crash reflects fear of major financial crisis - not collapsing share values. Sharp rise and fall of sharemarket could affect real economy - because a debt-fuelled binge blew up equity bubble. Security companies had $3.7tr in margin loans - about 5 times that at start of year. A chain reaction is possible. Forced selling could escalate. There are also hidden risks in structured products. Government support for shares could turn them into dead assets (ie having value but no liquidity) as property has become. Suspended shares could block China's effort to portray itself as shifting to market-driven economy.  The average PE ratio of suspended shares in 187. A loss of confidence will lead to capital flight and loss of confidence in government. PBOC may need to adopt a 'whatever it takes' approach (as US Fed did in 2008 and ECB did in 2012). Chinese will be less willing to invest in what government recommends. Asset bubbles have been needed to main appearance of growth - and to attract external capital. Once bubbles can't be maintained, the question of how large China's economy actually is will become apparent. Plans such as One Belt One Road, New Silk Road, AIIB, Megacities and China-sponsored pipelines / railroads across all continents are likely to be seen as less like attempts to gain geo-political power and more like the wild dreams of a face-saving leadership with empty pockets [1]

• China's effort to create a stock market boom failed. It has now reverted to credit expansion. This delays, but does not avoid, its coming crisis

 China is again seeking to engineer another mini-boom by expanding credit. The government outlawed falling equity prices. However China's situation is deteriorating. Capital outflows exceeded $244bn in second quarter - which is unprecedented. PBOC is being forced to run down foreign reserves to defend the yuan. $488bn may have been sold in second quarter. These bond sales amount to monetary tightening - just as bond purchases in the past had the effect of monetary loosening (by adding to domestic money supply). China is struggling to emerge from recession. Shipping volumes are contracting - and this adversely affects Russia, Brazil and the commodity exporters. China's industry had stagnated in early 2015 - as efforts to reign in excess credit became uncontrollable. Talking up a stock market boom was intended to counteract this slowdown - and this proved a disaster. After $4tr losses emerged, police state tactics were used to engineer a recovery. President Xi's emphasis on the use of market forces play a decisive role in economy has ended. There was always a contradiction between this and tight control on Internet, academia and political opposition. The need to shift to a more market oriented economy was documented 3 years ago. Its past growth model is obsolete. To end dependence on export-led growth and imported know-how (which must lead to 'middle income trap') China needs to end political control of economy - so that private sector can innovate. Various observers believe that China's current growth rate is about 4%pa  [1] 

• China's banks are likely to have to face significant losses from the stockmarket crash because of the significant use of margin debt in buying stocks - and this may merely be the start of broader problems with global impacts

China's equities have suffered 8.5% fall in one day - which has repercussions for commodity markets and currencies in East Asia, Latin America and Africa. There is a view that China's Communist Party may be losing control. Government had tested what would happen if they stopped intervening in the share market. Many investors are trapped as they used margin debt to buy stocks and can't cover this without selling. BoA estimates that $1.2tr of stock are based on margin debt (ie about 34% of market). When market eventually settles, the financial system could suffer contagion - because brokers and trusts have only $260bn to absorb losses and this may be inadequate. This further raises risk of run on the shadow banking system - because of concern that funds in this $2.1tr industry may no longer have implicit guarantee.  Chinese government may need to absorb losses. Government could reduce reserve requirement ration - allowing banks to provide huge amount of extra credit and thus defer the day of reckoning. Government does not want to do this - because it wants to shift economy from reliance on debt to equity. This got out of hand because of growth of margin accounts. China's debt / GDP ratio doubled to 260% after 2007 and is now $26tr. Credit is over-extended and losing its economic benefits. While stock crash is a minor matter in itself its effect is combined with bursting of property bubble; a tidal wave of debt restructuring; and soaring exchange rate (due to $US peg). Not all a negative about China's situation. But as China is a major commodity consumer, Brazil, Russia, South Africa and many commodity exporters are facing a freeze in imports just as US Fed starts raising interest rates [1] 

• Migrant workers were a key driver of China's economic miracle. However their numbers have been declining - and turned negative in February 2015. Also migrant workers are rapidly aging. Declining migrant worker numbers will lead to rapid rise in wages and declining international competitiveness. This is affecting China's status as world's factor. Productivity will have to be raised rapidly to compensate. Population aging will also impose pressure on China's fragile social security system. It will come to have the world's largest pensioner population. China needs to urgently review its demographic crisis - perhaps by changing one child policy [1]
• China's exports fell 8.3% yoy in July 2015 (and imports also fell sharply) where only a 1% fall had been expected - after a slight increase in June. This reflected depressed demand from Europe and a slight drop in exports to US [1]
• China is seen to face a difficult choice between devaluing the yuan to boost export competitiveness (which would also increase the risk of capital flight) or maintain the yuan and see exports continue to decline. China needs to shift to domestic demand - yet conditions are not yet available to allow this to occur [1]
• China devalued yuan by record amount (1.8%) in August 2015 resulting in a flight to safety in $US [1]. The next day it devalued again by 1.6%, and this was equally disruptive of bond yields, Asian equity markets and $A [1]

PBOC had been propping up yuan value until recently. There is likely to have been net outflow of capital from China because of monetary policy uncertainty. PBOC has been easing in the face of economic slowdown. FED is likely to tighten policy soon. China has large FX reserves but would not want to use them to defend currency value. China's economy / exports have been weak, China wants its currency to be included in IMF's SDRs - and this would require it to be freely convertible - and China seems to be moving in that direction. It is possible that China's devaluation will be disruptive - but unlikely given the small percentage change involved [1].

China devalued for a second day. However it did this by changing the mechanism by which its currency value was determined - which was what international community had wanted it to do (ie adopt a more market-oriented exchange rate). It is too early to say that this is the start of a long term process of devaluation that would amount to a 'currency war' [1]

China's currency devaluations are seen as triggering currency wars in Asia. The ten most widely traded currencies are already set to decline for a third year - and China's move is likely to trigger a vicious cycle [1]

Despite past problems China maintained its currency value - even when others cut the value of their currencies. With renminbi's biggest fall in decades, there is concern that China's weakening economy is worse than reported and that government is panicking. Credibility of China's government and president in managing a slowdown is suspect. Growth is said to be 7% - but construction is very weak as real estate struggles. Consumer spending is weak. And financial services (a major growth driver while stock market was strong) is slipping. Some provinces / regions could be in outright recession. The data is not reliable enough to tell [1]

China's recent devaluation has been presented as a way to boost a floundering economy - but there are two reasons for concern: (a) doubts about the proficiency of Chinese officials; (b) concerns that all that is being attempted is to make a case for acceptance of the yuan as a reserve currency by the IMF - even though what was done does not help meet IMF criteria. Others suggest that concerns about this are overblown [1]

It is possible to see parallels between recent Chinese devaluation and the currency collapses and instabilities associated with the Asian Financial Crisis of 1997. While there is no certainty of any such deterioration (and Chinese authorities have many options to stabilize their situation), in the event of a crisis the US should be little affected - because of limited US export / investment exposure to China [1]

Other Asia countries have been caught up in effect of yuan devaluation - raising fears of another Asian financial crisis. The PBOC claims this is part of market liberalization push, others see it as a competitive devaluation that risks a global 'currency war'. Where economies are closely linked to China their currencies have been sold off [1] 

China's steelmakers will be able to flood the world with cheap steel because of yuan devaluation - and their competitors in Europe and US are protesting. Similar concerns affect other sectors [1]

Recent PBOC actions have raised the possibility of both ongoing yuan devaluation and government stabilization of a managed float. After three days of yuan falls, PBOC asked state banks to stop this by buying yuan. PBOC is not allowing a free float - but rather calculated intervention [1]

Emerging markets will suffer from yuan devaluation. If China wants to devalue to boost competitiveness, then a great deal of devaluation can be expected. However if it wants to set up more flexible financial system without a deluge of flight capital then tight control will be maintained on currency movements. Both create problems. Emerging economies already favoured devaltaion - and yuan devaluation will add to this trend. Emerging markets had faced slowing China growth(dampening resource demand). And trade surplus was strong indicating export competitiveness. At the same time US interest rates are likely to rise - and hurt emerging economies dependent on foreign capital. Emerging market currencies are thus at 15 year low. Lower yuan will hurt all these emerging economies. And if more yuan devaluation is intended - this will increase. If China keeps yuan where it is, this will be no use unless capital no longer seeks to get out of China. Devaluation partly reflected a year of strong capital flows out of China (because of domestic economic weakness and fear of confiscation). Capital outflow will explode if China creates the impression it will devalue strongly. If China wants to hold the line on yuan, it will need to draw on its foreign exchange reserves. Any resulting flow of $US out of China would be achieved by selling US Treasuries - and this is likely to force world interest rates up (and further damage emerging economies) [1]

PBOC says that yuan will move both ways and that more 'adjustments' are unlikely [1]

• China's huge economic advantage over the rest of the world (ie a rapid increase in the number of workers each year) has now disappeared with a reduction in the workforce now occurring for the first time in decades [1]
• There was increasing doubt about the adequacy of China's financial system and the people who run it.

Allowing market forces to influence exchange rate (as PBOC recently did) is only one obstacle to capital flows across China's borders. China's stockmarket meltdown shows holes in its financial regulations - and this makes political leaders nervous about allowing investors to move money in and out of China. At the same time China is experiencing economic weakness. Financial supervision might be inadequate in dealing with disruptive capital movements. Yet PBOC continues to emphasize market liberalization - though it needs to prevent currency free-fall. Stockmarket fall happened after epic rally associated with the creation of lending tools that had escaped regulators notice until debt build up caused investors to run for exists. Officials are now worried about increasing risk. China's saving's glut (deposits stand at $21tr - 50% of GDP) could pour out of country if capital controls are loosened before financial system is strengthened. PBOC is pushing for liberalization - yet many are concerned that China's state-controlled financial system is not robust enough [1]

• China's financial and economic difficulties have the potential to bring on a global recession [See also CPDS speculations about this in Debt Denial: Stage 3 of the GFC... or Worse? 2009)
• It is possible to develop a 'doomsday' scenario in relation to China's current situation - given contagion from the effects of stock market falls and devaluation (to other markets, capital outflow and accelerated problems associated with financial sector weakness and corporate indebtedness [1];
• China may have long term problems but in the short term it is not facing the sort of financial crisis that affected US and Europe in 1931 and 2008 - because it has tight exchange controls and a state banking system. China's recession is over because stimulus has revived its property market, so the day of reckoning has been put off again. China has a $600bn pa trade surplus and is thus rapidly accumulating foreign exchange reserves so its reserve losses will not get out of control (as happened to many countries in Asia at the time of the Asian Financial Crisis). China's credit growth has been 20%pa over past 3 months. China had been affected by severe monetary / fiscal shock as declining inflation had forced real interest rates up in an attempt to deflate China's property bubble and wean economy off its $26tr debt dependency. But the policy overshot at the same time that budget spending contracted. Banks had apparently refused to roll over short term loans to local authorities - because these were no longer covered by government guarantees. Local governments were expected to issue bonds instead - but bond market was slow to develop. This is why China crashed into recession in first half of 2015. China's government has now reverted to strong credit stimulus. The property market has strengthened. China's devaluation is probably not significant. China would face serious risks of capital flight if it engaged in ongoing devaluation  [1]
• The PBOC is preparing to flood banking system with liquidity to boost lending - as its recent currency moves are squeezing yuan funds out of market and renewing concerns about capital flight. Cutting deposit ratios are a sign that China's exchange-rate maneuvering backfired - but merely involves doing again what China has done before which failed to stimulate economic activity [1]. The PBOC ordered an emergency interest rate cut after the stockmarket experienced 2 days of large falls. This was seen to counteract downward pressure on China's economy [1]
• China's recent economic troubles make it seem a threat to (rather than rescuer of) global economy.

During GFC China launched massive stimulus which acted as shock absorber. Now it is the source of shocks. Growth starved world has come to depend on China. With 15% of global GDP, China has contributed half of global growth. China's economy is a 'black box'. Government economic statistics are suspect. And policy manouvers are suspect. A desire to micro-manage yuan value undercuts its ability to pursue independent monetary policy - due to spill-over effects on domestic liquidity. Risk averse banks continue to favour SOEs - thus requiring private firms to rely on high interest rate financing. SOEs face overcapacity. The stream of bleak news reached critical mass recently - generating near panic. It still has positive features - but its growth is slowest in 25 years and government is losing control. It had hoped that stock-market would help fund indebted companies. Then market fell. There is now doubt about China's economic management. Past methods used to support growth are losing effectiveness - because of structural inefficiencies and larger economy. Fiscal expansion has limited potential. China's senior officials are reportedly divided on what to do. Reliance on state investment / exports is losing effectiveness faster than expected. Exports were down 8.3% yoy in July. Construction starts fell16.8% yoy during first months of 2015. Advanced technology and entrepreneurship are slow to fill the gap. Many firms are succeeding - but this is not enough to replace the old economy which is contracting quickly. The flow of migrant workers to cities is reversing - because of weakening demand / conditions. Worker protests and strikes are more than double a year ago. PBOC is flooding the market with liquidity to counter these problems - but would prefer not to do so. Buying / selling the yuan to affect exchange rates influences domestic liquidity - and thus requires changes to monetary policy also. Beijing is having trouble getting people / institutions to follow its instructions. Some suggest that concerns are overdone - as there are bright spots and for many it is business as usual [1]

• China is experiencing serious economic problems - partly because promised and necessary reforms have not been made

There are abandoned / unfinished apartment blocks all over China - as a result of rash judgments made during the world's most extreme speculative investment bubble. These are not 'ghost cities' - merely empty unfinished buildings. This has implications for Australia because it was assumed that China's demand for coal / iron ore was insatiable. But imports of these have fallen / collapsed. And motorways have been built everywhere that are almost unused. China's excess steel / aluminum capacity has caused a global glut. Investment has comprised 50% of China's GDP - and this has to fall. At the height of the boom China was using half the world's steel / cement to build (often) empty buildings. There are no statistics on abandoned buildings but there must be tens of thousands of them. China claims that its housing sector is still expanding - but more slowly. However there is doubt about such claims. Exports are flat. Manufacturing is contracting. Electricity use is falling. Cranes are thinning out. Millions of workers are moving back to villages. China's sharemarket problems are not really significant. The problem analysts see is that Xi Jinping promised structural reforms in 2012 / 2013 which have not been made (eg of household registration system; financial reforms to fund credit-worthy borrowers not those with political influence; creating land market; rural education; intellectual property rights; reform of SOEs). Migrant workers in cities have declined (due to growth slowdown and aging population). This matters because migrant workers drove productivity gains. Many expect China's growth to fall to 5% pa - but bursting of housing bubble and flat global demand could lead to uncontrollable recession. China's ghost concrete towers are a symptom of a financial system that supports groups that obtain finance on the basis of connections without objective credit analysis. Some expect excess property to be absorbed gradually - but there is now over 2 years stock on hand. China is facing vested interests who are blocking necessary reforms. China's earlier reforms forced the Party to change - but it did not require that it lose control. This is now what is needed and it is being resisted. [1]

• China has warned its people and the world that much slower growth is now likely as it moves from smokestack industries, huge exports, vast infrastructure spending - all underpinned to trillions of state-backed debts. Debt is now twice GDP and some industries (construction / steel) are in trouble. China's leaders are having trouble managing the transition. There are areas of improvement - but consumer spending is not rising fast enough to compensate for declining areas. China had seemed to be a dependable source of growth - and now it is exporting volatility [1]

• China was seen to be headed for recession (defined as growth below 4%pa) unless large scale fiscal expansion monetised by PBC was put in place - and authorities were seen as yet unwilling to do this [1];
• China's deepening problems were seen as adversely affecting global economy [1];
• China's proposals for the development of a new economy (which probably included reliance on a share-market to provide capital for industrial investment) have not been going well - and this will have adverse international effects [1]
• While China is experiencing difficulties, it was seen as likely to weather the storm

Financial crises in 1987 and 1998 did not lead to recession - though crisis of 2008 was different. Crash of 1929 did not cause Great Depression - as the real problem was tight policy by Federal Reserve from 1930 on that caused banking system collapse. The 1987 crash followed two Fed rate tightenings - and then prevented this having any effect by increasing liquidity.  And in 1998 the Fed tightened because of domestic inflation fears - and countries with too much $ debt suffered. Then Fed reversed policy and US economy continued growing - a step that some see as a mistake. Question is whether ructions in China matter. US economy is accelerating, Consumer confidence is up. Housing sales rose 21% in July. Job openings ratio is high. Germany is solid. Eurozone is doing well. There is no monetary implosion now like that in 2008. QE is still strong. US loans are rising. China is main unknown. Some never believed in China miracle. Its post-2009 credit blitz is unprecedented. China's premier agrees that China faces middle income trap unless it ditches catch-up model and weans off investment led growth and Party grip on China's society. While trouble was likely, crumbling credibility of China's leaders is painful. One year borrowing costs rose to 5%. Local government reforms were botched - leading to fiscal crunch (19.9% spending fall in January). Stock market mania was stoked. Capital flight reached $200bn in July (or more). PBOC is burning foreign exchange reserves to defend currency - and this squeezes domestic liquidity. It can't cut rates to support economy without encouraging further outflow. China will probably weather current storm. Fiscal spending is growing at 13%. Housing market is recovering. Service grow at 10% pa. [1]

• China (the world's largest holder of US Treasurys) has been selling (over $100bn) since currency devaluation - in order to protect value of yuan. Many see this as bearish for US bond prices - though this may not be correct as there are complex factors involved [1];
• China's economy was seen by Citigroup as likely to crumble with huge increase in money supply by central bank. China would take the world into recession with it. Another observer suggested that stagnation is the best outcome that China can expect over the next decade. Another drew a parallel with Japan's lost decade [1]
• China's debt (not changes in share market) are its real problem. Local government debt increased dramatically over past two years - and this is major facto in China's financial instability. Government is seeking to bring problem under control.  [1].
• While China has consistently hit growth targets, it has a major problem because its debt levels have been rising 2-3 times faster [1]
• Significant falls in factory activity in China and a cooling services sector suggest that China could be headed to a hard landing [1]
• Capital outflow from China will have a self-reinforcing adverse effect on its economy;

China's dumping of US Treasuries is big issue. Usually share market volatility causes investors to buy Treasuries - but recently their prices went down. China has pegged yuan to $US since 1994 - and moved to managed peg in 2005. This allowed $4tr foreign exchange reserves to be accumulated. To maintain peg (and China's competitiveness) China needs to 'print' yuan to exchange for $US. These can be sterilized to reduce inflation risk by issuing notes / bonds / increasing banks reserve requirements. Or surpluses can be invested in US Treasury bonds (or Fannie Mae / Freddie Mac) which had implicit US government guarantee. This pushed US interest rates down - which lead to consumption / house price boom and to 2008 bust. This adversely affected China - because its economic structure was oriented to manufacturing for Western consumption. China launched a stimulus / credit boom that (in conjunction with West's reflationary efforts) encouraged continuance of pre-2008 speculative flows. China's foreign exchange reserves grew again and speculative capital flowed into China - expecting China to revalue yuan higher. QE and zero US interest rates encouraged borrowing $US to buy yuan to take advantage of higher Chinese interest rates and lack of currency risk. However a country can't maintain a fixed exchange rate, have free capital flows and set interest rates independently. China long had a closed capital account - which allowed them to control exchange rate and set monetary policy. But as capital flows were allowed. When China's economy slowed in 2012/13 and US moved towards capital tightening, speculative capital started flowing out of China. Thus China must now sell (rather than buy US Treasuries). The unwinding of speculative inflows is self-reinforcing - because running down foreign exchange reserves reduced liquidity in China - which is not what it needs when economy is already slowing [1]

• the rapid growth of local government debt in China (ie 30% over 18 months) - combined with falling revenues compounds other concerns about China's economy [1]
• China's economic reform agenda has been slow to be implemented. It was seen as legitimizing and reinforcing Communist Party rule. It also included: raising incomes; promoting markets to allocate resources; and become more consumption based. While some progress has been made (eg on market liberalization) little has been achieved on most of the reform agenda [1]
• China is spending increasing amounts of its foreign exchange reserves to defend the yuan ($US94bn in August 2015 - double the amount in July). This signals that the currency has further to fall - and that the currency has to be propped up (ie demand is artificial) [1]
• China is experiencing significant and increasing capital outflow.

