The ultimate in ‘this time it’s different’? Part 1, China’s building monopolies
By: David A. Smith
At extraordinary speed, as reported in this recent New York Times article about China’s invisible obligations, China is transforming itself from a mainly rural agrarian power into an industrialized and urbanized nation, and doing it with a capital-spending frenzy not seen since America’s Roaring Twenties.
Around the clock, seven days a week, the construction crews burrow to build Wuhan’s $45 billion subway system. One segment snakes beneath the mighty Yangtze River.
“For most areas we dig down 18 to 26 meters,” said Lin Wenshu, one of the planning directors of the Wuhan Metro. “But for part of this line we’ve had to go down 50 meters because there’s high pressure and a lot of mud from the river,” he said. “But the citizens want a subway system, and so we’re going to build it as fast as possible.”
So breakneck is the pace of construction and capital movement that nobody can possibly know what’s going on – though some of us have much more information than others of us, all of us are ignorantly guessing.
There is no question that China needs new infrastructure and transportation networks if it is to meet its goal of transforming most of its huge population into city dwellers. Less certain is whether the country can afford to keep building at this pace, and whether many of these projects will ever pay off in terms of the economic development they are meant to support.
What’s happening underneath Wuhan’s smog blankets?
China is the world’s most booming economy, whose shivers and shocks will affect the globe, and literally nobody knows what’s going to happen, so I’ll keep posting about the flashes of news we get, and speculating on their implications
Construction in Wuhan, from the Times slide show
Building Boom in China Stirs Fears of Debt Overload
Wuhan, China — In the seven years it will take New York City to build a two-mile leg of its long-awaited Second Avenue subway line, this city of nine million people in central China plans to complete an entirely new subway system, with nearly 140 miles of track.
And they may well, China’s laws regarding private property rights and eminent domain and community process being spectacularly more development-friendly than America’s.
“If China’s good at anything, it’s infrastructure,” said Pieter P. Bottelier, a China expert at the Johns Hopkins School of Advanced International Studies in Washington. “But right now it seems the investment rate is too high. How much of that is ill-advised and future nonperforming loans, no one knows.”
Selling vegetables at roadside in Wuhan
And the Wuhan Metro is only one piece of a $120 billion municipal master plan that includes two new airport terminals, a new financial district, a cultural district and a riverfront promenade with an office tower half again as high as the Empire State Building.
A booming state capital along the Yangtze and Han Rivers
The construction frenzy cloaks Wuhan, China’s ninth-largest city, in a continual dust cloud, despite fleets of water trucks constantly spraying the streets. No wonder the local Communist party secretary, recently promoted from mayor –
When moving from mayor of China’s ninth largest city to becoming local Communist party secretary is presented as a promotion, that tells us something profound about where the power lies in China.
– is known as “Mr. Digging Around the City.”
I’m Ruan Chengfa, but you can call me, “Mister Dig”
In a speech in February, he said, “If we want Wuhan to have leapfrog development and enhance people’s happiness, then we must build subways and bridges.”
Tunneling to happiness?
The plans for Wuhan, a provincial capital about 425 miles west of Shanghai, might seem extravagant. But they are not unusual. Dozens of other Chinese cities are racing to complete infrastructure projects just as expensive and ambitious, or more so, as they play their roles in this nation’s celebrated economic miracle.
Thousands of candidates entering a Wuhan university for their postgraduate entrance exams; China’s 2010 exams attracted 1,400,000 applicants
For the last decade, as economists have sought to explain China’s rise, a popular image has emerged of Beijing technocrats continually and cannily fine-tuning the nation’s communist-capitalist hybrid. But in fact, city governments often work at odds with Beijing’s aims. And some of Beijing’s own goals and policies can be contradictory.
As a result, China’s state capitalism is much messier, and the economy more vulnerable, than it might look to the outside world.
I’ve previously chronicled the dynamics of local government and state-owned development companies and their gleeful borrowing to finance building, but there can be no denying the extraordinary physical accomplishments, which show growth on a scale not seen since the late 1800’s Gilded Age in Europe and America.
Those were the good old days, weren’t they?
In the last few years, cities’ efforts have helped government infrastructure and real estate spending surpass foreign trade as the biggest contributor to China’s growth.
