Central bankers usually give dull and opaque speeches. Former US Federal Reserve chairman Alan Greenspan once warned that “if I turn out to be particularly clear, you’ve probably misunderstood what I said”. So it was a big surprise last week to hear the outgoing chairman of the People’s Bank of China “come as close to someone in [his] position can… to yelling ‘fire’ in a crowded theatre”, says John Authers in the Financial Times.
He warned that excessive optimism could lead to a sharp correction, “what we call a ‘Minsky moment’”; China needed to be on its guard. Hong Kong equity investors were clearly terrified, with the index posting its worst daily fall this year.
US economist Hyman Minsky posited that stability begets instability. In good times people become complacent, and overconfidence prompts the financial system to take on too much risk and leverage as speculation becomes rampant. The cycle reaches a stage of “Ponzi finance”, when the credit bubble reaches its final expansion and then bursts, sending shock waves through asset markets and the economy. The Asian crisis of 1997, the Russian default in 1998, and, most significantly, the global meltdown of 2008-2009 are textbook examples. Is China due one too?
Its overall debt (household, government, corporate) has ballooned from under 150% of GDP to over 250% in a decade. As the world economy cratered in 2009, the state stimulated a lending spree to make up for the loss of export markets.
But a Lehman-style Minsky moment is unlikely. As the government controls the banking system, it can force banks to keep lending, buying itself breathing space to attempt an orderly deleveraging. There is little foreign portfolio investment in China, and it is difficult to move it quickly, adds Mohamed El-Erian on Bloomberg. So China isn’t vulnerable to a panicky sell-off of bank assets by foreign investors.
Moreover, the state “has the space on its balance sheet to clear up bad debt and recapitalise the banking system”, reckons Pantheon Macroeconomics. Public debt is relatively low; most of China’s borrowing is by companies. But while a big bang should be avoided, China could still be vulnerable to a long, slow decline as debt saturates and chokes the economy.
Already “it takes China too many units of debt to generate a unit of growth”, says El-Erian. The more this goes on, the harder it becomes to generate the income required to service the existing debt. Ongoing structural reform and liberalisation of the financial sector should attract capital from abroad and generate new domestic dynamism to keep this spectre at bay. Otherwise, China could suffer a Minsky decade.