China's problem is no longer what to do with capital inflow. Not long ago the world was awash with cheap $US - due to US Federal reserve monetary policies and the re-export of China's offshore trade earnings. Then China started investing in expensive off-shore initiatives (eg AIIB and New Development Bank, Silk Roads projects) while also recapitalising its policy banks. China's problem has shifted from excess reserves to questions about whether its reserves will be sufficient. What the PBOC is doing has the effect of 'quantitative tightening'. The more market-determined approach to exchange rates could lead to a dramatic fall as capital outflows increase. China's foreign exchange liabilities probably account for 40% of its foreign exchange holdings. The IMF estimates that it needs a minimum of $2.6tr in reserves. There are about $2tr in various financial arrangements that could be a source of outflows [1]

• a long term China 'bear' suggests that China is running out of room to borrow - because its debt grows 2-3 times faster than its GDP. China could lose control of its currency - and this may have been the cause of August 2015 market instabilities [1]
• China's leaders expressed deep concern about the economy at G20 meeting - despite official claims that growth at 7% pa will continue

 Reference was made to stock market bubble bursting. However more significant was a statement by officials that China would suffer 10 years of tough economic conditions - with a lot of pain for 5. China is trying to move its economy to one based on domestic consumption. To generate cash for this China encouraged investment is the stock market. Until mid-2015 this market had seen a major rally. Then this method for corporate capitalization failed. Also China's economy has started slowing faster than expected. Export and manufacturing data were well down yoy - and services / property sectors are not growing as fast as expected. China is walking a tightrope with its currency. It allowed yuan to fall a little - but risks capital flight if it falls too far and has to spend a lot on money ($95bn in one month) to stabilize yuan. The PBOC can't do this indefinitely . There are also rumblings that some officials want China to end its 'new normal' shift. Serious infighting is possible [1]

• China's declining imports suggest that its transition to a consumer driven economy is slow [1]
• China's real problem is in its banks - not its stock-market.  China's entire foreign exchange reserves might be needed for a bail-out - see details;
• China has again stimulated its slowing economy with infrastructure spending - a step which sets back efforts to get its debt load under control [1]
• There have been suggestions that China could experience problems like Japan did in 1980s and 1990s - but this is not so. China's problem is much harder to deal with - eg because of higher levels of government intervention [1]
• China has announced plans to reform its debt-laden, mostly state-backed corporate sector. It desperately needs foreign investment - but now does not seem to be a good time to invest.

China has announced plans to reform its debt-laden, mostly-state-back corporate sector. This has been inevitable as China shifts from reliance on foreign investment to domestic consumption. The plan involves selling off bad assets, reducing government's role, privatizing and allowing markets to have a fee hand. But this is happening while China's economy is in trouble. Government wants to both maintain control and get cash. President Xi announced China's desire for foreign investment - and also that it would not change its heavy-handed policy on foreign investment . The reform process China envisaged has fallen apart. Everything would have been fine if reform had been financed domestically (ie by encouraging China's people to get into stock market). This initially led to a boom - but then to a bust. China's $529bn in offshore (euro and dollar denominated) debt rose $10 with a 1.9% devaluation. China promises now to defend yuan but doing so cost it $110bn in August 2015. China's corporate sector was already struggling with PPI deflation - so debt was becoming harder to repay.  China wants foreign investment - but it does not seem to be a good time to do so [1].

• Property sales are increasing rapidly in China and stimulus / credit is unleashed. There is a shift to hard assets after confidence was lost in stock markets. Interpreting China's economy is hard, as data are unreliable. Fed held off rising interest rates because of fear that China may be in real trouble. Efforts to rein in China's credit bubble seem to have been abandoned. It is unsure whether what is happening will translate into new property development because of the large over-supply of properties. Land sales attract no buyers. Also flow of migrants to cities has slowed and China's workforce is now falling 3m pa. China has a housing shortage for poor people and an over-supply of glitzy apartments. [1]
• China's falling foreign exchange reserves are forcing PBOC to increase monetary easing to keep liquidity flowing. This used to be automatic and a consequence of China's increasing foreign exchange reserves [1]
• after the collapse of China's sharemarket bubble, funds were widely shifted into Chinese bonds - where the problems may be even greater [1]
• informed observers suggested, in relation to what is going on in China is that: (a) there is great uncertainty about the competence of China's administration - but no uncertainty about who is in charge; (b) the collapse of Shanghai share market was the result of deliberate creation of a stock bubble by government - as values reached could never have been justified. China's people were made to think that government could dominate market forces; (c) China is in for a bumpy landing - and faces great uncertainty. Official FX reserves are falling; (d) the end for China is not near - progress continues to be made; (e) China's equity market bears no relation to real economy - growth will be maintained by fiscal expansion; (f) China is trying to shift to service / consumption driven economy at a time when the advantages it had in manufacturing no longer exist ; (g) China is seeking to deleverage from past excesses - and this is becoming harder ; (h) China's growth is slowing because of high labour costs, unsustainable debt levels and enormous supply capacity related to politically-motivated investment. There is a risk to Communist party from slower growth, stagnant wages; rising unemployment - and widespread corruption. Despite talk of reform the government seems to be increasing its economic control; (i0 government seems to be fighting the corporate deleveraging that is needed because they don't understand the problem. Hare brained efforts at government-sponsored stock market rally smacks of desperation; (j) China is in difficulties - but it would be unwise to ignore its remaining strengths [1]
• The UK rolled out red carpet for China's president. Britain's pivot to China is based on its economic strength. However there are reasons to expect to expect China's future economic performance to be poor

• China's economy has been slowing for years. According to authorities its September 2015 growth was 6.9% - though the true figure may be lower. There are many reasons to expect problems: (a) China's huge demographic challenge; (b) China's real estate investment has been massive (10% of GDP) - and this is incompatible with its demographic challenge; (c)  there is large industrial sector over-capacity; (d) everything now depends on consumption - and though there are signs of improvement, in many areas growth is weak or negative; (e) China has very high debt levels [1]
• China's official interest rates have been cut - but this will make little differences because liberalization of China's financial system (to gain IMF recognition for the yuan as a reserve currency) will mean that banks will increase rates. In any even China's most pressing need is to reduce the dependence that economic growth has had on increasing credit [1];
• The profits of China's SOEs are falling because they have taken on too much debt. Their response is to increase debt levels - and this makes the situation worse.  However without that increase in debt they would be unable to function. To move from investment-led economy to one based on consumption China needs to restructure SOE debt - but to maintain its economy China needs to keep giving SOEs access to credit [1]
• China has decided to end its one-child policy. However its workforce is already declining rapidly and this change can not increase working age populations for another 20 years. It will do nothing to alleviate China's expected 140m workforce deficiency in the early 2030 - when dependency ratios will be very high [1]
• Weak exports (related to China's reduced competitiveness as a result of wage rises) and weak domestic demand are both contributing to a growth slowdown in China [1]
• China now seems to be applying the same methods to stimulate its economy as it has done in the past and getting less economic impact from doing so. Stimulus measures were introduced following problems in mainland stock-market and precipitous fall in exports are having little impact. Easing money policy started in 2014 - and usually has an impact in a few months. Data now suggests a slower response.  China is moving from reliance on investment to consumption - while trying to avoid a credit event. This requires continuing to provide high levels support for property sector and SOEs that carry huge debts and a proving sluggish. Most credit has gone to SOEs. China needs to shift its emphasis from rescue to reform. [1]
• Chinese borrowers are taking on record amounts of debt merely to repay interest on existing loans. 45% of new debt is for this purpose. This is a classical Ponzi scheme - which is a formula for a financial crisis [1]
• The steady stream of capital outflow from / fleeing China which has disturbed global financial markets is likely reach a record ($113bn) in November 2015 [1]
• Rises in / normalization of US interest rates could be economically disruptive - but this has to be done sometime to avoid simply creating greater future risks. However the biggest risk world faces is large Chinese devaluation. This could set off further declines in commodity prices and a currency war across Asia (and elsewhere) that replicates 1998 - but is more dangerous. China's fixed capital investment is $5tr pa (equal to North America and Europe combined). There is massive excess capacity. Capital outflows are over $100bn per month. $57bn in foreign exchange reserves are being used monthly to defend the $US peg. RBA estimated capital outflows at $300bn in third quarter - and that $200bn of foreign exchange reserves had to be liquidated). Such reserve depletion entails monetary tightening - and thus makes a 'soft landing' much harder. Chinese exporters want to keep foreign earnings in $USs - and foreign suppliers have reduced willingness to accept yuan. China held vast quantities of $US bond in Belgium - and these have now been halved. China's exports stalled in November 2015 - and fell 6.8% yoy. China is exporting excess output into saturated global market. There is debate about whether China's currency is overvalued. It has $800bn current account surplus. Yuan is linked to strengthening $US while Japan devalues yen and currencies in Russia and East Asia have crumbled. Chinas effecive exchange rate rose 30% since mid 2012 - at the same time that it runs out of cheap labour.' This has squeezed corporate profits. There are major problems in ship-building and steel industries. Devaluation has been resisted to avoid falling into Japanese-style outcome - and would be hard to square with China's ambition to be a stabilizing pillar of world economy. China has a ''new economy' that is doing well. Yet there are domestic political tensions associated with this transition. China's president is mainly concerned with using 'reforms' to ensure hegemony of the Party - and this is incompatible with a market economy. Those promoting economic change could be pushed aside [1]
• China's debts are rising significantly relative to GDP. This is however not likely to lead to a financial crisis because most debts are by state-linked companies / agencies to state-linked banks - and the government controls the whole financial system. However there is a cause for concern because those rising debts indicate poorly-directed investment and this will harm China's ongoing growth prospects [1]
• China is seeking to prevent a spread in the value of the yuan between the somewhat higher exchange rate it achieves in China, and the lower value attributed elsewhere [1]
• China is facing increasing difficulties in managing its economy. There were problems in 2015 - and policy induced turbulence is possible in 2016. A sharp yuan depreciation is a risk - which could trigger competitive devaluations elsewhere. It is also hard to know how markets would react to significant corporate default. Debt has been increasing significantly - and government efforts to constrain this could lead to problems. other challenges relate to pollution, to possible policy paralysis as a result of anti-corruption campaigns. However positive gains are also possible - and whatever happens will make a big global difference [1]