Richard Poplak of the South African Daily Maverick, in an extremely snarky and incisive article entitled Woo! Han!, describes it in more colorful terms:
The kind of mega-building endemic in Wuhan, also known as fixed asset investment, has powered the Chinese economy since the eighties. (And you thought it was exports? Shame.) It was especially necessary during the crash, when Beijing power sprayed even more renminbis into infrastructure. Now, Beijing is trying to manage growth to keep inflation under control.
We’ve already seen that Chinese economic statistics are highly questionable, making any analysis of China’s economy speculative at best.
As municipal projects play out across China, spending on so-called fixed-asset investment — a crucial measure of building that is heavily weighted toward government and real estate projects — is now equal to nearly 70% of the nation’s gross domestic product.
It is a ratio that no other large nation has approached in modern times.
This one small chart speaks volumes
The capital flows in China are twice as big as the rest of the economy put together. It’s as if China is willing itself to grow, by spending money at a prodigious rate on infrastructure, not consumer demand. This is a trillion-dollar bet that consumer demand will follow the expanding urban infrastructure.
Two years ago, Ken Rogoff co-authored a terrific book, This Time It’s Different, chronicling eight centuries’ worth of pricing bubbles and the rationalizations used to justify them.
It’s never been totally different yet
Rogoff and Reinhart’s gloomy theory (they don’t call it the dismal science for nothing)? It’s never different. That applies to China.
Kenneth S. Rogoff, a Harvard economics professor and co-author of “This Time Is Different: Eight Centuries of Financial Folly,” has studied China’s boom. He predicts that within a decade China’s lofty property bubble and its mounting debts could cause a regional recession in Asia and stifle growth in the rest of the world.
“With China, you have the ultimate ‘this time is different’ syndrome,” Professor Rogoff said. “Economists say they have huge reserves, they have savings, they’re hard-working people. It’s naive. You can’t beat the odds forever.”
Rogoff and Reinhart have to be right:
There are growing signs that China’s long-running economic boom could be undermined by these building binges, which are financed through heavy borrowing by local governments and clever accounting that masks the true size of the debt.
I’m an accountant, and I won’t tell you anything
The danger, experts say, is that China’s municipal governments could already be sitting on huge mountains of hidden debt — a lurking liability that threatens to stunt the nation’s economic growth for years or even decades to come.
Like the Wuhan subway builders, we’re about to start digging deeply into the4se figures, because they become more alarming the deeper we go, starting with another New York Times article (June 28) on local debt risks:
Shanghai — The head of China’s national audit office warned on Monday that the country was facing growing risks because of a sharp rise in local government debt and poor controls over borrowing by investment companies set up by municipalities, provinces and other bodies.
Liu Jiayi, the top auditor in China, said on Monday that at the end of last year local government debt had reached $1.7 trillion, or about 27% of the nation’s gross domestic product. He said better regulation was needed to manage the debt risks.
In English or in Chinese, better transparency is worthwhile
Just as overborrowing is contagious, so too is default, as the observant herd responds to how the early defaulters are treated, and the latte almost always follows the former, as it fairly clearly has done in China:
That survey said local governments had created 10,000 investment companies to borrow money from banks, mostly to finance ambitious infrastructure projects. (China does not allow local governments to issue bonds to finance projects.)
I have yet to write a primer on special purpose vehicles, which are simply legal entities tasked with doing only one thing (usualloy raising money to finance a particular property).
Sit up straight when you see an SPV box
They’re useful legal tools, but they’re also convenient devices for stashing leverage and liabilities, as the Enron boys demonstrated to our sorrow.
Should have had a special purpose getaway vehicle: former Enron CFO Andy Fastow leaving prison
After all, if it’s in its own special box, how dangerous can it be?
Are you worried?
Last week, Charlene Chu, an analyst at Fitch, the credit ratings agency, said China’s growth had recently become too reliant on loose credit and that “easy money” was helping fuel inflation and a property bubble, according to a presentation she delivered at a global banking conference in Hong Kong.
Ms. Chu reports a 60% chance of a Chinese crisis within three years, because
Factors that have led to previous crises are all there:
State owned banks lending to state owned companies [No moral hazard risk there! – Ed.]
Ms. Chu also reports ‘anecdotal evidence’ that developers are running into funding difficulties – and as we saw in the US, when the music stops, it can stop very quickly.
[Continued tomorrow in Part 2.]