China: No Leverage, No Growth

When it comes to the very simplest axiom on modern Keynesian economics, it seems one can’t repeat it enough times: have leverage, have growth… don’t have leverage, don’t have growth. That is the main reason why in lieu of any organic credit growth (total consumer bank loans and leases now are still below the level when Lehman filed), it has been up to the Fed to step up and provide “leverage” into the system, in the form of excess reserves, resulting in $2.5 trillion in excess deposits over loans, or just the void filled by the Fed’s printing of lower powered money. That is also the reason why in early summer, China tried to conduct a mini-taper of its own to streamline its monetary pipeline which had been so filled with bad and non-performing credit, that the PBOC effectively pulled the switch on new liquidity for over a month.

What happened almost immediately after, when rates on ultra short term funding soared to 20%+, nearly destroyed the domestic banking system and resulted in a major slowdown in the Chinese economy. “Luckily” for China, its close encounter with the taper was brief, if quite painful, and following a period of shock, the Chinese central bank had no choice but to resume injecting banks with their daily dose of monetary morphine all over again. This in turn, has brought us to square one: nothing in the local banking system has been fixed, and what’s worse, while China has bought itself a few months respite, the dominant old problem of a collapsing credit impulse, as described before, in the country with the largest corporate credit bubble in the world, is about to come back with a bang in a few short months.

In short: China just did what the US has boldly done so many times before – kicked the can.

But don’t take our word for it – here is SocGen’s Wei Yao with the most succinct explanation on China’s predicament, which can be summarized simply as follows: suffer lots of pain now, or kick the can for a short period of time and suffer far greater pain later. Not surprisingly, China has picked the latter.

No leverage, no growth for China?


Following the surprisingly robust activity data, China’s money and credit growth also came out strongly in August. Particularly, shadow credit bounced back significantly.


M2 growth picked up further from 14.5%yoy in July to 14.7% yoy in August (Cons. 14.6%; SG 14.5%). New yuan loans extended by banks also increased to CNY711bn from CNY700bn, albeit slightly less than expected (Cons. 730bn; SG 740bn). This small miss was easily offset by the strong rebound of shadow credit as well as bond issuance. As a result, total social financing increased CNY1580bn in August, nearly doubling the amount in the previous month, and growth of total credit stock ticked up for the first time in five months.


Entrusted loans added CNY293.8bn in August, which was the biggest monthly increase ever; undiscounted bankers’ acceptances added CNY304.5bn, reversing more than half of the cumulative declines in the past three months; and the net monthly increase in corporate bonds recovered to CNY122.7bn from CNY46.1bn, albeit still well below the average level of CNY230bn during the first five months of this year.


Our call for a very short-lived growth recovery hinges on the expectation that China’s credit growth would continue to decelerate as policymakers aim for (slow) deleveraging. If credit growth picks up persistently from here, China’s current growth recovery may well last bit longer and go bit further. However, that only adds to the downside risk afterwards, as the leverage of Chinese corporates and local governments keeps rising from the already alarmingly high level.


In other words, you are here:

And here:


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