2016

• China is tightening rules related to foreign currency trading in order to stem the flow of yuan out of the country - because China's economy is weak and outflows increase pressure on yuan value - which is already being devalued [1]
• A Chinese player in stock investment believes that Communist Party will save stock market and make people rich. Many Chinese now make highly-leveraged stock bets. they could run into problems because of China's debts. China's debts are rising as its economy slows. Overall debts ($28tr) are half the world total. Since GFC China's debts escalated, while US's were reduced as % of GDP. In Singapore / HK, non-financial private debt is 200% of GDP. This would not matter if growth wasn't slowing. China's real growth has slowed by 1% - because inflation is low. But in nominal terms growth slowed 7%.  China's loan growth has slowed - but not as much as nominal GDP growth. China's debts are now 282% of GDP - up from 121% in 2007.  China's corporate debt / GDP has grown twice as much as next highest country.  In 2007 few Chinese companies had debt service costs over profits - now over half of them do. Debts in emerging markets have boomed. The $US has appreciated against other currencies. China used to rely on foreign currency inflows to its financial system - but this year as US raised rates China started losing foreign exchange reserves. AS China's debt increases it is less able to pay it off.  Much of China's increased debt has been taken by local governments - and is also hidden in SOEs. Some argue that the world is in last stage of debt super-cycle when it suppresses growth everywhere. This may already be happening in Asia - ie people have so many debts that banks can't lend more. China won't have a credit crisis in 2016 - but several companies have defaulted on their debts [1];
• China has injected $100bn of liquidity into financial system and cut interest rates to stimulate economy - but this may be insufficient because of capital flight. This was necessary to stop liquidity drying up and reverse passive tightening associated with capital outflows. The PBOC is also drawing down foreign reserves - and this has unintended consequence of tightening monetary policy (which is why countries can't use foreign reserves in a recessionary downturn). It is uncertain how much cash has gone offshore - but the PBOC might have burned through $200bn since August. China's strategy is unworkable. Trying to defend exchange rate requires bleeding reserves and loosening monetary policy at the same time. China probably has about $900bn in reserves that could be used - a sizeable but not unlimited stock. Running these down would also be constrained by high levels of short-term external debt. China's reserves are in fact low by emerging market standards. Analysts are uncertain whether China's problems are over. There are signs of improvement (eg in house prices, transport, demand for aluminium, services (growth at 10% pa). There are also positive international economic signs. [1]
• China is struggling to get its debts under control. It seems to have appropriate policies - but is having trouble putting them into effect [1]
• China started 2016 in hopeless position - noting stock market crashes and investors' alarm about currency depreciation.  Comparisons are being drawn between China now and US on the eve of GFC. However what happened in 1998 is more relevant. The AFC caused China's growth to fall. Foreign demand for exports crashed, and it was impossible to rely on domestic demand. This is like China's current problem. SOEs were in serious difficulties - profits were weak and there was excess capacity. And real-economy problems affected the banking system - creating huge bad debts. Solutions were similar to those now being proposed - loose money policy, and adoption of more market-centric reforms. Tough policies were introduced - loose lending practices and infrastructure duplication were avoided. Efficiencies were sought in state sector - which was significantly reduced allowing more scope for private operations. The bureaucracy was also tightened. The short term effect was severe - but the long term effect (combined with joining the WTO) was China's rapid subsequent growth. 1998 reforms show that China's problems are not insurmountable - but current regime seems more concerned with consolidating its political power, fighting endemic corruption and flexing its muscles abroad. Without decisive action current government will end China's economic miracle  [1]
• China's shift to a service economy is being driven mainly by a decline in export and domestic demand for manufactures. In most cases of sustained economic growth in modern economic development, industrialization is the key. Countries fall into the middle income trap due to the inability of manufacturing to move up the value chain and compete in global markets when wages reach a certain level. The increase in China's services share is a symptom of the hollowing out of its manufactures. China still needs substantial improvements in manufacturing - and this requires investment  [1]
• China is trapped. The more it uses foreign reserves to defend the currency, the more it tightens domestic credit. Bad debts in China's banking system are 4-5 times greater than officially admitted. Massive malinvestment has occurred during China's $26tr credit bubble. China's credit may still be growing faster than economy. Foreign reserves have fallen $700bn to $3.3tr as capital flight overwhelmes the trade surplus. This would normally lead to a 25% devaluation - which would have a huge deflationary impact worldwide. China's government is trying to maintain currency stability. China believes it is different because it funded growth from domestic savings and capital - and thus can deal with financial market risks. However investors are not sure that China can defend the yuan. The more it burns through reserves to defend the yuan the more it tightens internal monetary policy. This worsens credit crunch and causes more bad debts. Opinions are divided. Some see property crisis claims as exaggerated as 'new economy' companies are buying real estate to rent. Others see that there is excessive pessimism about China - which will probably muddle through [1]
• China suffered much larger capital outflows in 2015 ($1tr) than anyone had expected. China's foreign exchange reserves are thus declining faster than expected - and could soon be below the recommended safety level. Those reserves are needed to allow China to stimulate its desired economic structural adjustment [1]
• while most observers have been concerned about China's stock market and currency values, China's biggest problem probably lies in local government debts. These had become unsustainable (because of borrowing huge amounts at high interest rates on short terms from shadow banking system). In 2015 maturing debts were refinanced through long term bonds at much lower interest rates. This process needs to continue - but it is not certain that issuing such bonds will still be easy [1]
• China may fall into the 'middle income trap' rather than continuing to grow at a rapid pace and become the world's richest and strongest nation. China's income gap with US is only now reaching the level that Brazil and Turkey achieved in 1970s - and they have never succeeded in further closing the gap. The middle income trap could be due to: rising wage costs which reduce competitiveness; too much physical investment and too little spending on education and skills; or political failure. [1]
• Markets have gone from excessive admiration of China to excessive pessimism. However China's growth is not slowing - but rather accelerating after recession in 2015 that was due to bad policy actions.  Growth is however based on stimulus measures that are unsustainable and will perhaps only be able to be continued for another year or two. Capital outflows are a major source of concern - even though much of this is sensible reductions in $US debts - given rising US interest rates and $US value [1]
• China is experiencing the greatest capital flight in history. Cash reserves fell $700bn last year. This complicates China's economic transition and also raises risks for other emerging economies that are also experiencing cash outflows. China's huge foreign exchange reserves mean that this poses no immediate risks. A devaluation by China would be a major worry - this would make other emerging economies less competitive and increase their risk of capital flight. Capital flight usually reflects economic turmoil, political instability of external crisis. China is affected by several inter-related factors. Large amounts were invested in China on (false) assumption that strong growth would continue. Anti-corruption campaign is encouraging people to get money out. Also Chinese companies that had borrowed offshore and reducing external debts. Flight is also encouraged by the view that getting money out will become harder.  The issue is complicated by possible difficulties for heavily indebted companies and local governments to refinance their debts. Russia's problem with capital flight was much worse than China's. China's challenge is not to stop the phenomenon but to contain it [1]
• The fact that stockmarket problems don't tell anything about China's economy does not mean that everything is OK. China's main vulnerability is inexorable rise in debt - and unless this is addressed any solutions are worth nothing. Important reforms of China's real economy havs stalled. China can continue producing 7% growth rates for a couple more years - but this is not a solution if it requires increasing overall debt levels much faster [1];
• Institute for International Finance suggested that China had not been convincing in dealing with capital flight risk - and that significant renminbi devaluation was possible. Authorities have not yet expressed a coherent strategy. Capital outflows could accelerate and get beyond China's control. Foreign exchange reserves have been falling - perhaps by $140bn in December 2015. Big renbinbi devaluation would have deflationary shock worldwide. The bulk of outflows are probably to pay off liabilities - and thus benign (and not 'capital flight'). But the component that is not just repaying debt seems to be increasing - and even when all external debt is repaid Chinese companies may continue outflow if China seems to be losing control. China needs to restore confidence by pushing reforms through. [1]
• China's large debts are unlikely to be a major problem because government has necessary controls. Capital outflows are a bigger risk of triggering a hard landing. China's foreign reserves fell $100bn in January. China has been forced to expend reserves to prop up currency. However doing so is a bit like trying to prevent a run on bank - as it encourages others to also try to get out. Wealthiest Chinese have deep distrust of China's policy-makers. Anti-corruption reforms have been too narrow and have not addressed inequality which is becoming socially destabilizing   [1]
• A credit crisis in China could see banks incur losses 5x those of US banks during sub-prime crisis according to Kyle Bass (Hayman Capital). China’s banks (like those of US before GFC) have pursued excessive leverage. Regulatory arbitrage and irresponsible risk taking. China’s banking system has $34.5tr in assets – up from $3tr 10 years ago. This funded huge / inefficient infrastructure investment that propped up China’s growth. Loans are not made on the basis of borrower’s ability to repay but on their political connections. This is compounded by problems in China’s shadow banking system. Losses in China’s banking system from 1998-2001 were 30% of GDP. Losses in current cycle are likely to be as bad – and this now equals $3,6tr. China could be forced to recapitalize banks by printing $10tr yuan. Doing so would result in 30% yuan devaluation. China’s foreign exchange reserves may be only $2.1-2.2tr – after allowing for $700bn in China’s sovereign wealth fund – compared with $2.7bn minimum required for banking sector bailout. A collapse in China has been long predicted. And Bass has been predicting a collapse in Japanese government bonds for 5 years – which has not yet happened. In fact bonds surged recently because they move inversely to interest rates [1]
• Concerns about China were seen to be overblown by Deutsche Bank - who sees only a 20% hard-landing risk. Buffers against NPLs include those already written off, excess provisions and $1.1tr in pre-provisional profits. Also only $20tr of China's banks' $34tr assets were credit-type. The rest were reserves at PBOC, interbank deposits / lending and treasury bonds. There is also potential for 20% recovery of collateral - with 43% of loans collateralized. The PBOC has also strengthened oversight of shadow credit while banks have improved risk controls [1]
• Kyle Bass (Hayman Capital) argues that wealth management products have been used by China's banking system to contribute to China's rapid growth of credit. They offer investors guaranteed interest and principal payments but are not on the banks balance sheet (where there is a limit of obligations relative to bank capital). However in the event that there was a repayment problem they would need to be brought back onto balance sheets. A particular variation of this involve Trust Beneficiary Rights which (Bass says) are being used to hide loan losses away from regulators' view. When loans approach a non-payment status they are pushed into TBRs (ie to Trust Companies for whom the bank is guarantor). Then bank records TBR as an asset. TBRs require much less bank capital to support (2.5%) than than on-balance-sheet loans do (11%).  Some banks now have more TBRs than they do loans  [1]
• China's economy seems to be facing problems when one looks at its stock market (which is not a significant source of finance for industry) and GDP - which largely measures what is happening in China's 'old' economy. However rapid growth in services and consumer-oriented industries is occurring - which suggests that China will not have a 'hard' landing [1];
• Pessimism about China (because of growth slowdown / high debts / policy bungles) has been seen to be excessive. reasons to suggest that a wave of bad debts would not sweep through China's banking system were that: (a) the yuan is only modesty over-valued; (b) banking sector losses would only come from bad banking credit not from total system assets. Also banks have ample liquidity and don't need to recognise bad debt immediately; (c) China does not need to use FX reserves to recapitalize banks - as the state could do this directly; and (d) China's $3.2tr FX reserves do not include China's sovereign wealth fund. The IMF believes that China needs $2.7tr in reserves as a minimum - but China has capital controls that it can implement [1]
• There has been concern about China's FX reserves and the stability of its exchange reserves. China's central bank has now argued that China does not need to devalue the yuan. China has a large current account surplus. Capital outflow is seen as mainly associated with repaying foreign currency debts - not with 'capital flight'. Despite this China still faces a currency risk [1]
• China's private debt / GDP ratio (290%) is the highest in the world and is growing at 28% pa. This is an indicator of a likely recession - which occurs when debt ratios cease rising [1]
• China's debt levels are of concern but are unlikely to lead to a hard landing because credit is primarily provided by domestic savers through state owned banks to state-owned companies [1]
• China's attempt to  to end its massive over-capacity in steel and coal industries could have serious adverse effects domestically (leading to politically destabilizing levels of unemployment) and internationally (through have to export the products of its excess capacity - and thus undermining similar industries elsewhere and potentially triggering trade wars) [1]
• China's attempt to defend its currency will end badly because doing so by running down foreign exchange reserves because doing so has the effect of tightening money supplies and thus creating a deflationary environment. A once off devaluation is needed. Authorities are worried this could lead to an unstoppable currency slide - but this would be unlikely to happen [1]
• Panic about China has abated - as the yuan has strengthened and money outflow eased. Growth is expected to increase. Yet there is a problem because this has been achieved by stimulus through more rapid credit growth - which increases the risk of future problems. Without needed structural reforms China is headed for middle income trap. China's 'credit overhang' [ie the deviation of the credit-to-GDP ratio from trend] has risen to 25% - leading to falling factory gate prices / profits and putting China at risk of 'debt-deflation' trap. Many firms have declining ability to service their debt obligations. Gross debt to earnings has doubled since 2010. Median days to pay suppliers have risen to 70 - as compared with 35-45 elsewhere. Potential loans at risk are 15.5% of GDP ($1.3tr - with potential losses of $756bn).  The IMF warned of an abrupt re-pricing of risk - even though banking system is an arm of Chinese state. Total credit is rising rapidly - much of which is used to repay old debts. The GDP growth for extra debt has collapsed 2/3 since lending spree started in 2009. The structural (market liberalization) reforms that President Xi promised in Third plenum in 2013 never happened. Instead the government deliberately inflated a stock market bubble with margin debt - which collapsed. SOEs are still getting most credit. It was never possible to deliver a 'free market with Chinese characteristics' while tight political control was maintained. Despite headlines indicating that China has recovered - this can only last a few months. When this ends rapid capital outflows from China could resume and swamp its reserves / force a massive devaluation / disrupt global trading system. This could happen just as inflation risks rise in US [1]
• reports of improvement in China’s economy in early 2016 seem inconsistent with reports concerning Chinese enterprises and China’s trading partners [1].
• Turmoil in likely to resume on China’s financial markets and spill over into the world’s fragile financial system. Concerns about China’s financial system emerged in late 2015 when currency devaluation was botched. This continued with stock-market sell-off that rippled globally. China’s connections to global financial system is likely to increase. Assuming that China is still a growth engine and a place where profits can be earned is dangerous. China recently opened its huge bond market to international investors – but its domestic economic reform program has lagged. And Chinese companies are investing offshore. This has involved Chinese firms with non-transparent financial positions buying insurance firms – which could cause a lot of problems if things go wrong.  Closure of China’s stock, bond and currency markets to foreign investors in the past has protected the world from China’s ups and downs. This is ending – as China opens its bond market to spread the risks associated with its credit binge.  The problem is that in China, stability and political goals have always overshadowed financial goals. China wants to spread its market risks to the rest of the world – though its markets are not markets as others understand them but a government political tool.  Even without this the world is heavily exposed to China – via bank lending. Turmoil in China could lead to large losses to banks elsewhere. China needs to keep its economy growing – but so far it has only been able to achieve this by borrowing more. This poses risks in bond market and to companies / banks that have invested in China. Devaluation of the yuan would be a way to boost growth [1]. 
•  Everyone used to believe that China's growth was going to continue to be strong. Now many doubt this. Some see parallels with Japan's problems in the late 1980s as a result of build up of bad loans. China could experience a situation it can't control (ie a banking crisis). China total debt levels are estimated as 308% of GDP (ie $30tr). Debt growth has been enormous in 2016 - and much of this has found its way into property market which the government seems to have chose as growth engine despite the existence of 2-5 years glut of unsold properties in smaller cities. This is just more of the old' China - where the post 2009 stimulus package led to inflation, asset bubbles and excess capacity [1]
• China debt-fuelled growth has been suggested to face a risk like US experienced in 2008. Both involved unsustainable expansion of credit heavily linked to real estate [1]
• China's elite have wanted to have everything - stimulus by money printing, reducing support for companies that lose money, boosting role of markets and private sector, and supporting SOEs. This leaves everyone unsure of ultimate direction. PBoC is injecting large amounts into financial system increasing risk of housing bubble. Government usually intervenes to stop dangerously fast property price growth. If this does not happen soon a boom / bust cycle is likely. China's housing sales rose 1/3 in first quarter after 2% previously. However corporate profits in China fell in 2015 - for first time since 2000. However China's debt rose to 237% of GDP - double that of 8 years ago. Monetary policy needs to be reducing overcapacity / stockpiles / leverage / overcapacity - but it has actually been doing the reverse [1]
• Global banks expect China's latest credit-driven boom to lose momentum by late summer 2016. Curbs have already been placed on lending for property in eastern cities to prevent a speculative bubble [1];
• the amount of debt now carried in the Chinese economy (mainly by zombie SOE) is now so high that a financial crisis is seen to be  likely [1]
• China's government now seems less likely to be willing to bail out its huge corporate bond market - a perceived willingness that allowed Chinese companies to borrow heavily in recent years [1]
• Research by CLSA shows why China had to apply economic stimulus at end of 2015 (ie falling job creation, rising wages, reduced competitiveness, effect of trying to slow property boom) - though the benefits might be unsustainable. China's problem is that property sector is its economy (ie drives 43% of economic growth). This driver was falling at end of 2015. This had to be reversed - though the sector is unproductive, there are 5 years of housing inventory, and there is overcapacity in all industries that contribute to property. Unproductive growth means that economy / banking sector is susceptible to problems. IMF says that 14% of debt of Chinese listed companies is 'bad' - though adopting less conservative criteria suggested that this could be 28%. [1]
• rampant speculation in China's commodity markets could adversely affect global markets and the global economy. Trading volumes and volatility have been so extreme that they make stock market swings seem mild. Prices have fallen after reaching a massive price spike - which could have seriously damaged China's already fragile market system [1]
• Authorities in China are increasingly discouraging negative reports about its economy from being published - as its problems become more severe [1];
• China is officially talking about reducing its economic dependence on rapidly increasing debt - but seems to actually be continuing that dependence [1]
• In June 2016, the yuan seemed to be depreciating rapidly again (as early in 2016 - when this led to international instability) and again encouraging Chinese to try to get money out - and generating aggressive official reactions  [1]
• China has been involved in a huge rate of offshore deal-making - to buy foreign companies. However such deals are increasingly failing (in an environment in which attempts have been made to get money out of China and its government has attempted to block this). Information about the deal-makers and government agencies that block them is not available. The situation is further complicated by links between deal-making companies and government. Government wants China to have same international influence in deal making as it does in economy - but external partners don't take proposals on simple trust [1]
• CLSA suggested that China's banks' bad debts are reaching crisis levels. Non-performing loans are seen to be 19% of bank assets - not the official 1.6% and global average of 4.5%. Despite this government is injecting massive new stimulus into economy as unemployment rises, manufacturing contracts, bonds default; GDP growth slows; and DFI falls in key sectors [1]
• Most of what China reports about its economy is meaningless - as its leaders prefer propaganda to facts and never publish anything that might cause alarm [1]
• China's debt problem can be seen to be a symptom of 'state capitalism' which does not present any immediate risk of a financial crisis - but will lead China into an economic trap unless policies are changed. However this view seems overly simplistic. [See outline of that suggestion and CPDS comments in China's Problem is Neo-Confucianism not Hypothetical 'State Capitalism']
• China needs to address its soaring debt levels and accelerate reforms to its financial system to avoid serious problems - according to IMF. Its outlook was uncertain because of rapidly rising credit, structural over-capacity an opaque / interconnected financial sector [1]
• China's banks have $1.7tr in losses (according to Societe General). 60% of capital of China's banks is at risk. And debt is expanding rapidly - rather than shrinking. China's non-financial debt rose 15.2% to $35tr (250% of GDP) in 2016. Problem is mainly confined to China's SOEs. SOE inefficiency is dragging down China's economic performance - but recognising even small part of SOE non-performing debt would overwhelm financial system. And SOEs still have preferred access to bank finance.  Technically-bankrupt companies still accessing finance is dragging down economic performance. There has been talk of reform - but abundant credit continues to be provided.  SOE debt restructuring would jeopardize 50% of banks capital. Attempts to restructure SOEs in 1990s pushed banks' NPLs to 30-50% of GDP. Government was slow to respond. They can't do this again - as recognition of banks' credit risk could overwhelm the system. Unlike 1990s restructure, doing so now won't be supported by very strong economic growth. A fast restructure could lead to economic hard landing - which threatened social stability. Government favour a gradual approach to restructure - which risks loss decade and policy uncertainty [1]
• China's looming debt crisis (which, as for Brexit, companies don't want to consider what they will do about it) is big issue. Companies are taking on new loans to cover overhead and operating costs. Debt-equity swaps and securitization of NPLs would be an option (as China did 15-20 years ago) - but would now be much harder. SOEs have liabilities of 115% of GDP. Government said that it had not used a 'strong stimulus' to maintain growth - but it had been 2/3 of GDP in year to April 2016. Warnings about China's debt from 'authoritative person' was believed to indicate a willingness to tolerate growth below 6.5% - but this may not be so, in which case even more stimulus would be needed - resulting in wastage / corruption. Indications of trouble emerged with rapid growth in capital needs for a 'bad bank' that had taken on some of China's debt mountain. [1]
• The numbers of loss-making enterprises in commodity sector is rising rapidly in China. Local governments want to keep them going because of potential adverse effects on employment. To overcome the problem structural reforms are needed in China as a matter of urgency. The recent rebound in commodity prices has been due to Chinese policy-makers again turning on the stimulus taps (to increase infrastructure / residential construction in the face of overcapacity) is likely to reverse in late 2016 [1]
• China not only has a very high debt / GDP ratio but this is now being increased by $1tr / quarter (ie about 25% of GDP) for speculative investment rather than for investment in real (ie not always used) infrastructure and property - see here
