Will China have to ease its policy?

Good Morning. We have a stimulus in the brain today. Will China be forced to resort to it and did it work in the scary early days of Covid? Send us your thoughts: [email protected] and [email protected].

Will Evergrande force China to change its policy?

The latest news on Evergrande suggests the developer is on the verge of default, and the stocks of the over-indebted group say pretty clearly that it will. The stock fell 20 percent on Monday, a move barely visible on the long-term chart:

The Chinese authorities seem to be doing with Evergrande what they (so far) have successfully done with the over-indebted insurer Anbang: a kind of orderly, dissolving, liquidating thing that does not require a general rescue of the sector, or fiscal and monetary juicing of the economy.

This includes government agencies taking over Evergrande’s assets and liabilities at prices that do not require large losses to be recognized. The government’s goal is to “strike a balance between short-term stability and long-term reform,” as JPMorgan Asset Management’s Chaoping Zhu put it in the Financial Times today. What if you think about it, what we all strive for in life, right?

But that balance requires discipline, and there are some signs that China may usher in a general easing in financial conditions that encourages risk-taking rather than discourages, but eases short-term pain – and supports markets.

The first clue that the official discipline may not be armored, of course, is that the People’s Bank of China is the required reserve ratio (RRR) by 50 basis points on Monday, the second cut this year. This releases credit into the economy.

Another, more subtle, form of economic support is through the purchase of land rights through local government funding vehicles. LGFVs (state-owned corporations that fund public projects) fill the void in local budgets left by poorly funded developers who have scaled back land purchases. As reported in Caixin Global last week:

LGFVs bought more land use rights across the country from the third quarter onwards as the liquidity crisis deepened at some private property developers, and in some locations these vehicles became the top bidders. From July to November 15, LGFVs bought 13.38% of the land by value across the country, up 4.38 percentage points from January to June, according to calculations by brokerage firm Zhongtai Securities.

Here is Michael Pettis from Peking University discussing these steps Twitter:

These LGFVs are controlled by the local governments and borrow under their guarantees, so this means that the local governments borrow from the banks and treat the proceeds as revenue. I am surprised that this is allowed, but I think local governments have little choice if they cannot otherwise sell enough land to meet the revenue needs.

However, this means a doubling of the real estate sector. Why? Because if the real estate market revives and prices continue to rise, the LGFVs can then resell the land and make it profitable. But if the real estate sector doesn’t recover, the LGFVs will be left with losses that local governments will have to make up for.

Are actions like these likely to be signs of more accommodating policies? Larry Hu and Xinyu Ji, China economists at Macquarie, believe they are. The RRR cut and the “devise” tone at the Politburo meeting on Sunday suggest that “political priority is shifting from tightening regulations to supporting economic growth” and “monetary and fiscal policy is shifting from tightening in the coming quarters loosening ”, albeit gradually.

They suggest that the “credit impulse” (contribution of new loans to GDP growth) has bottomed out and will emerge, and that budget deficits, which have been falling for a year, are rising again. The result? Stock market valuations should rebound:

Good times. But not everyone agrees with this picture. CrossBorder Capital’s Michael Howell, who is closely monitoring China’s credit and liquidity positions, sees little sign of policy easing. He notes that since the first week of December, the PBoC’s open market operations (basically the buying or selling of bonds from banks) have not added any new liquidity to the economy:

Obviously, an independent prediction of Chinese politics is way above Unhedge’s pay grade. But seeing how disciplined the Chinese authorities will be in the face of the Evergrande Test will be one of the most interesting dramas of the coming months.

Voices and lockdowns

The US response to the terrible early days of Covid has been twofold: grueling lockdowns and ample fiscal stimulus. Bans should “break the curve” and prevent mass hospital admissions, while fiscal support keeps those stuck at home afloat.

Whether this was a good policy mix has been investigated for decades. But early evidence suggests that pairing lockdowns with fiscal generosity is quickly becoming chaotic.

A paper by four economists (Alan Auerbach and Yuriy Gorodnichenko from the University of California, Berkeley, Daniel Murphy from the University of Virginia, and Peter McCrory from JPMorgan) suggest that locking decreases the effectiveness of stimuli. From the paper:

Our evidence suggests that fiscal incentives are indeed more effective in recessions, but not when spending constraints or other forms of economic activity are in place. Lockdowns effectively limit the economy’s ability to absorb a downturn, and no consumption responses are discernible that would contribute to greater general equilibrium effects on government spending.

When you’re stuck at home with businesses closed, that stimulus check can be hard to issue. You can buy a new dress online, but you will likely only be saving the money. In an April-June 2020 study, the authors found no association between government spending and higher local consumption (i.e. buying from your city bookstore instead of Amazon), even in areas with no lockdowns.

When we spoke to Professor Auerbach, he remembered how unprecedented the situation was. While the lockdown / stimulus-check combo may have been a bit self-destructive, the bottom line is that catastrophic economic damage has been avoided.

The lesson – familiar but worth repeating – is that we’ve never been here. We didn’t know what would work during the crisis. We shouldn’t be sure how the rebound is playing out in the markets or elsewhere. (Ethan Wu)

Good read

Some financial advice from Courtney Love.