HOW can this be normal?
Twenty-nine countries with roughly 60% of the world’s GDP have monetary policy
rates of less than 1% per annum. The world is awash with debt, with sovereign,
corporate and household debt of over US$230 trillion or roughly three times world
GDP.
To finance their large debt and deal with deflation, both the European Central Bank
(ECB) and Bank of Japan are already experimenting with negative interest rate
policies (NIRP). If these do not work, look out for helicopter money, which means
central bank funding of even larger fiscal deficits.
Either way, at near zero interest rates, the business model of banks, insurers and
fund managers are broken. Deutschebank’s CEO has recently warned that European
bank profits will struggle more as negative interest rates play into deposit rates. No
wonder bank shares are trading below book value.
The problem with the current economic analysis is that no one can ascertain whether
exceptionally low interest is a symptom or a cause of deep chronic malaise.
Exceptionally high debt burden can only be financed by exceptionally low interest
rates. The Fed now feels confident enough to raise interest rates, which means that
the US asset bubbles will begin to deflate, spelling trouble to those who borrow too
much in US dollars, which would include a number of emerging markets.
As Nomura chief economist Richard Koo asserts, the world has followed Japan into a
balance sheet recession, with the corporate sector refusing to invest and
consumer/savers too worried about outcomes to spend. The solution to a balance
sheet (imbalanced) story is to re-write the balance sheet, which most democratic
government cannot do without a financial crisis.
Like Japan, China’s dilemma is an internal debt issue of left hand owing the right
hand, since both countries are net lenders to the world. This means that foreigners
cannot trigger a crisis by withdrawing funds. The Chinese national balance sheet is
also almost unique because the financial system is largely state-owned lending
mostly (about two thirds) to state-owned enterprises or local governments. The
Chinese household sector is also lowly geared, with most debt in residential
mortgages and even these were bought (until recently) with relatively high equity
cushions.
Unlike the US federal government which had a net liability of US$11 trillion or 67% of
GDP at the end of 2013, the Chinese central government had net assets of US$4
trillion or 42% of GDP. Chinese local governments had net assets of a further US$11
trillion or 123% of GDP, compared to US local government net assets of 45% of
GDP. Local governments hold more assets than central or federal government
because most state land and buildings belong to provincial or local authorities.
Thus, unlike the US where households own 95% of net assets in the country,
Chinese households own roughly half of national net assets, with the corporate
sector (at least half of which is state-owned) owning roughly 30% and the state the
balance. In total, the Chinese state owns roughly one-third of the net assets within
the country, compared to net 4% for the US federal and state governments.
Sceptics would argue that Chinese statistics are overstated, but even if the Chinese
state net assets are halved in value (because land valuation is complicated), there
would be at least US$7.5 trillion of state net assets (net of liabilities) or 82% of GDP
to deal with any contingencies.
Furthermore, unlike the Fed, ECB or Bank of Japan, the People’s Bank of China
derives its monetary power mostly from very high levels of statutory reserves on the
banking system, which is equivalent to forced savings to finance its foreign exchange
reserves of US$3.2 trillion. Thus, the central bank has more room than other central
banks to deal with domestic liquidity issues.
What can be done with this high level of state net assets, which is in essence public
wealth? My crude estimate is that if the rate of return on such assets can be
improved by 1% under professional management, GDP could be increased by at
least 1.5 percentage points (1% on 165% of GDP of net state assets).
How can this re-writing of the balance sheet be achieved? There are two possibiliies.
One is to allow local governments to use their net assets to deleverage their own
local government debt and their own state-owned enterprise debt. This could be
achieved through professionally managed provincial level asset management/debt
restructuring companies.
The second method is inject some of the state net assets into the national and
provincial social security funds as a form of returning state assets to the public.
People tend to forget that other than the painful restructuring of state-owned
enterprises in the late 1990s, which led to the creation of China’s global supply chain,
the single largest measure to create Chinese household wealth was the selling of
residential property at below market prices to civil servants.
The size of the wealth transfer was never officially calculated, but it paved the way for
boosting of domestic consumption by giving many households the beginnings of
household security.
The injection of state assets into national and social security funds was not achieved
in the 1990s, because the state of provincial social security fund accounting was not
ready. But if China wants to boost domestic consumption and improve healthcare and
social security, now is the time to use state assets to inject into such funds.
At the end of 2014, Chinese social security fund assets amounted to 4 trillion yuan,
compared with central government net assets of 27 trillion yuan (Chinese Academy of
Social Science data, 2015). Hence, the injection of state assets (including injection
by provincial and local government) into social security funds as a form of stimulus to
domestic consumption and more professional management of public wealth is clearly
an affordable policy option.
In sum, at the individual borrower level, there is no doubt an ever increasing leverage
ratio in China is not sustainable. But the big picture situation is manageable. If the
policy objective is to improve overall productivity (and GDP growth) by improving the
output of public assets, the timing is now.
Tan Sri Andrew Sheng is Distinguished Fellow, Asia Global Institute, The
University of Hong Kong.
A version of this article appeared in The Star Online, 11 June 2016
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