• Increasingly Chinese companies are taking on new debt to pay old debt - which ultimately could mean that debt is not being repaid - creating a Ponzi-like situation. The percentage to repay old debt was 8% in 2014, 44% in 2015 and 42% in 2016 [1]
• China may have attempted too early to shift from an  economic model based on investment in manufacturing to one based on domestic consumption. The shift lowered China's productivity growth. China's debt / GDP ratio is 280% - mostly due to manufacturing / industrial functions which now suffer overcapacity [1].
• Leading economists agree that China faces a debt crisis, there are no signs of policy renewal and recession (either sharp / calamitous or drawn out like Japan's) is almost inevitable by 2020 though not immediately. Debt has grown faster than GDP for years. And government has had to provide huge stimulus to maintain desired growth. Outstanding loans are now about 200% of GDP (double the 2008 figure). Total debt is about $35tr. The debt bubble (unproductive loans) is now past US 2007 subprime level. At current rates of expansion banks will find themselves unable to fund their assets safely. There is now widespread agreement about the dangers posed by China's corporate debt (which is still increasing rapidly). Until recently there had been disagreement about this because some presumed that China's regime would prove competent no matter what. President Xi seems to be driving policy - yet seeking to be able to shift the blame if problems arise. Mismanagement of stock market bubble and of exchange rate caused concern. Rating agencies are now downgrading China. CLSA suggests that China's debts have reached crisis levels - with NPLs now 19% of bank assets (not the 1.6% official figure and global 4.5% average). Most NPLs come from loss-making companies - yet these continue to receive funding at the same time that unemployment rises, manufacturing employment falls, there are bond defaults, foreign investment falls and property experiences declines. China's (mainly state-owned) banks would need to raise 15% more capital to cover bad debts. Shadow financing (off balance sheet lending by banks) has reached 59% of GDP. Some economists argue that Communist Party is incompatible with China's future. Despite talk of reform to give market grater role, little has changed and state sector is still favoured.  Government announced an intention to shift from exports / investment to consumption / services. But little has been achieved. Investment remains main growth driver (46% of GDP). There is a need to close / privatise worst SOEs - but Communist Party doesn't want to do so as this would reduce its ability to direct economic change. Change is needed to avoid 'Japan trap'. IMF warns that countries that experienced rapid debt growth like China had financial crisis. Xi is seen to be running a gigantic monetary bubble that has corrupted every aspect of economy. A massive proportion of the credit that has been given to companies can't be accounted for - and is believed to have been stolen. One industry leader has confessed to taking $20bn. many others are believed to have done likewise. Despite this, stimulus can't be turned off - as this would cause growth to collapse.  Unwinding is likely to start with banks becoming unable to get sufficient capital despite government funds' flow  [1]
• China's president (Xi) and Premier Li) have conflicting views on China's economy - specifically on reform of SOEs.  Xi called for stronger, better, bigger SOEs while Li emphasized slimming them down. This disunity is adding to uncertainties about proposed economic restructuring - which has been stuck for months [1] 
• China has major demographic problem - despite abolishing one child policy. There is a 24m surplus of men over women - because of preference for male children and abortion of females. History suggests that excess males can lead to rebellions to vent frustration. In relation to this it can also be noted that China's people are becoming more disillusioned with what is happening (noting increased strikes). They are also becoming more nationalistic - - and in this regard excess males could increase the risk of external aggression. China also faces problems in taking care of large numbers of seniors - eg because of poorly developed pension system. [1]
• China has been making progress towards cleaning up the bad debts in its financial system [1]
• China is pouring huge amounts of cash into buying Silicon Valley assets - just as Japan did in the 1980s. And like Japan at that time, China's corporate debts are very high [1]
• China's manufacturing industry that has been based on low cost labour will be under threat as robotics comes to dominate manufacturing [1]
• China is at risk of Japan-like 'liquidity trap' as monetary policy loses effect and economy approaches credit exhaustion - thus forcing a shift to Keynesian fiscal stimulus. PBOC officials have started calling for a fundamental change in strategy. They can't stop companies hoarding cash or halt slide in private investment. Growth of private investment has fallen to 2% pa - the lowest since GFC. Central bank is 'pushing on a string' - as funds are not flowing into real economy. A surge in public spending and a property boom is only masking the problem  [1] 
• China is at increased risk of falling into 'middle income trap'. Its government is trying to arrange an economic 'pivot' but is not committed to a real free market. China's economy has probably grown less than 5% this year as debt-fuelled, state investment led growth model ran out of steam and became counter-productive, China needs to change foundations of its economy - to reduce state role - to avoid what most other countries that have reached middle income status have experienced. Policy makers understand the problem - but the losses that resulted from loosening their grip on resources and capital created political difficulties.  Fiscal reform by local governments and attempts to create local capital markets have been poor.  SOE reform has not yet materialised. Instead of mixed ownership current reforms are creating stronger / better / bigger SOEs. Restructuring SOEs would require higher unemployment and more welfare spending. Financial system reform would leave government less direct financial control over credit growth, resource allocation and exchange rate - and a lower current growth rate [1]
•  Bad debts in China's banking system at 10 times greater than officially admitted - and rescue costs could be 1/3 of GDP in two years. NPLs are between 15-21% and are rising fast as China delays serious reforms. It would cost $2.1tr to fix this now - and government would carry most of loss. Banks have been taking losses off balance sheet into wealth management vehicles - with government collusion. The more debt grows the greater the risk to asset quality and liquidity shocks.  Defaults in China could lead other firms into distress because of mutual credit guarantees. The total damage would be much greater than 8% of GDP that was the cost of GFC bank rescues in US / UK - and would be like the failures in Ireland, Greece and Cyprus - but on  a much greater scale. Chinese state already has debts that are 55% of GDP following local government bail outs. China allowed a fresh bout of stimulus spending in early 2015 to counter risk of serious recession - and abandoned any pretense of serious reform. Credit reached 243% of GDP at the end of 2015 - double the 2008 levels. Curbs on property lending and much of the new credit flows into housing speculation - driving up prices 30-40% pa. As credit has grown faster it economic efficiency has fallen - and GDP growth has halved making it much harder for China to work off its debt load. China would be unable to repeat what was done to deal with financial crisis in 1990s - when roaring global boom reduced the burden and financial repression was used to reduce deposits at cost to savers. Interest rates have now been liberalised and China faces strains from shrinking workforce. The fact that major banks are instruments of Communist Party reduces the risk of a western-style banking crisis. What is more likely is something like Japan's lost decade of muddling through [1]
• China could have $2tr in bad debt - 10 times the official level [1]
• China has been seen as the biggest threat to global economy. Its economy is slowing more than official figures show. It is going through major political transition (eg related to anti-corruption campaigns and shift to consumer-driven economy). China has a debt problem - because of credit-fuelled growth - and such problems go on forever.  Its situation is like US before financial crash of 2008. [1]
• China has started allowing some badly indebted SOEs to fail [1]
• Markets believe that China's economy has stabilized - because of headline data. However close examination of other data suggests that it has gotten worse. Corporate borrowing has risen across the board while profits and cash flow fell. All that is still growing are old (investment driven) drivers of economy that government has been trying to wind down in favour of domestic consumption. Deteriorating corporate finances and a reversal of rebalancing are a high price to pay for maintaining growth. The government seems to be preparing for things to get worse - by allowing credit default swaps and allowing a SOE to prepare for bankruptcy  [1]
• many Chinese believe that China will 'rule the world' given its comeback from centuries of relative weakness and 'national humiliation'. And many non-Chinese seem to agree with them and expect a China-centric order will supplant a crumbling West. Martin Jacques suggested that China's economic transformation will provide a platform for unrivaled influence and an alternative path to modernity and a very different world order. In Australia there has been debate about whether Australia can accommodate China's rise without losing independent / sovereignty and the values of a liberal democracy. Former UK PM (David Cameron) seemed to accept the need to accept China as the world's new emperor from the East. Independently minded SE Asians seem powerless to resist China's military clout and economic / financial blandishments. The Philippines' president announced the end of joint naval patrols with US - because he believed that China now has the power and military superiority in the region. Should Australia get onto the Chinese train. This requires examining the assumption that China is on track to being dominant global power in 2030. People believe that assumption because everything in China is big (geography, reach, population, building, ambition) and China has been able to harmonise its hard and soft power assets. China's surge from under-developed backwater to emerging superpower has been impressive - and China aspires to lead now in everything without much concern for whether it plays by established rules in doing so. China supports Robert Mugabe (the Zambabwean dictaror) and puts cash into many other areas of Africa. It has thus become Africa's biggest trading partner. The Chinese military now operates everywhere. A supposedly civilian space facility was established recently with Argentina - which could have military implications. Soft power strategies have also been used effectively to reinforce China's image as a nation of standing and influence in world affairs - and heir apparent of declining US. The Dastyaria affair illustrated this in Australia. President Xi Jinping's new silk road (OBOR) project would position China as the centre of economic and geopolitical influence. Australia's federal government sees Australia as part of this - and links it to its plan for northern development. Given about $3UStr at China's disposal, the OBOR project might succeed and allow China to rule the world - but there are reasons to believe that this won't happen. China has economic problems - eg may be unable to maintain 6-7% growth rate / transition from export dependent to domestic demand driven economy. Debt is rising twice as fast as GDP growth. China's exposed banking sector might have to write off debts 4 times larger that US banks did in 2008. Many experts expect a China debt crisis. China's OBOR goals could be adversely affected by negative reactions to its South China Sea activities. China's international expansion (with about 5m Chinese national working internationally) could require funding to expand / protect that exceeds China's ability to support.  China also faces risks of imperial overstretch and hubris - given the rapid expansion of its influence. China also faces: (a) demographic challenges - given its aging population and the consequent end of its inexhaustible supply of cheap labour; and (b) potential domestic political instability. Xi has been seen to have broken post 1978 practices by a revival of ethno-nationalism and Mao's practice of rule by fear. Xi may thus only succeed in undermining China's political system - in much the same way that Mao did.  It is not unreasonable to assume that China has already peaked - and will continue as a leading developing nation for a couple of decades on the basis of its momentum but won't bypass the US or rule the world. There is a need to recognise that China's party state will use soft power to exaggerate its achievements, influence and power. This should not stop Australia having a constructive relationship with China - providing: (a) this does not conflict with core Australian values; (b) is accompanied by trade diversification to prevent over-reliance on China; (c) good relationships are emphasized with other countries in Asia. Until China's regime changes, there will be growing resistance to the notion of a China-centric world  [1]
• The shift of speculative investment in China from shares to property suggests that it is facing a bubble. However China was not included amongst the locations that face a property bubble in recent UBS report - because of the lack of reliable data. However the existence of a problem is demonstrated by the fact that the case for buying land in 10 major Chinese cities disappears unless property prices continue to increase - which is a classic sign of a bubble (ie buying on the basis of a 'greater fool' theory) [1]
• Recent data suggests that China is continuing to favour near term economic growth while ignoring concerns about mounting debts [1]  
• Those who believe that China is experiencing a bubble according to two major Chinese companies. Suggested problems are real - but are being addressed by Chinese authorities. The transparency of economic and fiscal information in China was said to equal that in the West. China's economy is highly dependent on the big four banks and the government seeks to ensure that they are safe. And rather than not being free, China's economy was seen to be highly competitive while the government encourages entrepreneurship  [1]
• Leyland Miller (China Beige Book founder) as asked about China's future. Latest data suggests that China is not rebalancing as growth was confined to old economy functions while services and retail weakened. It is thus wrong to believe that China is stable.  China has a property bubble - and belief that China will strengthen commodities demand could be wrong. Some official data is unreliable but there are data that indicate what is going on. However data quality is getting worse and government attempts to control it. Kylie Bass predicted a banking crisis in 2017. However the banking system is insolvent - so there is a 'crisis' already. However government control means that China is not vulnerable to the sort of crisis that can occur in US / Europe. China has a non-commercial banking system - and government can move money around the system at will and also draw on Forex reserves to deal with the most pressing problems. This is a formula for economic stagnation - but not for an immediate crisis [1]
• China has a debt problems - but it is not due to industrial sector or SOE but to the booming private property market. GFC showed that debt problems in one part of the world could have global effects. Since 2008 China has been responsible for 50% of borrowing globally. 2/3 of China's debts are accounted for by corporates.  Many commentators blame inefficient SOEs for China's problem. And though construction and excess industrial production are part of China's problem, the main problem arises from real estate and private developers. China's overall debt trajectory is unsustainable. To solve its problem China needs to reduce property speculation [1]
• China's government has introduced new measures (M&As, bankruptcies, debt / equity swaps; and debt securitisation)  to try to deal with its corporate debt mountain - but observers are not convinced this will work. The goal is to reduce corporate debt level soon - from current 169% of GDP. China's debt mountain, like the subprime problem that led to GFC, was a result of political miscalculation that economic analysts have trouble taking into account. Encouraging local governments to use venture capital to fund projects looks promising. S&Ps believes China's debts are unsustainably - and increasingly risky. Its banks should be strong enough over the next year or two - but any major problem that derailed a bank could have huge effect. China's extremely high level of state-driven investment is likely to continue - as China's regime needs to maintain credibility. The credit ratings of China's top 100 companies are deteriorating. Maintaining China's growth requires increasing stimulus. growth is being prioritized while reforms are ignored and there are growing problems in banks and state enterprises [1]
• most people are familiar with made in China products - but China intends to become a developed nation by mid century - and a focus on innovation is central to this. Progress is being made through a three stage process: (a) moving from copying to 'fit for purpose'; (b) moving from being world followers to world standard; and (c) from seeking new resources to new knowledge [1]
• China has many asset bubbles due to torrents of speculative money flowing to stocks / bonds / commodities. The most obvious bubble is housing - but prices for niche assets (eg caligraphy, antiques and art) as well as pig feed and a pipe making material have also surged. A lack of real economy investment options has caused investment in virtual economy (shares / bonds / commodities). There is concern that China's credit expansion has gone too far and is producing hazardous side effects. Senior officials have warned excessive credit could lead to systemic financial crises, recession and destruction of savings. The risks have global implications - eg in relation to iron ore.  Risks have grown because banks, companies and investment funds participate in speculation. Consumers have sunk savings into high return investment products - some of which have collapsed. Increases in apartment prices have been faster than anywhere else in the world.. China's total debt will rise to 260% of GDP - up from 154% in 2008. The debt binge started with a crisis related stimulus package. A stockmarket bubble burst in 2015 - and money then moved to bonds. Many investors repeatedly bought bonds by borrowing against those they already held. Deflating China's asset bubbles poses risks for China [1]
• China's GDP remains dominated by fixed investment - but growth is being experienced in the GDP's 'other' category. During the recent G20 meeting, China's president promised emphasis on supply side reform - and urged global leaders to join him in 'real action .. not talk'. China is using pledges made at the G20 to turn the 'China dream' into a 'China program' - as a step towards a 'China solution' to the world's problems.  The Communist Party flew global leaders to an October meeting - and participants praised China's efforts to promote international cooperation and global economic governance. They praised public goods provided by China to the global economy and global governance - eg through OBOR project to generate new demand by increasing effective supply. Despite this China is having trouble rebalancing its economy. It wants to shut down excess capacity in SOEs while using OBOR badged credit from state banks to export excess capacity to others. Central planning and the Party's determination to remain in control (which are at the heart of Xi's program) are incompatible with supply side reform. Fixed asset investment remains over 50% of GDP - but it used to be 70%. The 'other' category of China's GDP used to be 3-5% and is now 19% (including education, logistics, tourism, e-commerce, software. R&D, healthcare). Most growth is driven by the private sector. China's private-dominated sectors are providing investment options for brands from the rest of Asia to become more competitive with Western brands. The biggest concern is the rapid build up of debt - which has been staggering. However it is internally owned and concentrated in SOEs  [1]
• There is concern about a possible repeat of 2015's panic associated with questions about China's currency reserves - given simultaneous concerns about US elections and Fed rate tightening. Reserves fell by $100bn in October 2016 - 5 times greater than in September.   [1]
• 2017 will be decisive for China. Low cost exports have declined as a share of its economy. To maintain growth China's leaders have embraced monetary and fiscal stimulus which escalated outstanding debt to 250% of GDP. Corporate debt (the largest component) rose 60% to 16% of GDP. A nationwide debt crisis looms - given business defaults / bankruptcies / low industrial profits / poor return on investment / another likely real estate slowdown. China always depended heavily on fixed investment - and this has increased over past decade as low-cost exports and household consumption decline. Funding has been obtained from many sources - but mainly by increasing debt - and mainly from state owned banks financing SOEs. The latter account for 55% of debt though they only contribute 20% to GDP. After GFC China's supposedly temporary stimulus became start of long period of investment-led growth. By 2013 Beijing started cracking down on wasteful local spending.  This increased reliance on corporate debt - most of which is dependent on real-estate-linked construction. In 2014-15 the latter appeared to be headed for downturn - before being re-invigorated though still with a slow rate of actual construction. China's authorities recognise the risk - but the problems are huge and suggestions of 45% tariffs on exports to US will compound these problems  [1]
• Chinese demand for global property has become the world's biggest real estate frenzy. One estimate was that the amount spent in the first 6 months of 2016 was the same as in 2015. Money is getting out despite the Chinese government's efforts to stop it. Middle class Chinese buyers are following the lead of China's elite. [1]
• China is planning tighter restrictions on Chinese companies who want to invest offshore [1]
•  China wants to convert its store of $US reserves into foreign assets but is concerned that outflows could turn into a tsunami unless tightly controlled. Companies are investing offshore in search of better opportunities - because of tight competition from SOEs at home. Families are doing so because of concern about yuan devaluation. Families could get around restrictions on investment in foreign real estate - but those routes are now being blocked off [1]
• China's debt levels are the and of England's greatest concern about global stability. Debt / GDP ratio has risen 100% since 2008. bear record capital outflows in September 2016 quarter add to concerns [1]
• China's banks are disguising bad debts by turning them into securitized packages writing them down according to IMF. This parallels what was done in the US prior to sub-prime crisis [1]
• China's central bank has increased its efforts to drain cash from that county's financial system - to reduce excess borrowing and frothy markets. At the same time PBOC has been guiding state-owned banks to restrict short-term ;ending to other financial institutions. This has contributed to sell-off in domestic bond markets. This is all part of government's deleveraging campaign - designed to bring China's debt under control. The days of easy money are over. This is totally unexpected - and occurs at a time when banks need lots of cash which the PBOC would normally provide [1]
• When Marco Polo went to China he found that China was creating money out of paper. He did not know how risky that policy would be for the country that invented it. Many Chinese rulers have paid off spiraling debts by printing money - and encountered inflationary scourges. The Mongols and Mao's Communists seized power after after China had destroyed the value of its paper currency. China is now struggling with its latest bout of monetary excess. China's problem is not inflation - yet. But it has created the biggest pool of domestic liquidity in history to help stimulate its economy and finance a crushing debt burden. Between 2007 and 2015 China created 63% ($16tr) of world's money supply. China's problem is that debts are increasing almost as fast as money is generated to service them. China will have a problem when it ceases creating money fast enough to service debts that are now 250% of GDP. Officials fear that Chinese people believe that they would be better off getting their money out of China - as capital flight would sap the liquidity needed to keep China's bubble from bursting. China is seeking to control outbound capital flows.  China's stock of foreign reserves fell from $4tr in early 2014 to $3.1tr in October 2016 [1]
• China has made itself liable to bubbles (currently in commodity markets) because it has created a great pile of money that has to go somewhere [1]
• China's debt problem is likely to be worse than most statistics indicate - but this may not matter because the primary goal of its financial system is not to make money but to follow political instructions [1]
• China's trade (especially imports) have fallen significantly in March and April 2016 - indicating the government efforts to stimulate the economy are not working [1]
•  China's debt is extreme. Its credit-to-GDP gap (a BIS measure) is 30% -  the highest of any country back to 1995and three times the level BIS regards as unsustainable. The government plans debt-for-equity swaps but this is only a temporary measure (eg because banks would not want equity stake in problem companies). China needs real market reform. Companies need to be restructures, hard budget constraints imposed and losses revealed. SOEs are kept afloat for political reasons. Equity swaps would need to come with control to reform the problem companies. China's debt is now about 300% of GDP and 25% of companies don't earn enough to pay interest on their debt. The IMF has suggested a reform strategy - though it would be difficult politically and constrain growth.  [1]
• After 25 years of growth Australia's bank balance sheets are good. There are however issues related to household debt (187% of GDP) and heavy investment in apartments. While Australia is likely to see reduced asset quality - rather than a disaster this may not be true for China. It has 75% of Asian NPLs. This implies pressure on earnings / volatility - or at worst a financial crisis - if there were a liquidity event such as Lehman Bros in US. China under-reports NPLs - and the real figure could be 15-20% of gross loans (ie about the same level as the Asian Financial crisis in late 1970s). ANZ noted that this had happened before and ,ost NPLs are to SOEs - so it is basically just government money going round and round. Growth is what is needed to solve this problem. UBS suggests that most NPLs come from private sector in manufacturing / wholesale / retail and SMEs. The most overcapacity sectors (mining / construction / real estate) are yet to contribute much to NPLs. Considerable progress has been made in dealing with the problem - as major banks are well capitalized to deal with a large number of NPLs. However if credit continues to rise 2-3 times faster than GDP, the problem will grow faster than the ability to deal with it. [1]
• China's growth could rise in 2017 - given a large fiscal / monetary stimulus. This could open up capital markets, prompt service sector growth and achieve transition to consumption-led economy. China's future consumer spending will be more than that in Europe. It has become much easier to operate foreign banks in China over the past two years [1]

