Forget the trade war: in China the fingerpointing over who is responsible for China’s economic mess has begun.
In an unprecedented turn of events, China’s central bank and its Ministry of Finance are having a public feud about the future of the country’s monetary policy. Worse, it comes at a troubling time for a deleveraging (at least until recently) China whose economy has slowed sharply, just saw its biggest default of 2018, and is engaged in a bitter trade – and now currency – war with the US, all of which have sent its stock market into a bear market.
The feud started a week ago when the head of research at the PBOC, Xu Zhong, commented on July 13 that the country’s fiscal policy wasn’t active enough. Zhong claimed that the county’s deficit was tightening as evidence that the country’s “proactive” fiscal policy isn’t being implemented properly. China is aiming for a 2.6% deficit this year which is tighter than the 3% that China posted last year. In addition, another concern is that taxes for corporations are rising and are growing at a rate that is far higher than GDP.
Just days after Zhong lashed out at the Ministry of Finance, the MOF responded in a July 16 article in Caixin, a well known financial magazine. It was written under a pseudonym (“Qingchi”) which argued that simply focusing on the deficit was an elementary way of looking at things and that the government had other tools at its disposal that it could use to help support growth. Then, as The Economist notes, the argument got “nasty”:
Mr Xu had faulted the finance ministry for its hand in China’s debt mess, saying it was pushing the problem onto banks rather than fixing the fiscal system. Qingchi countered that financial institutions have been accomplices, structuring complex loans for local governments. All the while, Qingchi wrote, the central bank has moved too slowly in liberalising interest rates, which would have bolstered market discipline. Hence the most cutting line of the rebuttal: “officials act as if they were managing a small country’s central bank.”
The Economist’s take is somewhat naive: according to the Rothschild owned publication, the all too public feud between the nation’s two top financial institutions – something that never happens in China – while highlighting the problems that China has under the surface, demonstrates that China is “taking the medicine” in a way we’d likely be afraid to do in the U.S. – allowing stocks to fall, allowing defaults on debt and having a good old fashioned deleveraging.
We would beg to differ because as we described this week, while Beijing has indeed allowed a record number of defaults to take place, China also just reversed sharply on its deleveraging policy, and is now actively easing by not only cutting rates, but also engaging in shadow QE and also appears to have launched a new flood of (non-shadow) loans. While the trade war with the US is a catalyst, the slowdown in China’s economy is a far bigger driver behind this strategic U-turn.
In any case, The Economist concludes that any change in policy is going to have to come from Xi Jinping himself who is the ultimate decision-maker in China.
The economy has held up well, growing by 6.7% year on year in the second quarter. But decelerations in credit and investment suggest that a sharper slowdown lies ahead. The trade war with America only adds to the headwinds.
The deleveraging campaign is also starting to claim more victims. China had a record number of bond defaults in the first half of the year. Stocks are in a bear market, down by more than 20% since January. No regulator wants to take the blame for this distress. Tough new asset-management rules have been delayed as a result. But at the same time no regulator wants to be seen as the one that gives up on the fight against debt. Better to pass the buck.
Institutionally, the debate is intriguing. Neither the central bank nor the finance ministry is independent; each answers to the State Council, China’s cabinet. Larry Hu, an economist with Macquarie Securities, says the solution must come from a higher level. These days, that is a euphemism for Mr Xi and his senior advisers.
Meanwhile, the two bureaucrats continued to bicker online, according to the Global Times:
Qingchi said that China’s 2018 fiscal budget report highlights major tasks including stabilizing and adjusting budgets to handle income, deficits and special debt. “Authorities have taken various measures to increase the activeness of the current fiscal policy, so even though the deficit budget is tighter compared with last year, it will still be effective,” Qingchi said.
The finance official also refuted one of Xu’s ideas, claiming that assets currently held by State-owned financial institutions do not contain authentic data, as the finance ministry had previously not injected any money.
In contrast, Xu had argued in his column that in actual fact, with the help of the central bank, financial institutions had bought national bonds, which was a way to self-financing. “This is misunderstood,” Qingchi claimed.
Needless to say, it is embarrassing for China – which always seeks to exude an air that everything is under control and any debates only take place behind closed doors – to air this type of dirty laundry out in the public, unlike in the United States, where the President simply tweets out his thoughts on the Forex markets on a daily basis.
There is another take: as the Economist observes, “as the dispute breaks into the open it raises another fear—that internal channels have become blocked, at a delicate time.” This is indeed the biggest worry, because if anything, the feud suggests that Chinese decisionmakers are lashing out only because they have hit a brick wall with conventional policies, and anything that comes next will be purely experimental. As a result, the pre-emptive blame game has already started.
However, there is a silver lining, because behind the optics the bizarre feud shows that in China there is at least an active policy debate about monetary policy in China. Meanwhile, in the United States, for the past decade it has seemed that politicians had simply just given up and accepted the monetary policy path we are on, regardless of what the long term consequences will be. Ironically, the one chance to stir things up over the “independent” Fed which is anything but independent as Ben Bernanke’s former advisor shockingly admitted once, comes again from Donald Trump, who in the past 48 hours has launched an unprecedented campaign to “advise” Fed Chair Jerome Powell how to act. In other words, for better or worse, the only hope for some – any – change at the Fed, lies with none other than President Trump.