Li Keqiang: No Stimulus Coming

iFeng: 李克强：不会再通过“强刺激”的投资来扩大内需

We will not pass "strong stimulus", "flood irrigation" investment to expand domestic demand

One of the big themes I covered here in recent years was the leadership transition (lots of links at bottom of that post) and the economic thinking of the new regime, mainly Li. I summed up a lot of this in an article here: China's New Age Of Reform. From the summary points:

Rhetoric has been followed up with action, with major reforms in the SOE and financial sector underway.

Monetary stimulus is off the table unless the economy slows substantially or the reform camp suffers a political setback.

It turns out reforms are moving much slower than expected, but monetary stimulus continues to be doled out in doses only large enough to prevent a crisis.

The leadership has been saying no stimulus for several years. It is a message I covered repeatedly on this blog because foreign media kept repeating the "China stimulus" theme in past years. Li Keqiang in particular has consistently voiced opposition to such a stimulus and it continues to this day in the midst of a serious slowdown. He is not wrong on the economics. Making the hard choices is what good leaders do. Stimulus and currency devaluation are the policies of weak leaders and almost never resolve the underlying problems. As in 2008. The biggest difference between 2016 and 2008 is amount of debt. What was a big problem has grown into an incomprehensible crisis.

Li may also be right on the politics of deflation. The leadership has been jailing corrupt politicians at a healthy clip and removing their political opposition. There are still many party insiders who oppose the economic reforms because it will take money and economic power away from party officials up and down the line, as well as introduce market forces and foreign influence into the economy. Local governments have refused, at almost every turn, to implement the leadership's policies on reforming local economies. The best way to push reforms then, may be to break their enemies with deflation.

China is already on the path to reform. The leadership is moving slowly because they don't want a disorderly transition. They want the growth from new markets to offset the slowdown in old markets, but if there is a crisis of any size, it will accelerate reform, not derail it— assuming the leadership has consolidated power and squelched opposition.

If there's no credit, then it's game over for every over indebted local government and state-owned enterprise.

Li has been saying the exact same thing on economic policy going back at least to 2010. Many reforms such as property taxes were part of a push to build a Chinese middle class. The political leadership that designed the 2008 stimulus has seen its power diminished, with the PBoC becoming more powerful than the Ministry of Finance. For those who lean towards the political intrigue, a brutal deflation would wipe out many political enemies because the companies and governments under their control will go bust.

Going back to the economic policy. More than a year ago here: Kuroda Says Dump Yen, Yuan to Fall

China cannot simultaneously cut interest rates and expect the yuan to appreciate because hot money will flow out of the country. Short of igniting an economic boom, a yuan rally isn't going to happen. Since the leadership does not want an investment led boom, which is the only way the current economy would be able to deploy massive capital inflows/credit growth, the hot money will leave if rates continue to slide. The other option is to let the tight credit conditions deflation do its work. The painless short-term solutions are gone. Long-term, reforms will lift the economic growth rate, but short-term there are no painless or costless options.

The point I've been trying to drill home on the blog is that China faces no pain free choices. It cannot control the laws of economics, but it can control where the fallout lands. Yet until recently, the "mainstream" opinion on China was still that their reserves and the ability to do stimulus would allow them to avoid any real pain.

Now the mainstream is finally coming around to the idea that China has to pay the bill for its 2008 stimulus binge.

The Australian: China’s tough reform choices as ‘era of easy growth over’

Some economists don’t rule out an abrupt drop in growth, a hard landing that would see bad debts soar, consumer confidence tank, the Chinese yuan plunge, unemployment spiral and growth crater.

More likely is that Beijing will continue to prop up growth, steering more capital to money-losing companies, unneeded infrastructure and debt servicing, depriving the economy of productive investment and leading to the sort of protracted malaise seen in Japan in recent decades. But China is less prosperous than Japan.

...“They don’t want to take the pain,” said Alicia Garcia Herrero, economist with investment bank Natixis. “But the longer they wait, the more difficult it becomes.”

I suggest that this type of statement should be accompanied by the question, "Who doesn't want to take the pain?"

Conclusion

This moment was unavoidable. Xi and Li have been on the right path with economic policy and based on the consistent public statements by Li, they haven't deviated from their agenda. (The stock market bubble is a glaring exception.) That reforms haven't been implemented and overcapacity is still a major issue could reflect a lack of commitment by the leadership, but I don't believe this to be the case. In addition to consistent public comments on policy, there are reports of Li's "table pounding" moments in closed door meetings with local officials in past years. More likely is there is still hefty political opposition. High-ranking officials with personal interest in preserving the status quo to those at the bottom in local government form a powerful bureaucratic opposition. Add in legitimate fear of a major economic crisis among the leadership, plus a belief or desire that reform be achieved with as little pain as possible, and it's clear why Xi and Li may not have pushed reforms hard enough to overcome opposition. It is a natural tendency to avoid painful decisions, especially when one still hopes there might be a better outcome. Plus, if you act early and trigger a smaller crisis, you are blamed for the crisis, not the avoidance of a depression. Even in a non-democracy like China, the political pressure pushes one to wait until the crisis is full blown. We should know by March, after Spring Festival, if the leadership will finally start managing the crisis rather than reacting to it.

Although devaluation is a bad policy as a solution, I have forecast yuan devaluation for several years not because I viewed it as inevitable based on the growth in debt, the trend in the U.S. dollar and economic history. At some point, the imbalances will end. Liabilities and assets must balance. With potentially trillions of dollars in bad debt, either the debt collapses and asset prices follow, or the currency collapses to "save" the debt and nominal asset prices. If China did implement another 2008-stimulus, it is currency devaluation by another name. In keeping with the reform ideas of Li and the PBoC, it is much preferable to have the international currency market force the yuan lower, then to resort to a stimulus that will end up having the same currency effect, but in the process, set reforms back a decade.