• Someone powerful in China has declared war on debt and the fantasy of perpetual stimulus - and commanded an end to reliance on credit. China needs to take its punishment (with bankruptcies) before matters spiral out of control. China's debt is $30tr - and has increased since 2007 by more than total liabilities of US, Japanese, German and Indian commercial banks combined. SOE debts alone are 115% of GDP - and 20% may require restructuring. Leverage rose by 50% of GDP in Japan before bubble burst in 1990, in Korea before 1998 Asian crisis and in US before subprime crisis. In China debt has risen by 120-140%. Given China's role in commodity markets any problem will have global implications. Proposals now for reform of China's SOEs have parallels with reform proposals under Qing Dynasty and Kuomintang - where the reforms failed and stagnation resulted. China's credit cycle has now accelerated into epic blow off - and is reminiscent of 2015 stockmarket boom and bust. Those who expected a China bust in 2015 may see this in 2016. 100 firms have cancelled or delayed bond issues in April 2016 due to widening credit spreads. 10 companies defaulted in 2016 - and expected government support was missing. [1]
• Chinese banks are classifying loans as investments in order to be able to continue providing credit to maintain economic growth. This makes it easier to put off hving to acknowledge bad debts [1]
•  PBOC foreign reserves fell $69bn (to $3.1tr) in November 2016 - a total fall of $500bn in 2016. Government has sought to reduce this by clamping down on foreign investment and gold purchases. This has deep roots and could affect China's ability of China to buy Australian products. The story started with devaluation of yuan in August 2015 - to boost exports and growth. This triggered a huge capital outflow. During boom years investing in China had offered good returns - and China's shadow banking system grew and flourished. It made sense to borrow at near zero rates in US to invest in China - until China devalued. Now yuan denominated assets are being sold to repay old loans before it is too late. This further devalues yuan and creates feedback loop. Before 2015 PBoC bought $US from Chinese companies earned from exports and printed yuan to do so - thus providing credit for huge expansion in China.  Now it is selling its reserves to prop up yuan - which increases the cost of capital and puts further pressure on foreign exchange reserves. At the same time government encouraged Chinese firms to 'go global' - and foreign investment in China fell as labour and other costs rose. This is part of overall strategy of internationalisation - while moving away from export dependence to dependence on services / domestic consumption.  This domestic consumption has not occurred to the extent expected.  A crackdown on luxury consumption (seen as corruption by Communist Party officials) has further detracted from domestic consumption. It is hard to prevent movement of yuan out of China through offshore yuan market -especially as China pushes for yuan to be used as international currency. All this means that Australia will need to engage more with China's economy - not just sell 'stuff' to China.  Australia should also be more willing to transfer technologies to China while China arranges better protection of intellectual property [1]
• A slowdown in China's property market could overwhelm lenders. China's banks are masking $2tr of loans as investments (ie about 20% of their existing loan portfolio).  Attention is increasingly given to the levels of China's debts. Two years ago shadow banking was studied - now it emerges in a different form. Off-balance sheet vehicles are a risk for China if liquidity dries up - eg if there is a property slowdown. Classifying loans as investments (especially to property developers) means that banks are not holding capital against potential losses. China's officials are aware of the problem. But lending by any means necessary is mandated by top level directives that China must maintain 6% pa growth - which requires state-owned banks to support growth by providing credit to struggling businesses despite the risks. China's official debt levels (250% of GDP) are only part of the story [1]
• Middle class Chinese investors are providing funds for property development in the US - as technology (smartphone apps and online lending platforms) makes this easier while bypassing banks and other traditional funding sources. This adds to money pouring in and boosting property prices thus raising local concerns about affordability. This digital flow of wealth reflects Chinese people's desire to diversify in times of worries about a slowing economy and China political / social challenges. Though China restricts the flow of money, these new technologies make it harder to do so. New financial platforms have really good lawyers. Money can be invested in yuan and repaid in $US - thus effectively moving money offshore which is otherwise difficult. These new technologies have lept ahead of regulators. China cracked down on money flowing abroad after investors started shifting funds out at an alarming rate contributing to a sharp fall in foreign exchange reserves. New steps were taken requiring scrutiny of transfers over $US5m. Investing channels have not yet been affected. Mobile apps (eg Niuniu, Jimbox and Tioger Stocks) allow offshore purchases / sales of foreign stocks from smart phone. Online portals allow money to be pooled to buy real estate.  Chinese investors want wealth preservation and peace of mind the same as others. China limits individual transfers of $50,000 - but online portals make transactions on behalf of individual investors to bypass those limits [1]   
•  Chinese yuan has been in steady controlled decline since start of 2014 - which has drawn criticism from Donald Trump. However China's currency is still over-valued in trade weighted terms. As $US strengthens because of rising Fed interest rates, the yuan will weaken as money pours out of China. Capital outflows are increasing and the yuan is viewed bearishly. They may have risen from $70bn in September 2016 to $80bn in November.  China's foreign reserves are $3.3tr - and its net reserves are $1.8tr [1]
• Chinese bond yields soared (and prices fell) and authorities halted trading as the global bond market sell-off worsened after Fed signaled faster increases in interest rates [1]
• While US sharemarkets have risen, China's has been falling despite the close US/ China linkage. China is being forced to tighten. Its $9tr bond market is seizing up. 40 companies have cancelled bond issuance this month while 24 large companies are in default negotiations. China had a 4% of GDP fiscal deficit - which stoked a housing bubble. It was like China's post-Lehman blitz - but much less effective because the efficiency of credit has collapsed. Despite severe capital controls, net currency outflow from China has accelerated - eg to perhaps $15bn in November 3 times the level in October. Foreign investment by Chinese companies is on hold. others are having trouble getting money out of China. Higher bond yields in US while yuan faces devaluation have attracted Chinese money. China's central bank slowed the yuan slide by burning through $US1tr of foreign reserves. It's reserves are $3tr just above the $$2.8tr needed by a country with a managed exchange rate. China's system is more deformed tahn it was under Mao or Japan was at end of Nikkei bubble in late 1980s. PBOC is in a bind. It can't raise interest rates to slow capital outflows because of stresses in banking system. Its recent tap on brakes led to  liquidity crunch and shockwaves in bond market. Global markets are too complacent about the risks of financial turmoil in China in 2017. Continuing to defend yuan value which drove reserves down to $US2tr could cause market panic. Letting yuan float to find its own level is seen to be needed. Corporate debt in China is larger than that in US - and a lot of bad loans are just being rolled over. Bad debts may be 10x official figures and result on losses 30% of GDP [1]
• There has been a massive (ie up to 43% pa) rise in house prices in major Chinese cities - because of urbanization and rising incomes. 8 out of the top 10 cities worldwide in terms of house price growth are in China [1]
•  China's debt-fuelled property boom and potential bust will be main issue facing China's government in 2017. Rapid rises in land sales / auction prices / debts need attention [1]
• China's regulators need to wean the economy off cheap borrowing and rising credit levels - which will be anything but easy because of the complexities involved. China also needs keep its currency stable to prevent capital flight [1]
• China's capital outflow will be a major 2017 issue as it will contract domestic liquidity. China boosted domestic liquidity in early 2016 - but capital leaked out at an accelerating rate. FX reserves are falling at an accelerating rate. Authorities are trying to stop this. This is important as wealth in China is in few hands so decisions by a few people can have big effects. China's credit / GDP ratio has been rising very fast (ie well above long term trend) and it is not clear how long this can continue [1]

