1. Could you please tell me what you mean when you say “art of the increase in bank lending consisted of putting back on balance sheet loans that were taken off balance sheets”?

I heard (from you or Yves or Sester) they kept loans off-balance sheet by by structuring them to wealth management products and selling them to depositors.

Now, if the banks are putting this back to balance sheet, that means they are buying them back from depositros. However, this is logistically very difficult not to mention the difficulty of setting prices. I do not think this is realistic.

2. About your reader’s input that part of the loan growth is “an accounting exercise, clearing or otherwise funding non-bank debts piled up by SOEs”:
This still contributes to growth because the employees and suppliers of SOEs who did not get paid before now received cash and they can spend now. if you look at SoE’s balance sheet, there is no difference, but there are clear beneficiaries here.

A lot of my thinking revolves around what I think is the fundamental economic mistake that has been made over the last few years, which is the adoption of what I would call “monetarism” or “Greenspanism.” This belief is the idea that governments should be responsible for only managing high level abstract quantities such as interest rates and government spending, and should not and in fact cannot “micromanage” the economy. The monetarist philosophy is basically that governments should just sit interest rates and let the rest of the economy do its own thing.

The big problem with this is that if you view things like interest rates and government spending as the *only* variables that a government can control, you find that you don’t have enough flexibility to avoid big problems.

For example in China right now, if you argue that the only thing the government can control is the supply of money, you’d be forced to make a decision between understimulating the economy or having large numbers of NPL’s in the future. But I’d argue that you have this dilemma because you’ve intentionally reduced the controls that you have to just changing the money supply. Once you realize that you have other controls, then the dilemma is smaller.

Take what happened to the United States in 2001-2002. Yes it was necessary to cut interest rates, but I think that the mortgage bubble and NPL problems could have been avoided with tighter regulation. The reason that there wasn’t tighter regulation, was the belief that the “market knows best.” However, this belief ignores the fact that the dynamics of the market is heavily influenced by the state anyway. The US financial system was designed to put lots of credit into residential housing so any new credit would have gone there unless you took some active regulatory steps to avoid this.

Similarly, the Chinese financial system is currently biased toward providing capital toward SOE’s, and if you just increase credit and do nothing else, you are likely to end up an overabundance of heavy industry in SOE’s. If you are a supporter of “Greenspanism” then your only choice is to reduce credit and contract the economy, at which point people start to riot. However, I’d argue that this dilemma happens only because of limitations you’ve imposed on yourself, and that the solution is to increase credit and figure out ways to “micromanage” things so that this credit doesn’t result in heavy industrial factories. For example, increase credit while at the same time taking dividends from SOE’s and issuing capital budget restrictions.

Having said that, it is very encouraging that everyone is worried (justifiably) about future NPL’s rather than a collapse of the banking system now. One thing that makes things difficult for US policy makers is that they have to deal with a collapse of consumer demand and a banking system crisis at the same time, and these two crises are interacting.

In China’s case, the major crisis right now is the collapse of export industries leading to migrant worker unemployment, and having banks that aren’t already broken and companies with large cash reserves increases the number of options available.

Much of corporate retained earnings exists in the form of bank deposits, some of which are set aside as reserves, but other parts are made available for investment.

A. West: And if you have overcapacity today, why would you borrow to invest in creating more capacity tomorrow.

If you have overcapacity, you wouldn’t create additional capacity in the same thing. But if you have retained earnings, you can start new lines of business, or else if you have nothing else to do, you just keep the cash in banks, and let them redeploy the capital.

One note is that corporate forms are usually rational responses to financing constraints. US companies in the 21st century tend to focus on core competency because they get ready cash from the securities markets and there is no need to redeploy cash to and from unrelated businesses.

Chinese corporations tend to be conglomerates because they depend on retained earnings for finance and this structure makes it easier to redeploy capital. In this the tend to resemble US companies of the 1960’s.

A. West: I don’t think government “investment” can match the levels of investment the semi-private sector reached in past years.

I don’t see why not. The only thing that would prevent massive investment is budgetary limitations, but wise investment can increase long term tax revenues. A lot depends not on the amounts of investment but the types of investments, and there is no lack of things in China that would be improved if money was spent on them. In particularly, there is a major lack of public goods in China in health and education. Also there is a huge lack of investment in small and medium enterprises and service industries.

Loo: Building excess inventories again at this point in time when the market is still very weak is a very dangerous ball game.

At that point the thing to do is to drop money from helicopters so that people buy up excess inventories. Building up inventories *is* dangerous since it only buys time, but keeping people employed for six months is no small thing in a crisis.

Northern China at the moment is having the most severe drought since 1951 which spreads over 300 million mu of agriculture land. Water i.e rain is strategically important and if it doesn’t come quickly China economy will be seriously hit again after the Snow Storm in the south and the earthquake in Sichuan.

I would therefore consider the drought as “The Third Wave”, the snow storm as “The First Wave” and the earthquake as “The Second Wave”.

Based on the above observation I am of the opinion China will not bottom out until the drought in north is over.When it will be over is a six million dollars question. It can drag until the next Spring in 2010. I very much hope this will not be the case. Let’s keep our fingers crossed.

Having said that, however,beginning February 4 the Spring equinox has arrived and it is time to have rain. If rain doesn’t come by March 15 then it will be a big problem. Once again “Beware The Ides of March”.