Is Bubble Reinflating the Right Way to Go?

Here are excerpts from a Caijing Magazine news article entitled "China’s Loan Binge: Stimulus or Insanity?":-

"China's banks approved a combined 4.58 trillion yuan in new loans during the first quarter – a remarkable cash surge equal to the total amount of bank lending for all 2008. It shocked some to see the credit floodgates open smack in the middle of a global financial crisis. Even more surprising was that, a month into the second quarter, lenders were showing no sign of letup; neither the market nor government policies appeared to be putting on the brakes."

"Most local governments set criteria for regional branches of the big banks. For example, they decide how much the banks should provide to support local economies, making these evaluations public on a regular basis and, thus, putting pressure on the banks. But pressure from the central government in Beijing may be even greater. According to a local branch executive at a state-owned bank, local branches have been asked by central authorities to increase lending several times since the beginning of the year."

"Chinese banks have not followed the path of overseas markets, where lending has been cut or frozen. Their extremely active lending quarter has shielded the Chinese public from feelings that a recession is under way. Public confidence in the economy has even strengthened in recent months. Yet many bank executives and regulatory officials interviewed by Caijing expressed concern over the efficiency and effects of the lending spate, as well as its impact on economic structural adjustment.

'Will the economic stimulus plan disrupt the self-adjusting nature of the economic cycle?' asked a state-owned bank executive. 'The biggest contribution made by an economic downturn is survival of the fittest, along with structural adjustment.'

These effects are particularly clear from a microeconomic perspective. A source close to Beijing authorities pointed out that local economies have seen overcapacities in some industries and have faced rising pressure due to excessive inventories."

"Several bankers told Caijing that many local banks have been under pressure to issue loans for local projects in response to the central government's economic stimulus plan. Now, some fear that cash may have been misappropriated. Such abuse could be tied to bank loans issued to meet local liquidity needs, to back letters of credit, and for buying securities. Moreover, a corporate banking executive said some big enterprises have been known to concentrate capital by pooling their loans and recycling the cash. When that happens, banks lose control over the direction of their loans. And when big companies are unwilling to increase capital investments, citing concerns about the economic cycle, borrowed money is likely to flow into the stock market and real estate for speculation."

The following are excerpts from an article entitled "Bulls, Not Bears, May End in Tears" by Caijing Magazine columnist Andy Xie, who was Morgan Stanley’s Chief Economist for Asia Pacific from 1997 to 2006:-

"But this is a bear market bounce that will end in tears. What will bring it down will be the likely torrent of new issues. Banks that report good earnings and speak about recovery will probably try to raise massive amounts of capital, taking advantage of the market rally, to weather the long winter ahead. IPOs will swamp emerging markets. Money flowing from bullish investors will become the winter clothing for distressed banks and companies."

"Many who argue for a bull case are actually hoping for another bubble. The thinking is that if enough people believe in the bull case, their money keeps it going, rising asset prices support demand growth, corporate earnings improve, and the bull case is validated. The hope for another bubble is widespread in the world today. Even policymakers are secretly hoping for another bubble. They all remember how good life was during the bubble. The crisis has weighed down on everyone’s spirits. It seems that ‘doing the right thing’ is just too hard."

"The pain so far is acute but not depression-like. The reason is government stimulus measures are helping businesses and households stay afloat despite their insolvency. As governments exhaust their fiscal and monetary firepower, they are trying to verbally improve investor confidence, hoping that asset markets will improve and economies will follow. Such verbal stimulus is indeed having an impact."

"Property prices are falling and unemployment rates are rising across the world. Temporary euphoria in financial markets cannot reverse that. Reality will eventually extinguish the irrational euphoria. Once inflation rises, it will close the final door of hope – the government bailout. Interest rates can and will rise despite badly performing economies. Only then will asset prices truly bottom out."