Continued below for 2017 when the risks associated with China's rapidly rising debt and falling foreign exchange reserves seemed to be being officially recognised

Throughout  2016 the viability of the Chinese 'system' itself (which had long seemed to be at risk as suggested in 2004 and 2009) continued to be questioned (eg see Understanding China's Current Regime (2015) and Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures, 2016). [^ >]

Moreover:

• the rule of China's Communist Party was seen to be at risk because the crackdown that President Xi had put in place had made all Chinese people fearful [1];
• China's autocratic political system was seen to be in danger of collapse in the much same way that this happened in the USSR

China's National People's Congress can be seen as either sign of strength or a theatrical veneer. China's political system is badly broken. President Xi's crackdown on corruption is supposed to end this problem. But his despotism is severely stressing China. It is hard to predict the end of authoritarian regimes. The endgame has however started. This is indicated by: (a) China's economic elites are poised to flee; (b) political repression has been severely increased in recent years; (c) loyalists are only going through the motions in defending the system - without conviction; (d) the corruption that pervades China's society / military also pervades the whole society. The problem is rooted in China's system - and can't be eliminated by an anti-corruption campaign; and (e) China's economy is stuck in a series of traps - because necessary reforms challenge entrenched interests [1].

• There has long been debate about the relevance of Singapore's model of authoritarian capitalism for China [1]
• Though the 'Umbrella Revolution' by students against Chinese authoritarianism had failed in Hong Kong, organized protest action continues and is highly disruptive of the relationship between mainland China and Hong Kong [1]
• The 'rule of law' that China's leaders had espoused as a critical to the country's future was seen as not necessarily consistent with the way China was actually ruled.

The campaign to entrench the rule of law in China is now recognised, but many have trouble understanding its implications. Before Xi's appointment, his predecessors had lost control of political power (noting Bo Xilai' efforts to create his own kingdom in Chongqing). Xi's reform commitment (and power) has given China more certainty - but it is not clear where it is headed. Problems had included: power of SOEs; business / government collusion - which exacerbated corruption; and inflated real estate prices. Xi's reform proposals included a rule of law. These attempts are real. However in China 'rule of law' is seen as subservient to rule of one-party state. The Party is seen to be leading the rejuvenation of Chinese system. Its mandate is to do whatever is needed to transform economy / society and the drive progress. The Party alone is seen to have the correct intellectual approach and the ability to make 'rational' decisions. The 'rule of law' seeks to strengthen control over party-state apparatus. Some support this, yet others note its inconsistencies. [1]

The arrest of Crown Resort employees shows the problems that foreign businesses can have in China where the rule of law down not apply. It is impossible to rely on law because in China the government has the final say [1]

18 staff of Crown Casino's were arrested in China. China has a lot of laws - one of which stipulates that one can't advertise gambling in China - and Crown staff advertised gambling in Australia for 'whales' / high rollers as an alternative to Macao. This would have upset China's 'mafia'. The Chinese government enforces law arbitrarily - and those charged will not receive a fair trial  [1] 

• it was argued that the position of China's leadership was too weak for them to risk conflict with the US (a view which in the present writer's opinion is probably simplistic and strategically-dangerous if taken at face value - see Understanding China's Current Regime below). 

Outline: Bao Tong was director of political reform in Communist Party's central committee. He was policy secretary under Zhao Ziyang.  The Communist Party once had a liberal wing. Young Chinese believed in reform slogans and opening up. Bao paid for his beliefs. He was arrested in 1989. Zhao was purged. Days later Deng Xiaoping sent tanks to Tiananmen Square. Now while dictatorial princelings rule China, Bao helps us understand what happened. China and US have become rivals as China seeks to expand power beyond territorial waters. China is on US's policy agenda in a way that it has not been for a generation. US's problem is: What is it dealing with (eg Germany in 1900). Or is China an era-of-globalization power whose rise won't bring war. Policy-makers should read Bao's words to understand. China's Communist Revolution and Mao Zedong's victory broke an old civilization, killed its gentry and overthrew the social order. China had been the greatest trade market. Mao abolished capitalism. Bao argues that Mao turned private property into state property. Deng Xiaoping transferred national assets to party elites. China's 'princelings' now control much of China's wealth. The biggest princeling is President Xi Jinping - who no one knows much about. From 2012 he became the most powerful leader since Mao. He unleashed a campaign against corruption - which sidelined rivals and frightened the bureaucracy. Bao says that graft is built into the system. When Deng began reforms he said some would become rich first. This was taken as a sign of free enterprise. But it really meant that party members / families / cronies would become rich.  The US faces a regime that aims to keep power in the hands of its leading clans and reform the economy while retaining state supremacy. Such regimes would not want war and their tyranny is an instrument of self-preservation. Throughout China's history factions divided. Nationalism is a tiger that China rides at its peril. The Party's endgame may be near. Bao has written about this for the US administration [1] 

• Intelligence agencies have believed that China needs 7%pa growth for social stability. While yuan devaluation and economic slowing is not necessarily a crisis for China - but China must adjust because of non-performing loans, overcapacity, exhaustion of old model. Since Tiananmen Square massacre China has had to create a new political dispensation. The problem was grass-roots resentment of insider privilege. China's leaders responded by emphasizing nationalism over communism (and also emphasizing ongoing growth). But (as Bo Xilia case showed) concerns about social / regional inequality remain. [1];
• China seemed to face the risk of another anti-Confucian cultural revolution because the neo-Confucian methods that has been adopted to achieve its economic miracle were based on the social inequality that Mao's cultural revolution had sought to eliminate;
• China's authoritarian political system was seen to have disrupted its economic reform agenda - concerning which CPDS comments are in Viewing China's Likely Breakdown Through the Lens of Traditional East Asian Cultures 

An authority on China's long-term reform efforts (Barry Naughton) suggests that the 'train wreck' of the Shanghai Stock Exchange shows how long term reform plans have been derailed by domineering style of China's president. Policy moves have been incompetent to serve his political agendas. Failure occurred in local government reform, SOE reform and the fiasco of cheer-leading an over-heated share-market and then injecting huge amounts to compensate for crash. This shows problems in how China's economic 'engine' works. Professor Naughton supported the Third Plenum reform program in 2013. But this was set aside as propaganda fuelled share-market's huge rise. The China Dream was seen as being achieved instantly. Then in July 2015 extreme measures needed to be taken to arrest the crash. Image of reform-oriented president has been replaced by an authoritarian leader who seeks to control the entire policy agenda - which is impossible. China's current economic dynamism and policy-making dysfunction is the opposite of what existed in early 1990s. China's 'miracle growth' phase is over. Healthy growth is unlikely for 5 years [1] 

• While the decline of China's share-market is unimportant, what is important is that China's leaders face massive challenges in shifting to a consumption driven economy and found it hard to deal with the mere bursting of a stock-market bubble.

China's share-market is a mere 'casino'. It is thus surprising that the government devoted huge resources to unsuccessfully trying to stop a bubble collapsing. It must have been driven to do so by concern about economy. China's actions in relation to devaluation are also strange - as it could imply a desire to return to export-based growth - which is unlikely. The real concern is whether China's authorities can achieve the shift from investment-led economy to consumption driven one while sustaining aggregate demand. Without the latter growth would fall and economic / political stability be lost. China is investing something like 44% of GDP yet achieving only about 5% growth - which suggests very low / negative investment returns. If wasteful investment were cut demand would collapse - and this seems to be what is most worrying China's authorities. There is nothing new about demand deficiency - as this started when GFC devastated demand for China's exports - and required China to embark on its own credit-fuelled investment boom. This occurred just as the potential return from that investment declined.  China thus faces three major problems - cleaning up debts, transitioning from investment-led to consumption-led growth and maintaining demand while doing so. Recent events suggest that China's authorities have not yet worked out how to do this - while their experiments over the past 7 years have probably made the situation worse [1]]

• China's president is facing fierce opposition to his policies - according the Communist Party's flagship newspaper. This arose at annual meeting of Party grandees. The useful statements about agreement were replaced by silence this year. Journalists believe that something went wrong for Xi Jinping - related to growing unease about China's economic management. The People's Daily criticised retired cadres for seeking to exert behind the scenes influence (eg former presidents, Communist Youth League and China's Prime Minister). Xi's reforms have met immense difficulties (eg bureaucratic inertia, greed, resistance by vested interests in SOE). There seems to be fear and loathing of Xi and concern that he is turning into another Mao who might never give up power. [1]
• China's government is losing control (according to German economic adviser) - and this poses risks for Germany and Europe. 40% of German economy is exported - with 10% of this going to China [1]
• Many analysts have expected a soft landing by China after 35 years of rapid growth - yet there is no sign of this. China has to shift from an economy based on investment to one based on consumption. In trying to do this it is clear that Communist Party wants to remain in control of economy. Instead of liberalization, the government is trying to fix the economy with a stick rather than a carrot [1]
• the dominance of the state sector in China has been seen as a major source of its current economic predicament

China's politics had been seen as economic virtue - ie the idea that authoritarian leaders could easily identify / fix problems. However it is now obvious that this is not so and the country has problems - both a growth rate much below official numbers and concern about the viability of its authoritarian model. In the 1980s and 1990s China advanced because policies increased domestic private sector's ability to thrive - but since then state sector has become increasingly dominant. A property bubble emerged as a government-driven response to GFC which had devastated China's advanced economy exports. State-owned banks were forced to lend mainly to SOEs to build more things to get headline growth - thus creating ghost cities. From 2008 to 2014 there was a $20tr increase in credit to economy. With excess capital around, it flooded into stock market. These fixes are being applied to enhance the dominant state sector at the expense of households and individuals - and this has just been making things worse. The repayment of $trs of local government debt wastefully incurred by their SOEs has been delayed - because state-owned financial institutions and other SOEs have been forced to buy it.  While liberal-democratic economies have their problems, China problems are worse. A radical transfer of wealth away from SOEs to the rest of the economy is needed [1]

• the risk of political instability seems to be a 'black swan' event that could disrupt global oil markets. Most observers associate China's risks with its economy - but the biggest risk could be its politics. The political environment has been deteriorating rapidly. Many see China in terms of Deng's market-liberalization reforms. This is being replaced by restless / unhappy country. Earning money has been replaced by a desire to make others bow down to China's superiority. Power, not money, is the currency of the realm. Foreign businesses are being pressured. NGOs are being directly supervised. Christian churches are being demolished. China's president does not see economics as a priority. China's main emphasis has been on militarization of South China sea - which only makes sense in terms of power politics. Continuing this will result in reduced incentive to invest in / trade with China. If China's President Xi wants to be the new Mao, then China's economy will perform as under Mao [1].
• there is now little / no confidence in China's ability to manage its debt crisis. This has been highlighted by dispute between China's top leaders (its President and Premier) over who is to blame for fruitless spending of 260% of GDP. State Council (and thus Premier) was criticized by an 'authoritative figure' (Xi) for keeping bank loans high and propping up share prices. The tension does not only reflect problems with policies - but also the structures that Xi has set up to increase his control [1]
• China has economic problems that could lead to political instability - because there is no political outlet for dissatisfaction. For 40 years the US has sought improved relationships with China - despite some frictions. This could now be different because China has become much more repressive. There has long been support for China's economic emergence - on the basis that a richer China is better than a poor one. The assumption was that China would change as it became richer. Until 2010 China became freerer as it became richer - but this is no longer so. This is illustrated by: (a) censorship of communications; (b) repression of civil society; (c) extension of China territorial borders; (d) the need to suppress corruption - which has been indistinguishable from a political purge; (e) warnings about foreigners and foreign companies; and (f) military tensions with neighbours. These trends started before Xi Jinping became president. - as the GFC was seen as a sign of a change in global power so China's moment would come. The more uncertain Xi feels the stronger he tries to act. China is challanging the US in many ways - and this could get worse. And the limits that are being placed on academic / scientific / commercial / cultural achievements by cutting itself off from the world are adversely affecting China's people. There is concern that there will have to be conflict between US and China as both will play on worst fears of the other. US leaders should not choose confrontation with China - but would emphasise collaboration. Many observers have suggested options if China goes 'bad' [1]
• A significant populist movement has developed in China that rejects official 'economy first' priorities and supports Mao's egalitarian ideas

UK and US have empowered populists. China could be exposed to similar backlash which will test national leadership. President Xi's ability to manage rising socio-economic pressure is uncertain. Cynicism about China's 'economy first' policies have given rise to New-Left / neo-Maoism that supports Mao's egalitarian ideas. Its emphasis is on using state power to redress injustice and negative effects of privatization / marketisation and globalization. China is seen to benefit from globalization - but there is widening socio-economic inequality and skepticism about free trade and open markets. Some expect China to overtake the US as world's largest economy - yet many still live in poverty or on very low incomes. Similar problems have led to reactions at the ballot box. China's New Left dates back to early 2000s when intellectuals became concerned about economic inequalities and social polarisation. It remains underground but is very popular with students, peasants and workers.  Many are questioning the government's pro-growth programs of last decade - and Xi administration seems to be listening [1]

• China's leaders will test the promise of rapid economic growth that has held the country together because it has been recognised to be dangerous to do so through rapid increases in national debts (see below)

^

However, despite the problems China was experiencing as a consequence of the neo-Confucian methods that the Chinese state had put in place in the late 1970s to accelerate China's economic advancement, Confucianism was increasingly promoted as a national religion - presumably in order to promote national unity in the face of expected social and political stresses. See further comments in Promoting Confucianism in China

In early 2016 it was argued that China was positioning itself as the centre of an international economic system that could dominate the world. Very large Chinese investments were being directed along the One Belt One Road route. The world economy was seen to be being driven by China's urbanisation, population growth and consumerism [1]

China's president (Xi Jinping) was seen to be seeking to have himself installed as leader-for-life in China so that he could remake the political landscape in China - which contrasted with the Communist Party's collective leadership in the post-Mao era [1]

[CPDS Comment:  To continue with state organized economy China probably needs to adapt to be more like Japan - ie  a virtual 'whole of society bureaucracy' under a great leader / (divine?) Emperor. China's presidents have been accorded the 'mantle of heaven' that was the authority base of China's emperors.  Perhaps President Xi Jinping would like that role for life. He has certainly been advocating Confucianism as the moral foundation of his regime and China]

In late 2016 Xi Jinping's status was upgraded to that of 'core leader' by China's Communist Party [1]

Attention was drawn to the extent and character of corruption in China, and the political motives that can be behind accusations of corruption (see CPDS Comment in Global Implications of Corruption in China).

There has been significant suspicion about the wealth of business people, investors and companies from China (eg in terms of tax evasion, corruption, stolen money, illegitimate / illegal businesses). However from a Chinese viewpoint, corruption looks different. The government's anti-corruption program is just as notorious. Diversion of state resources to private hands is of concern in China. There is no developed rule of law in China. Those (often officials) who have taken available state resources to generate wealth for themselves and China have been encouraged to do so. Many of the new wealthy have become so by exploiting housing allocations.  Taking state resources to generate economic activity was viewed positively - and doing so was not seen as corruption or tax-avoidance. Tight definitions of legitimacy have had little to do with China's past / current reality. A large part of China's economic transformation has been achieved by those who violated restrictive laws. Accusations of corruption can be part of a politically-motivated campaign. China's approach to this creates problems for other countries that wish to attract Chinese capital and are concerned if it is not legitimate  [1]

Attempts to suppress corruption have arguably also suppressed the initiative required for the development of China's economy - given the dominant role that local officials have played in stimulating / organising economic initiative while simultaneously profiting personally.

In China economic development and corruption go hand in hand. Local leaders seek out opportunities, exercise power and profit themselves in the process. President Xi has an impossible tasks in keeping economy humming under state domination while trying to eliminate corruption. Anti-corruption program dampened demand for luxury goods. It also forced officials to become highly risk-averse. The current environment does not tolerate mavericks. All policy innovations require risk - which can be unpopular and generate reactions including allegations of corruption. Now China's local officials sit on their hands - and China is becoming increasingly centralized.  In democratic countries bureaucrats are portrayed as lazy and risk averse - this is now becoming true in China also. IN US the market economy continues to buzz on its own - because private citizens are the main actors. In China, while there is a sizeable private sector state officials have usually played lead role in the economy. When bureaucratic initiative is suppressed development is adversely affected. President Xi wants to have both state control over economy and strict adherence to rules. China needs to place more realistic demands on its bureaucracy  [1] 

In late 2016 it was argued that President Xi's rise to 'core' leader status in China would allow him to succeed in purging the corrupting influence of the political faction established by a former leader of the CCP (Jiang Zemin). This would both increase stability in China and aid its economic development - because corrupt officials had both harmed the state and public welfare by stealing from the people. [1]

China's economy is facing a severe crisis - due to falling growth, rising unemployment, real estate bubbles, troubles in manufacturing and capital flight.  This was seen to have multiple causes. After the Cultural Revolution the CCP had forced through economic reforms to survive - and liberalizing reforms allowed Chinese people to create a 'miracle economy'.  However after 30 years that model was no longer viable - while continued economic growth is vital to maintaining CCP's legitimacy. Most of the problems relate to the influence of Jiang Zemin faction - which Xi has been purging (eg the financial system meltdown associated with sharemarket crashes). When Jiang Zemin took control there was no ideology or limit to its conduct. Corruption and a conspiracy of power and profit resulted. Clean officials were purged (eg Huang Jinguo). Corruption spread to the military, judiciary, health care, education, sports, media, SOE's, etc. China's economy was in the hands of interest groups that coalesced around Jiang's rule. In recent years corrupt officials have sought to escape from China with their families and stolen assets. The system of official theft and corruption Jiang created came as China was going though a process of privatization and economic transformation. Economic reform allowed theft to be concealed. This prevented China becoming something like a normal country via its reforms - and the economic and social foundations that enable order were undermined. As the moral turpitude of China's ruling class became clear any notion of fairness became remote for most Chinese people. Economics and morality are interlinked - and where morality is broken embezzlement, corruption, plunder and everyone for themselves results.  The Communist Party was digging its own grave. Purging corruption will enable: (a) stolen wealth to be returned to the people; (b) restoring proper economic order and trust; (c) allowing a workable system of government. One of Jiang's goals had been to persecute Falun Gong - and history shows that persecuting religions results in punishment. History also says that a change of dynasty is likely when many officials are corrupt. President Xi is distancing himself from CCP's historical crimes and from persecution of Falun Gong. Xi will abandon the CCP and allow China to make a peaceful transition to a non-communist future

[CPDS Comment: This has the 'feel' of propaganda - perhaps from a Falun Gong perspective. Other views of Jiang Zemin say nothing of suspected corruption [1, 2]. The above account acknowledges China's massive problems in late 2016 and blames them on a former regime rather than on features that that regime share with Xi Jinping's regime. On the other hand it is suggesting a process of cooption / theft of economic assets as the latter were privatized somewhat like Russia experienced on the collapse of Communism. This seems to be what happened in China - but what is not certain is who, if anyone, was at the core of the process]

In early 2017,it was suggested that:

•   China's move towards liberalization and 'opening up' to the world might be being reversed.

Under Clinton administration US policy towards China shifted to supporting rather than containing China in early 1990s because it was believed that it could be a stablizing force. But now there is tremendous tension in Hong Kong because of end of one China two-systems policy. Western observers tend to believe that China's system is likely to open up and be more like Hong Kong. Many assume that China will join the world and become the leading economy. China's anti-corruption program was needed. In early 21st century an influential Chinese academic concluded that democracy would be chaotic. China now wants to join global economy but not be democratic. Capital flight is another issue.  Wealth inequality in China is also giving rise to widespread discontent. Human rights are being increasingly violated. Darker view of China has gotten attention over last year. Question is whether China is going 'bad' (increasing crackdown / closing up). Previous Chinese presidents had supported constructive engagement / opening up. The West might now confront a weakening / closing China [1]

• surveys in Beijing showed that people (especially the young) were becoming less nationalistic (ie less enthusiastic about the way their country was being run relative to others) (see CPDS Comment in Declining Enthusiasm For China's System is Hardly Surpising).

 Increasing nationalism, especially amongst the young, has been presumed to be driving China's assertive foreign policies. Asia Pacific countries are being advised to either accommodate or Challenge Asia's rise on this basis. But surveys show declining nationalism since 2009 - especially amongst the young. Alastair Johnston (Harvard) says that China's coercive diplomacy in the South China Sea is being seen to reflect rising nationalism as a reaction to US-dominated liberal international order. Survey responses to question about whether China was the best country ever peaked in 2009 - and expressions of enmity towards Japan and US slowed down or started falling in 2009. China's 1990s' generation was more skeptical of China's government than their predecessors. Beijing's population has become better educated and been most exposed to economic and cultural effects of globalization. Some suggest that the effect of hard-core nationalists amongst political elites could be what is most influencing foreign policy [1]

•  China is now embroiled in an internal political struggle around the efforts of President Xi to make himself the most powerful leader since Mao Zedong

After excesses of Mao era, China developed a new model of collective leadership under Deng Xiaoping in early 1980s. It is now embroiled in internal political struggle around President XI's efforts to make himself as powerful as Mao. Deng was never president - but he created presidential system under which president was seen as paramount leader and to have 'mandate of heaven' - a quasi religious concept that bestowed legitimacy on China's emperors for 3000 years. The new system had a single leader chosen by consensus amongst Central Committee of Communist Party. Each leader was elected (in rigged process) to 5 year term and was allowed to serve a second term. At start of second term he would nominate two potential successors who would jockey for position during the second 5 year term. President Xi is certain to be elected for second 5 year term in March 2018 - but has not nominated potential successors. Some fear he wants to get a third term. XI ran an 'anti-corruption' campaign that resulted in the arrest of two of his most powerful rivals (Bo Xilai and Zhou Yongkang). XI could lose 'mandate of heaven' if he seeks a third term - or at the very least make policy responses hard to determine. China suffers internal contradictions to its global economic ambitions (internet censorships stifles exchange of ideas; one-child policy in the early 1980s - has resulted in large pool of unattached men ripe for anti-social behaviours). There is a risk of a breakdown in China's social order [1]

• China's economy and everything else is now subordinate to politics under China's President (Xi Jinping). It is wrong to see China as still a communist state. Reference to boosting the role of the market actually meant creating a structure in which private companies, NGOs and other organisations carry out the functions of government while being controlled by party committees.

 Main message from latest work report by China's premier (Li Keqiang) is that communist party is intensifying its control over the economy and all other spheres of life - and that President Xi Jinping is at the core of everything. Instead of speaking about the work of the government he heads, Li spoke of the role of the party in setting national directions. Xi could remain in power for another decade. Economic management is now subordinate to politics. China would continue to use the 'China dream' (Xi's first great motto) and core socialist values to build consensus. James Packer recently suggested that corporate leaders, public servants and MPs are wrong in still viewing China as a communist state. Xi's dream is starting to come into focus. Li spoke of enabling the market to play the decisive role in resource allocation. Three years ago this was viewed positively as indicating rapid reform - related to privatizing and pricing. But what Xi has in mind is a structure where private companies, NGOs and other organisations carry out functions previously performed by state bodies. These 'market' bodies would be guided by the party committees that they now have to have at their heart - and would be the chief agencies of party policies allowing the government to be stripped back. New credit in China now generates under 20% of what it did a decade ago. Credit in financial sector now represents 25% of banks total assets - double that a decade ago - prompting fears of financial bubble. Moody's was concerned that Li's report said nothing about implementable economic policies. 70% of the profits Chinese listed companies come from their investments (mainly in real estate) - not from main businesses. This highlights the challenge of reforming China's economy [1]

• China's foreign exchange reserves rose marginally ($7bn) in February 2017 - where a significant fall ($30bn) had been expected. This seems to reflect the fact that the PBOC ceased selling reserves to defend yuan value and instead started buying them. This could make China vulnerable to Trump administration charge that it is manipulating its currency to boost competitiveness [1]. At the same time the PBOC stated that China's gold reserves rose from $71bn to $74bn. China's import of gold from Switzerland had reportedly been 158 tonnes in December 2016 up from 38 tonnes in November. China started increasing its gold reserves in 2014. Official figures suggested that it held 1678 tonnes - though the World Gold Council believed that the official figure was 1843 tonnes [1]
•  China is emphasizing financial reform (re regulatory system, corruption, securities / insurance industries, local government and business debts, managing past debts). This will not lead to liberalization of the financial system and time soon - but rather will restructure / improve heavily state-influences financial / economic systems. China has long had financial reform as a priority - but little was achieved as post-2009 investment boom led to alarming rise in debt. NPLs are claimed to be low but could be 10-20%. Little has been done in the past to reform incentive structure that generated China's explosive debt growth in the first place. Leaders are no calling for better regulations and control of corruption. Reform has three dimensions: rooting out corruption, addressing local government debt and regulatory reform.  [1]
• A very well China-connected Chinese billionaire living in the US has claimed (with unknown reliability) that China's 'anti-corruption' drive is being driven by corrupt elements at the top of Communist Party [1]

Recognising the Financial Problem 2017+

In early 2017 there was a marked change in the tone of observers' comments after China's regime had apparently recognized that its rapidly rising debt and declining foreign exchange reserves were dangerous [>] - see CPDS Comments in China's Likely 2017 Financial Crisis: .

• China's leaders are about to test the promise that has held their country together (ie rapid growth). Until now China's leaders have done everything to deliver fast growth - but decided in December 2016 that it was too dangerous to continue doing so as this has required lifting national debts to 280% of GDP. A flexible growth target is likely until 2020. They had little choice. Capital is flooding out of the country - and this is pushing yuan value down. However China may have trouble cutting its debt dependence - and has been promising to do this since 2014. Maintaining political stability will be difficult without increasing the debt load - especially because of its highly centralized power (eg its president has cracked down on all forms of dissent).  A slowdown combined with political centralization could cause Chinese people to feel they are not getting the 'dream' they are paying for [1]
•  China promised to contain company debts and cut coal / steel overcapacity - while seeking to maintain solid / balanced growth and avoiding asset bubbles. China might accept modest growth in 2017 to avoid risks from debt-fuelled stimulus. Debts of non-financial firms will not be allowed to rise further - and debt restructuring will be encouraged  [1]
• Data show China's economy is buoyant. Its central bank is supporting yuan to deter capital outflows. However there is also concern about debt crisis, property bubble, financial market turmoil; slow economic reform; depreciating yuan and little prospect of recovery by export businesses that drive China's past rapid growth. Central Economic Work Conference was held in December, 2016 - which considered cutting excess industrial capacity, a more open economy and increasing foreign investment. There was a lot of discussion of managing risk. Martin Wolf argues that China has a problem because its president is too focused on purifying the party-state. A new politbureau is to be appointed. Stability is needed while debt soars. China is trying something different which no one knows about - because it believes that Western methods don't work. There will not be a crash because the state controls everything. Maintaining growth requires a massive amount of debt. [1]
• 'Stability' is the new official watchword for China's economy - though what this means is undefined. The Chinese Academy of Social Sciences referred to a decline in China's growth rate from 6.5% pa to 6.4% pa [1]
•  China's top leaders decided (off the record) in December that the cost of debt-fuelled growth was too high. Stability is now the main priority. A US analyst suggested that  small decline in growth (eg half a percent) would be less damaging that instability in bond / currency markets [1] [CPDS Comment: The latter estimate of what would be needed seems unrealistic]
• Strong $US is forcing China to slow the 'money machine' that has driven economy since 2008. This will adversely affect economies worldwide - as slow / weaker Chinese economy and weak yuan create competition in developing markets. There has long been concern as China's debts rose to 280% of GDP through actions of state-run banks. Now party leaders have said that it is no longer necessary to keep hitting growth targets - because of concern about mounting debt. At the end of 2016 a strengthening $US encouraged people to get money out of China to avoid losing value. Charlene Chu (Autonomous Research) suggests China is in unchartered territory. China took its own approach to GFC - it instructed banks to lend rather than having central banks buy bonds. This added 30% or more credit each year to economy. There is now $24tr more in circulation than 8 years ago and yuan value has remained almost unchanged. China's people have had a large increase in purchasing power. There is an imbalance between increasing yuan in circulation and steady currency value - and this will worsen if yuan does not weaken and financial sector continues expanding rapidly. Total bank assets would increase by 30tr yuan (to 228tr) in 2016 and by another 100 tr if banking sector grows only 10% pa - the lowest rate on record. Last month $82tr left China. Now China's main concern is keeping capital in the country rather than maintaining growth. It has been using foreign exchange reserves to support yuan - but can probably only do this for another two quarters. China needs to think about attracting money - so its money-making machine are winding down. It could do this by raising interest rates - which would hurt borrowers with high debt levels. Reduced liquidity would harm property market. Liquidity and market risk in the financial sector would become more obvious.   This is why China is preparing its people and the world for a slowdown. As the economy slows the yuan will weaken. The problem would be reduced if $US weakens. However it is clear that the largest source of monetary easing since 2008 won't continue as it has - whether by blocking outflows, a fall in Chinese companies / individuals  power or weakening exchange rate. Change will happen very slowly because the Chinese government has so much control over financial levers (eg controlling interest rates / money supply). Economists increasingly expect China to become like a poorer Japan [1]
• China has indicated an intent to curb investment in foreign assets. Chinese companies are expected to spend $US160bn in 2016 on new non-financial assets up from $US104bn in 2015. At the same time inward foreign investment has remained roughly stable ($US110). The widening gap has led to concern about capital flight. China's commerce minister referred to reducing the problem by constraining firms' capital spending and reducing obstacles to investment in China - though no details were given    [1]
• China's exports fell 6% yoy in December 2016 while imports rose 3% because of weaknesses elsewhere [1]
• Predictions for 2017 by Charlene Chu (Autonomous) include: China's inability to combat capital outflows with capital controls; and China's future depends on US and $US.  China's outflow problem has been resisted more strongly - but this can't be maintained indefinitely by world's largest trading nation. Growth will slow in late 2017 as a result of a weaker credit impulse - but this is of secondary importance relative to outflows and currency.  China has $82bn outflows in December 2016. Capital controls have been put in place to stem this - but can't be mintained indefinitely without hurting economy. FDI has weakened - with less inbound investment and more outbound. Chu estimates that China burned through $800bn in foreign exchange reserves in 2016 - and that China could lose half its reserves over the next few years.  nd foreign exchange controls are making households more nervous. if China lost $800bn in 2016 with limited contribution from households then the problem in 2017 should be bigger. China's authorities must either stop controlling yuan and interest rates or end free flow of capital in an out. Interest rates ill be be raised to keep money in the country and attract inflows - but this will hurt banks and heavily indebted corporates. A trade war with US under Trump could increase nerves and capital outflows.  [1]
• Trump sees protectionist policies as the key to increasing US jobs - while Nariman Behravesh (chief global economist, IHS Markit) regard this as the biggest threat to global economy in 2017 [1]
• Data shows that China's growth has stabilized after falling from 2010 to 2014. A breakdown of underlying demand-side components is not available - but it seems that 'secondary' industries (including construction / industry) have stabilised while 'tertiary' sector strengthened. There has been a slowdown in investment spending and in housing starts. While China's economy won't crash a growth slowdown below 6% pa is likely. China's external accounts are of more interest. Sizeable current account surpluses are achieved - at the same time that net capital outflows rose sharply. As net capital outflows have exceeded China's current account surpluses, its FX reserves have been falling since 2015 (ie from $4tr in mid-2014 to about $3tr now) after authorities spent $1tr to support value of Chinese yuan.  China's FX reserves have fallen $1tr because of rising net capital outflows. Gross inflows collapsed from record $563bn in 2013 and became negative in 2015 - though they improved somewhat in 2016. FDI inflows to China fell about 50% from 2013 to 2016. Foreign banks have resisted making loans to Chinese entities because of the high debt levels of Chinese businesses. Foreign bank exposure to China has fallen from over $800bn in early 2014 to $650bn in Q2-2016. Foreign deposits in Chinese banks have fallen from $500bn in 2014 to less that $350bn. Gross outflows were $200bn in 2013 before rising to about $400bn in 2014 and 2015 - and were likely to be about $600bn in 2016. Direct investment by Chinese companies had risen from $70bn in 2013 to $200bn (projected) in 2016. Portfolio investment from China rose from $5bn in 2003 to an estimated $90bn. China's government had sought to financially integrate Chinese economy with rest of the world - and that policy was working.  There have been increasing discrepancies in China's capital account and unrecorded capital outflows probably account for an extra $200bn outflows.  China's government has spent $1tr to slow the decline in yuan value. Despite stable growth, money is flowing out of China. This has been encouraged by economic liberalization - but concerns about underlying state of economy, expected yuan devaluations, rising rates elsewhere will contribute to outflow. China has acted to offset downward pressure on currency for 3 years and still has ample FX reserves. It could tighten capital controls further if necessary. China's government prizes stability and will prevent sharp falls in yuan value. [1]
• China's president spoke to the chief citadel of capitalism at Davos about the wonders of free trade, globalization and innovation. Many observers saw this as indicating a new era for China. However Mao's picture still adorns Tiananmen gate and China's constitution endorses Marxist-Leninism. However there was a problem with China's president's speech - related to capital outflow. The flow of cash out of the paradise of socialism with Chinese characteristics is its uncomfortable secret and one that Trump may exploit. Net foreign payments recently by Chinese banks for clients has risen sharply to now $24bn per month. Chinese people / companies are getting cash out as fast as they can. The yuan has been devaluing despite government efforts to support it. Despite speaking about free markets at Davos, China has strong capital controls in place - and outflow would have been much greater otherwise. If Trump's trade policies or FED interest rate rises strengthen $US, the rush for China's exist will increase. Trump wants to devalue $US but his proposals for border tax adjustments would have the reverse effect. China should not have too much trouble with any trade war Trump starts - because it still have huge foreign exchange reserves.. And its government is quite happy to subsidize exporters. Exports to US account for 3.7% of China's GDP - so if this were to fall 60-70% 2.5% would come off slowing growth rate. Also the fall in capital inflows to US-bonds would result in a sharp rise in interest rates and probably a recession. [1]
• China might be preparing for a yuan devaluation in response to President trump's anti-China rhetoric. China is struggling with too much debt, poor demographics and competition from low-priced suppliers. It needs economic relief. Fiscal stimulus just adds to non-sustainable debt. The easiest way to boost its economy would be devaluation. When yuan devalues it encourages capital flight. [1]
•  China has created credit twice as fast as underlying growth - and relies on hazardous bubbles to keep growth running - according the Fitch Ratings. Short term stimulus is papering over deep cracks in economy storing up serious trouble for the future. State control of the banking system will prevent a sudden collapse but China catch-up boom from early 1980s will splutter out as banks struggle with bad debts and chronic mal-investment. This may resemble Japan's problems in the late 1980s - with much slower growth by end of decade rather than by an outright financial crisis (according to Andrew Fennell, Fitch Ratings). All forms of credit grew 16% in 2016 while while nominal GDP grew only 8%. Non-financial debt is 270% of GDP (according to Wei Yao of Society Generale). There is no longer any point in sticking to foolish growth targets as China faces a demographic crunch - as it is running out of cheap labour. Fitch said capital outflows would continue to drain foreign exchange reserves (already down $US1tr) but were not fast enough to be systemically threatening - and even more draconian curbs could be used. Recent lending had led to asset bubbles in home prices which led Beijing to slam on the brakes and led to price falls in 20 of 70 cities. China regretted its 2015 effort to slow down a share-market boom. Local governments are more interested in maintaining prices at high levels rather than allowing market forces to work. China went into unacknowledged recession in early 2015 and let rip with a fiscal stimulus like that after 2009. Growth in infrastructure investment fell to 5.7% pa in December 2016 from 14.7% the month before. Yang Zhao (Noumura) said boom will peter out in 2017 - and the drag on growth more evident. December 2016 data were weaker than expected. The question is whether China will continue to seek perpetual 'uber growth' [1]
• A major risk to markets is emerging because of China's economy. China could submerge under the burden of its enormously high debt. The BIS's Credit-to-GDP ratio is a key measure and China's is now 28.8% - compared with the US's 12.4% prior to the GFC. The 19th gathering of the National Congress of the Communist Party will determine China's future leadership - and this will then decide whether or not structural reforms will be made [1]
•  China has been told (by MSCI - a company that makes stock indexes) it needs to either keep money from flowing out of the country or join the ranks of the world's modern, transparent economies. The former would be an act of desperation while the latter would unleash massive pain on China. China has wanted to be included in MSCI's Emerging Markets Index ETF - as this could encourage huge inflows to China's stockmarket. China has been trying to that its economy is open, transparent safe - but MSCI has said that it is not there yet. The yuan has declined at a record pace recently as economy is slowing because people are taking money out of country. China has tried to stop this - because it wants consumer-driven economy. Also China needs to attract money - but foreign investment has been falling. Charlene Chu said that China would be only be able to prop up the yuan for a few more quarters before something happens. Capital controls can't be maintained without hurting trade. At the WEF China's president urged the world to be open to free trade. But the yuan will continue to weaken as long as China's growth is fuelled by debt. Changing that requires deleveraging massive companies - and this would be a massive process taking years. But China does not have much time [1]
• The rate of major Chinese overseas takeovers is slowing as rules related to capital outflows are tightened. Many of the $225 bn overseas acquisitions announced in 2016 are stalled. While the value of acquisitions had doubled in 2016, the rate of Chinese acquirers backing out of deals is up by a factor of 7 to $38bn.    [1]
• Chinese overseas deals worth $75bn were cancelled in 2016 - due to regulatory clampdown. This was 7 fold increase over the 2015 figure of $10bn. European and US sellers of assets are becoming wary of Chinese buyers [1]
•  China's economic miracle has been built on rapid credit expansion. Busts that followed from credit booms occurred in Japan, Asian emerging economies and US - and is now due in China. Global debt grew $57tr since 2007. Over that period China's debt rose from $7tr to $28tr. It accounted for about 40% of total increase in global debt over that period. Despite this China's growth has been slowing since 2007 - as credit become ever less effective in boosting growth. China's growth might fall to less than half current levels by end of decade. China contained the collapse in its share market in 2016-16 - but the market remains 40% below its peak. China has been seen to be seeking short term growth at the expense of long term gains  [1]
• China's central bank is running out of ways to stem capital flight - and faces near impossible task of managing effect of extreme credit growth. Defence of currency by PBOC is no longer viable according to Standard Chartered. Powerful forces are driving capital out. IIF estimates outflow as $725bn in 2016 - and this is not slowing despite capital controls. Intervention in currency markets to slow yuan fall (eg selling $US reserves to buy yuan) drains liquidity and tightens financial conditions - which could do a lot of damage to domestic banking system. Nomoura issued parallel warning that East Asia faces financial storm - with region-wide credit crunch. Fund managers could pull money out en-masse. PBOC still has $3tr in foreign reserves - these can't be used are hard to use domestically without making things worse. Reserves are not as large as they look given scale of financial pressures and China's economic structure. M2 money supply has collapsed to 15 year low. If reserves fall much below $3tr people will worry about reserves' adequacy. PBOC is tapping on brakes gently so far - with increased interest rates. Stealth tightening has been underway since November 2016. Credit growth will become a drag on economy rather than a boost as it was in 2016. Imposing 'border adjustment tax' in US could boost $US value and create problems for $10tr offshore $US debts with no lender of last resort behind it. Much of East Asia is in final stage of exhausted credit cycle which has led to endemic mal-investment. Debt service ratio has rising 5 times over decade to 15% of GDP - just as at time of GFC in 1997. Property and debt overhangs and keeping zombie companies afloat is bearing down on China's growth. Monetary and fiscal stimulus are not the answer - as they are losing efficiency / fuelling bubbles / misallocating resources [1]
• China is trying to drain liquidity from its economy - but may be unable to raise rates too quickly because of fear of being labeled a currency manipulator by President Trump. China was not yet seen to be seriously trying to stem loan growth (according to Rabobank strategist, Jane Foley). China's FOREX reserves fell below $3tr - suggesting that China might devalue to stem currency outflow.   [1]
• it is clear that there is a desperate problem with China's economy because authorities have made it illegal to use bitcoin to get money out of China [1]
• China hopes to get growth from domestic consumption - but many contacts in Beijing seem to be hoping to get money out of China. China's Belt and Road Initiative (BRI) was presented to WEF as evidence of China's commitment to globalization while US withdrew.  However exposure to this could create new set of asset quality problems for China's banking system. In trying to move away from investment-led growth China invested heavily in infrastructure - which boosted SOEs and commodity prices and China's national debt. BRI was seen as a way to export China's industrial overcapacity and surplus domestic savings. It involved extremely expensive projects which do not have to demonstrate normal levels of return. There are problems with proposed Silk Road because many of the rail networks involved can't be connected because of different rail gauges. There is concern because Chinese banks do not have a track record of allocating resources efficiently at home. The BRI would be funded by loans - and create a new set of lending quality problem because many loans would be secured against volatile commodity prices. Obstacles are becoming more obvious [1]
• Investors need to seriously consider China - as government has established controls that will have a dramatic effect on capital outflow.. This needs to be recognized by: (a) property investors; and (b) equity investors into China. China's forex reserves are used to stem depreciation of yuan - and have been falling quickly. While $1tr of foreign exchange had flowed out of China over previous 18 month, this fell to nil in December 2016. Major developers are likely to see increased settlement risk. China's government will eventually need to devalue yuan. China's credit system is coming to a halt. Credit excesses in China have built up more than in other countries prior to crises. Recent growth has been driven by unsustainable state-led infrastructure spending - thus driving up iron ore prices. Credit in China's banking system rose from $3tr in 2006 to $34tr in 2015 - and many of these loans will turn bad. Rising bond defaults and cancellation of bond issues are signs of rising pressure on banks. PBOC has injected liquidity and cut reserve requirements for banks. A recapitalization is inevitable. The real test will be the large number of junk bond maturities in 2017 and 2018. Over the past 18 months debt rose $6.5tr while deposits grew $3tr [1]
• Chinese companies are stepping in as lenders as banks reduce their funding to struggling industries and China's huge bond market comes under strain. This rose 20% in 2016 to $2.5tr - and is now fastest growing segment of China's shadow banking system. Arrangements are made through banks as middlemen. Interest of up to 20% is being sought with limited checks on creditworthiness [1]
• Since GFC the viability of the economy China used to have has declined. To maintain growth monetary and fiscal stimulus measures have expanded debt to 250% of GDP. Corporate debt has risen by 60% of GDP to 165%. Now it faces a nationwide debt crisis amid business defaults and bankruptcies, low industrial profits and prospects of another real-estate slowdown. China's economy has always depended on fixed asset investment - but over past decade as cheap exports' share of economy collapsed and household consumption slid, this investment has been one of main drivers of economic growth and employment. Much of this comes from biggest state-owned banks which answer to Beijing. China funded investment by cutting interest rates, reducing bank reserve requirements, boosting domestic equity markets and direct spending. But most came from debt. Whereas countries like US and Japan use government money for stimulatory spending, China used its control over banking system. Most money went to huge SOEs. SOEs hold 55% of China's debt but contribute only 20% to GDP. Beijing's government debt is low - 22% of GDP in 2015. After 2008-09 crisis, stimulus measures became permanent rather than temporary. The biggest systemic risk emerged in local government debt - as most was borrowed by pseudo-corporations which had no assets or functional management structures. Beijing started cracking down on this in 2013. China's corporations have become its major source of financial risk. Big borrowers account for 60% of corporate debt - and have debt / equity ratios up to 85%. This is a problem because most of the big companies are involved in real estate construction. Construction has been limited, and after rapid price growth local governments have been pressured to curb speculation. Credit has become less effective in driving China's growth. A protracted property downturn would be catastrophic for major Chinese companies - given rising debt / equity ratios and shorter maturity periods on debt. Loans have been taken to repay existing debts.  Many companies in construction-related industries will default on debts or declare bankruptcy in 2017. China has set up measures to mitigate these risks (eg debt / equity swaps and special bankruptcy 'tribunals') - but these measures have achieved little to date and face structural obstacles. China is facing a difficult year. China's plans to tighten credit will be constrained by dire financial straits of many companies and depend on construction. At the same time external pressure from President Trump is likely. [1]
• In 2017 China's economy remains overleveraged with credit outpacing economic growth. Yet turmoil in financial markets has abated. Economic expansion has steadied - allowing central bank to mount a modest tightening. $US pull-back is also favourable. Selecting next generation of China's top officials will be significant this year.  [1]
• China's stockmarket is experiencing rapid growth - yet many foreign investors are staying away: concerned about capital flight, mounting debt and slowing economic growth. Economic growth has been 6.7% the slowest in 26 years - and US President has threatened to label China a currency manipulator. Sharmin Mossavar-Rahmani (Goldman Sachs) sees China as most likely source of global economic shock over next 2-3 years. The main concern is about rapid build-up of debt. Total social financing surged to a record of $545bn in January 2017 - double the previous month despite government efforts to rein in lending. A financial crisis is seen to be likely in next 3 years. Western investors continued to pull back from China in 2016 as outflows persisted. And outflows have continued (more slowly) since China's authorities sought to stem them in late 2016. [1]
• China has suffered continuous outflows for two years - but reforming its bond market could reverse this according to Goldman Sachs. FOREX reserves fell $12.3bn in January 2017 to just under $US3tr after a $41bn fall the previous month -for a total 2016 fall of $320bn after a $513bn drop in 2015, China could stem the outflow through its bond market. It is the world's third largest with $US1.7 tr outstanding but is not included in any major global index because of the country's capital controls. China could induce natural inflows (eg of $US250bn) by further liberalizing its onshore bond market and be eligible for inclusion in global bond indices. This could take 3-5 year with major concerns involving market access, hedging, liquidity and concerns over repatriation  [1] - see CPDS comment here
•  The biggest financial story in the world is that there is a $US shortage. This makes it impossible for China to control its currency, emerging markets to roll over their debts and prevents FED tightening monetary policy without making things worse. The Fed printed $4tr to bail out financial system in 2008 but since then global debt has risen $US100tr. When debt holders want money back there won't be enough unless new debt finances old. China is an example of the problem. It faces the risk of insolvency. China has $3tr in hard currency foreign exchange reserves, of which $2tr are illiquid or needed to bail out its banking system. $1tr is left over to defend the currency. It needs to defend currency because China wants to satisfy both US and IMF that its currency is reliable store of value. US has long complained that yuan is under-valued to promote exports. Recent support for yuan is seen to be intended to satisfy US. Yuan was kept artificially low from 2007 to 2010 - but $US weakened from 2011 and yuan strengthened. This phase is now over. Yuan has weakened due to government intervention in August and December 2015 and since then due to capital flight. China has used reserves to prop up yuan. China also needs to satisfy IMF that yuan can be global reserve currency (which requires stability). But China can't afford to support yuan. It does so by buying yuan with its $US reserves. Yuan would go into freefall when reserves run out. China still needs to use $US reserves to buy oil as yuan is not widely accepted in oil trade. And China's oil fields are drying up. China won't actually go broke - its options will be: (a) raises interest rates (which will bankrupt even more heavily-indebted SOEs; (b) impose capital controls - which are of limited effectiveness because businesses can disguise capital flight as normal business dealings. More draconian measures would anger the IMF; and (c) currency devaluation - which is its only real option. China's people have seen this risk and sought to get money out. A large overnight devaluation is likely after Trump confronts China over trade / currency wars. This will stop bleeding in capital account and also weaken demand for $US  [1]
• China's president suggested that China's economy will be transformed - by the death of highly-indebted SOEs to make room for new more privately owned service industry companies. The process of change would be painful because of the extensive job losses and need to retrain workers  [1]
• China's president has promised to speed up reforms. This involves a determination to get rid of SOEs that stay alive by sucking public funds. Previous concerns about social unrest associated with job losses will be accepted.   [1]
• China's premier (Li Keqiang) has suggested a cautious economic course - with a slight downshift in growth to rein in swelling financial risks and ensure smooth political changeover in late 2017. China is being made because binge of credit and infrastructure spending propped up economic growth while causing property prices and debt to balloon. The growth target would be 6.5% down from 6.7% - associated with tighter money supply, lower investment and lower military spending. Maintaining political control seems to be the main consideration as there is little sign of economic reform. Concerns about financial risks are leading to tighter monetary policies - and this will undercut growth. Li indicated a desire to cut excessive industrial capacity. In 2016 Li's program had backed 2 stimulus measures - which resulted 'authoritative' criticism of debt-fuelled growth policies  [1]
• China's premier indicated that China would continue to walk economic tightrope (ie avoiding strong stimulus measures while giving priority to creating jobs).  Global growth was seen to be weak because of de-globalization and protectionism. China would support multilateral trading regime. More industries would be open to foreign investment (eg services, manufacturing, mining) - and also to private investment from within China. Consumption was confirmed as main driver of China's growth (51.6% of GDP)  The high leverage of Chinese companies (especially SOEs) was criticised - and government would tighten constraints on credit. Steel production will be squeezed [1]
• China's corporate debts are too high but it will take time to reduce them - according to PBOC. Government has pledged to contain debt and housing risks in 2017 after years of credit-fuelled expansion. Analysts are doubtful about following through on reforms if growth falters. Efforts will be made to contain debt levels - including restructuring firms with heavy burdens and reducing industrial over-capacity. Banks won't support financially-unviable firms. But this will take time to be effective because of large stock of existing debt. Attempts to contain house prices will be made, but housing loans will continue to rise rapidly. China needs to stabilize its overall debts before gradually reducing them. China's debt growth has been fast by global standards and without a comprehensive strategy to deal with this it will have a banking crisis. PBOC has moved to a modest tightening stance - to discourage explosive growth of debt and speculative activity.  Yuan value has stabilized as authorities took steps to restrict capital outflow. China burned through $320bn reserves in 2016 to shore up yuan. Reserves had fallen below $3tr - but then rebounded due to fund outflow curbs and steadying yuan. China has opened its bond markets to foreigners - but won't seek to have them included in global bond indices  [1]
• Several senior officials have spoken out against China's debt spiral - suggesting a determination by government to deal with this. But asset management companies tasked with controlling NPLs continue to borrow to keep highly leveraged entities afloat. Bank lending in January and February 2017 was at record highs.  Local governments (main stimulus spenders) will be licensed to issue special bonds to cover $160bn in 2017 - almost entire deficit central government expects them to accumulate. They are being encouraged to spend to maintain 6.5% growth. Irregularities in the way local governments obtain loans are being investigated however. While government advocates shift from investment / manufactures to services / consumption, profits in heavy machinery rose because of local government stimulus program. Zhou Xiaochuan (PBOC) highlighted debt issue. Yin Zhongqing (National Peoples' Congress) suggested that attempt to deal with local government debt ($1.6tr in bonds) were merely cosmetic - and that it was hard to eliminate such borrowing. PPPs established by local governments to raise funds (where 'private' component is mainly minority stake in state-owned entity) is just disguised local government borrowing. There are already fiscal crises in some regions. Local governments never worry about repaying debts. Upper level government will pay the bill.  [1]
• China invested $225bn to acquire foreign companies in 2016. Now this is being discouraged. Some Chinese deals have come apart - either because of government constraints or companies own decisions. Chinese families and companies have been rushing to et money out for over a year - because of slowing economy, weakening currency etc, China has recently increased efforts to prevent this. Banks were told in November 2016 that movement of over $5m required government approval. They have also been told not to move more money out of country than they move in (after a past 6:1 ratio). This could interfere with global companies' ability to move profits out of China and thus with China's commitments to IMF. China is still likely to be active in international acquisitions in 2017 - where technical know-how is involved. Official portray efforts to constrain outflows as a desire to promote more responsible investment, rather than to protect China's financial system. However they have incentives not to emphasize administrative limits on capital outflow, as this would discourage foreign investment inwards. Many Chinese companies already have money overseas (eg $500bn was taken out after stock market plunged in 2015 - and another $50bn leaves each month). Many deals involving Chinese companies don't require getting money out of China. [1]
• China's PPI has swung from deflation to relatively high inflation over 6 months to March 2017. Wholesale prices and import prices are rising due to lagged effect of weaker yuan. CPI has risen also. If China exports inflation, US yields will rise worsening China's capital flight - reducing domestic liquidity and growth. There is some monetary tightening in China - and this may prevent inflation getting out of control. Rising inflation and lower liquidly is squeezing excess liquidity lower - which will remove support for China's equity / property prices [1]
•  China credit growth slowed indicating concerns about risks with rising debt - especially corporate debt. The risk has been acknowledged but the pain of aggressive deleveraging has led to reluctance to act. Latest figure show that the need to control debt is being recognised. Growth in new loans in January 2017 were at 10 year low. Non-bank lending was strong. Bank loand grew 13%. Non-bank lending grew 16%. .  [1]
• Former US Treasury Secretary (Larry Summers) has expressed concern about China's capital outflows and real estate. China has built strains in terms of debt accumulation - leading to those problem areas. It will be difficult to sustain growth - and growth over the next 2 years will be that borrowed from the future. State investment to maintain real estate prices can't continue. In the first two months of 2017 real estate loans rose at a rate of 8.9% pa.  China's capital outflow was huge by historical standards. China is delaying necessary reform - and this is a cause of concern [1]
• China is introducing new regulations to cover outbound investment to stem capital outflow and speculative investments.  Capital outflow by SOEs and private companies rose to $US170bn in 2016 - up 44% pa. This put downward pressure on yuan and led to concern that investment in China was being cut back. New regulations would define what types of investment would be limited. Emphasis would be given to strategic investment (especially Belt and Road initiative), Chinese companies announced $220bn in outward foreign investment in 2016 - but $40-$75bn were cancelled - a practice that has led to concern about Chinese buyers in some countries. [1]
• Alibaba and Huawei have become well known internationally after being major players in China's domestic economy. There are now hundreds of similar companies ready to take on the world. China now is not what it was 3, 5, 20 years  ago. These companies have innovative products perhaps better than those in the West.  [1]
• IMF and OECD have upgraded growth estimates for China. But concern about China's financial stability are still growing. Chinese authorities won't allow growth to flag before next national congress of Communist Party. Alvaro Peteira (EOCS) said China needs to do more to tackle spiraling debt. Corporate debt has risen from 100% of GDP before GFC to 190% - one of world's highest (compared with 50% in Australia).75% is owed by SOEs - which have excess capacity and poor profitability. China's big 4 banks have been disguising their exposure - and though regulators have tried to prevent this they have been circumvented. China's central bank has to deal with contrary objectives (ie support demand and contain risk). Michael Pettis (Peking University) argues that China's debt burden is worse than usually recognised - but that a financial crisis is less likely than a prolonged period of economic slowdown. Diana Choyleva (Endo Economics) argues that crisis is both possible and imminent - with interbank market being chief vulnerability. Non-bank share 0f this has risen from 14% to 54% over past 3 years - and they invest in illiquid assets with longer maturities. Deteriorating asset quality will eventually prompt lenders to reduce risk and lend for shorter periods - thus leading to mismatch in maturities.  China's central bank will have to lift interest rates because of rising inflation. [1]
• China is beating the US at innovation because it has significantly increased spending on the latter stages of R&D where discoveries turn into commercial products. By 2018 it will spend twice as much on this as US. The US does the hard work of inventing new technologies 9ie via R&D) while China (and other countries) emphasize turning them into commercial products. This is costing US huge amounts in manufacturing output and large numbers of jobs [1]
• While companies worldwide seek to access China's growing market, start-ups with HQs in China are seeking not only to conquer domestic market but also to come out on top worldwide. This is a continuation of 'going out' policy initiated at start of century by Alibaba and Tencent. This differs from earlier attempts to expand sales by offshore mergers and acquisitions   [1]
• Leading China-focused economists believe that it is vulnerable. Its problems are not like those of Soviet Union when it failed - but rather involves 'soft budget constraint'. China has a tottering and still accumulating debt mountain. Though a huge fiscal stimulus can keep going for years it will eventually make economy vulnerable (eg to external disasters or domestic bank runs). PBOC is concerned about capital flight. What seems to be closed circuits of lending and spending create moral hazards. China's SOEs have only soft (easily ignored) constraints on borrowing / spending. It controls less than half of economy - but those parts are critical to economy. 10 years ago privatisation of SOEs was being considered - but this idea is now taboo.  State sector has been expanding. China's economic thrust worked well when it had a single-minded aim to increase GDP.. But this has now changed. Issues other that GDP are emphasised. Bankruptcy laws have never been enforced. Local governments borrow from state-owned banks offering land as collateral - which enrages present users. Most of earliest listed 'Shanghi Eight' stocks have run into trouble - but none have been delisted. Privatisation would be a solution but leadership won't consider this. Private profits are being held down because governments and SOEs gouge profits wherever they can. China is exporting its problems through the belt and Road initiative  [1]
• China's property / infrastructure booms have been locked in by government for another year. This has driven commodity price recovery that benefits Australia - but creates uncertainty because no one knows when destabilizing mountain of debt will topple over. The constant postponement of efforts to rain in debt-driven spending brings reckoning closer. Attempts to constrain property speculation with a property tax have been ineffective. GDP growth has been mainly driven by property investment - and China's economy has again become investment driven. Laying a favorable foundation for 19th 5-yearly communist party congress in November 2017 has been given priority [1].
• a property boom in China that only benefits city dwellers has widened that country's wealth gap. Those born outside China's cities are unable to buy property in them. House prices have risen very quickly (about 700% over 10 years and the main cities). City dwellers now earn 3.5 times as much as those in the countryside - up from 2 times in 1978.   [1]
• China has become markets biggest worry. A problem has been recognized for months and is now supported by weak data. A slowdown will affect commodities. If China loses a lot of steam its currency will weaken and commodities will sell off. This would be negative for other markets. Government has slowed infrastructure spending thinking private investment will increase. Rising interest rates, tighter conditions and some new down payment method might make that impossible [1]
• There has long been speculation about China's corporate debt bubble. China's system can't be propped up forever. China is not manipulating its currency lower. It has propped up yuan to prevent economic destruction. Shadow banks have lent companies huge amounts at low rates which they can't repay. However yuan peg is unsustainable and will eventually trigger a GFC (especially affecting commodity markets). China is seen to be already below critical foreign exchange reserve level ($US2tr). After adjustments official $3.005tr reserves are only $US1.69tr. Government has tried to rein in over-leveraged shadow banking sector - but economy is too over-leveraged for capital controls to work. When China's dam bursts a global financial crisis will result. This will take down commodities as China consumes 50% of commodities globally [1]
• China's economy is slowing. Copper imports fell 30% month on month in April 2017. Copper inventories are increasing rapidly. Iron ore imports fell 13%. This is due to deliberate tightening of credit. Broad credit growth is now 15% pa down from 25% pa at start of 2016. It is unclear whether this is a standard Chinese slowdown or something more sinister. China can't go on increasing credit / debt forever. Commodity price downturn is not yet sufficient to suggest major problems in China's economy - though such problems could unfold. If China has problems so would Australia - because its economy is driven by: (a) 'dirt' shipped to China; and (b) debt to speculate on house prices. If income from 'dirt' falls, foreign creditors may demand higher interest rates - causing problems in housing markets and potentially major problems for economy [1] 
• There is an expectation that China will continue with its high rate of investment but ACAPITAL (which works for China Investment Corporation) argues that the 2016 spike in Chinese investment would end - resulting in investment levels like those in 2015. In a 90 minute address on China's foreign investment Australia was not mentioned. Europe and North America gain 70% of China's offshore investment - which has a total of only 10% of GDP. Politicians fete vising Chinese business leaders - though they are not actually investors. And when they do make announcements they often fail to follow through. The biggest constraint relates to concerns about pressures on yuan, capital flight  and financial stability generally. There have been no major foreign investments in China in 2017 - compared with $225bn in 2016. Large Chinese firms are mainly domestically focused. Foreign investors have found investing in China to be becoming harder [1]
• China's is cracking down on risky investment and causing problems for investors. Bond yields are rising, stocks are falling and more loans are defaulting [1]
• World Bank warns that China's local governments remain addicted to off-budget borrowing - despite government efforts to impose discipline. Runaway growth of local government debt is seen as a huge risk to China. There was heavy borrowing to sustain growth after GFC - and practice has continued. Returns on investment are falling. White elephants are common. Many projects don't produce enough cash to repay loans. In 2014 China tried to limit borrowing through special purpose vehicles - which localities had used to circumvent direct borrowing. But LGFV (Local Government Funding Vehicle) debt has accelerated since 2015. This accounts for most public investment. Government no longer monitors LGFV growth as this would imply official acceptance. Some localities are moving to restrain this. Fiscal sustainability requires ending public investment-driven stimulus measures soon [1]
• Rising bond and money market yield (which are at highest level in a year) concern Western investors. However China is different to 2007. China's debt problem is concentrated in corporate sector is seeing revenues growing at fastest pace since 2011 while real borrowing costs are falling. US economy was different in 2007. Mortgage debt had built but mortgage backed securities did not start causing problems until mid-2007. Employee income growth peaked in 2005 but Fed kept rising rates for a year afterwards. In China central bank started tightening recently. Factory gate inflation is at 6 year high - so real rates had fallen. Producer price-adjusted one year rates were 10% in early 2016 - but are now below zero. Firms earnings rose 10-14% in first quarter of 2017. This can't last forever. Big rises in 'shadow finance' have obscured problems - blunting the effect of tighter corporate bond market, Outstanding corporate bond debt fell 58bn yuan - while shadow finance grew 2tr yuan in first quarter of 2017 - twice as much as in last quarter of 2016. Firms are borrowing heavily and the banks backing them rely on risky interbank funding. Eventually there will be a problem. AS in US problem will arise when borrowers face higher borrowing costs and falling incomes. [1]
• There is a myth that China has excess savings. The US is seen to consume too much while China saves too much. After 2007/2008 financial crisis it was suggested that trade and current account imbalances had something to do with the underlying problem (ie excessive savings in China). The problem was supposed to disappear when consumer spending rose. But this didn't happen and Chinese government stimulus was the alternative. Now debts are rising rapidly - soaking the whole economy with non-performing loans. The IMF is warning of serious problems. Growth now requires increasing multiples of increased debt. However 'excess savings' may not be the issue. In The New Depression, Richard Duncan argued that it was wrong to believe there were not attractive investments in China so China had to send it surplus to US.  Instead US dollar export earnings have been converted to printed yuan and held in central bank reserve. Some were used to buy US T bills. This a a change in reserve account not in capital account and is a loan to US government not investment in US economy or purchase of US goods and services. The investments made by Chinese government make up the bulk of Chinese savings. The hoped for rise in consumer demand wont happen unless China's investments generate a return. High GDP growth matters as it implies that China is getting wealthier. [1]
• China's banks extended more credit in April than previous month - though household loans fell in a sign that authorities are walking a tightrope as they try to constrain debt. PBOC increased check on bank's off-balance sheet wealth management products. China is keen to ensure steady growth before Communist Party meeting in late 2017. Authorities have pledging to contain rapid debt-build-up this year. Crackdown is starting to result in weakened off-balance sheet financing (shadow banking) and household loans. Property lending is cooling. Cites have tightened up on real estate. Pick up in loan growth last month was more than offset by decline in bond issuance. Total new credit in economy rose $1.01tr in first quarter.  Crackdown on debt risks will slowly temper growth late in 2017 [1] 
• China's central bank made its biggest one-day cash injection into country's fragile financial markets in 4 month - indicating concern about damage to investor confidence from efforts to damp down speculative excesses. Bond issuances had plunged in recent months - making it hard fro struggling businesses with limited access to banking sector that favours inefficient SOEs. Companies raised 674bn yuan via bonds down from 1.8tr yuan in same period in 2016. Secret guidance has been given to large investors to avoid selling stocks ahead of OBOR summit [1]
• China's efforts to limit foreign investment have contributed to a 60% fall in foreign investment in Australian real estate. Treasury commented on Moody's downgrade of China's credit rating from AA to A - noting that China was maintaining growth by increasing use of credit. This downgrade follows 2 weeks after China agreed to allow big three US credit rating agencies to operate in China as part of a deal with President Donald Trump. Moody's noted conflict between China's desire to stimulate growth and slowing debt growth. China suggested that Moody's over-estimated the problem. Moody's concerns are shared by RBA and Treasury. China's efforts to maintain financial stability led to decline in outward foreign investment - and reduced foreign investment applications for housing from 40,000 in 2015-16 to expected 15,000 in 2016-17. RBA suggests that the longer China's growth is driven by financial distortions, the greater the risk of a financial crisis  [1]
• Running businesses in China (especially international firms) is getting harder. Companies depend heavily on government getting settings right for debt, currency values and capital controls. Recently policy has been seen as based on 'flexible' / 'anxiety'. China's finance Ministry objects to Moody's downgrade - on the grounds that government can organise structural reforms and expand demand. However there are problems. Reliance on Communist Party is rising. Emphasis on boosting the financial role of the market 14 years ago has been replaced by the view that the Party and its leaders are best placed to price risk for China. As the state sought to re-centralize control inder President Xi, local governments (with limited capacity to raise funds) have had a problem. Central government leveraged ever rising funds to maintain China's growth. Yet it is local government that undertakes vast infrastructure spending. After a government clamp-down on speculative investment it was found necessary to push $30bn into financial system in one day after fear of going too far. A lot f local government debt is off balance sheet. There are potential problems with this and with Belt and Road proposals. Made in China program has been launched to propel high-tech manufacturing. Cyber rules related to this will marginalize / ban dominant Western tech firms. Capital controls were tightened in early 2017 - which exacerbates problems for payment problems for China-based companies offshore activities. Re-pegging yuan at different level against $US is a further step away from market liberalization. Foreign operators in China now require agility and close attention to politics. [1]

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