Today is the second day of the dreaded gaokao, the national college entrance exam that more than half of all Chinese kids in their age cohort will sit to determine whether or not they will go to university (just over 60% of the test takers will start college next September) and, much more importantly, which one they will attend. Throughout Beijing anxious parents are standing glumly in the heavy (but cleansing) June rain waiting for their kids to emerge from the exams so that they can pepper them with worried questions. It is a scary time for a lot of people.
In the previous six years the number of students taking the exam has jumped every year, from 5.3 million in 2002 to 10.5 million in 2008. This year, for the first time, the number of students sitting the exam has actually declined to 10.2 million.
The official position is that the decline reflects a drop in the number of 18-year-olds in China, but there has been widespread discussion in the press that the decline was too large to be explained just by the smaller number of high-school graduates, and that in part it reflects fears of rising unemployment among college graduates. College is becoming a less attractive option to some Chinese.
6.1 million college students will graduate this month and, according to the Ministry of Human Resources and Social Security, about 1 million have been unable to find jobs so far. Over the past three years the number of college graduates finding jobs has stagnated even as the number of graduates has surged, even during the boom years of 2006 and 2007. Part of this was caused by the surge in college enrollment, but at least part of the employment difficulties facing college graduates has been blamed on the very poor quality of university education, especially in the new or newly expanded schools, and its failure to prepare students for the kinds of jobs that the market wants.
Over recent months the government has made finding position for graduates, including in the army and as rural high school teachers, a top priority. The front page of today’s People’s Daily has an article citing a speech by Premier Wen Jiabao in Xi’an (in Shaanxi province) encouraging graduates to widen their job search:
Chinese Premier Wen Jiabao has urged the country’s college students to find grassroots jobs in less developed regions as the economic downturn increases pressures in employment market. Visiting Xi’an, capital of central Shaanxi Province, from Friday to Sunday, Wen said employment was one of the government’s priorities for the sake of the country’s economy and for the future of individuals.
“College students, laid-off workers and migrant workers waiting for jobs are my biggest concern,” Wen told job hunters at an employment center. He encouraged graduates from universities and colleges to find work in grassroots regions, and called on employers to create more jobs.
Since the second half of last year, the government has implemented a series of policies to create jobs. The State Council, or Cabinet, also decided to give living allowances to graduates who went to the central and western regions for internships.
Besides exhorting college grads to take the kinds of jobs they usually shun, the government is also still working on boosting growth. The Ministry of Finance recently raised the rebate of export taxes by around 15%, according to another article in today’s People’s Daily. This is part of the move to increase China’s export competitiveness, but I am not sure these kinds of measures are likely to have much positive global impact beyond crowding out export competitors and worsening the global trade environment.
As badly as Chinese exports have been hurt, and exports were down 22.6% year on year in April, Chinese exporters have still done much better than other exporting countries in Asia and elsewhere, suggesting that they have managed to avoid much of the brunt in the contraction in global imports, led by the contraction in the US. This, as I argued in last week’s entry, has as much to do with credit and interest rate policies as it does with any inherent competitive advantage.
Not surprisingly, given these moves, expectations of a rise in the value of the RMB are declining. For the fifth day in a row, according to an article in today’s Bloomberg, the 12 month RMB forward declined, trading currently at 6.714, implying a 1.8% appreciation over the year (because these forward markets cannot easily be arbitraged, they do not price according to interest differentials, as forwards normally do, and so may contain more expectational content that a lot of other forward markets).
Meanwhile an interesting article in always-hard-hitting Caijing worries about the flood of bank credit, and whether borrowers are earning nearly enough to cover interest costs:
Chinese bank lending increased to more than 5 trillion yuan between January and April, nearly three times the credit level reported during the same period last year. Even if new loans average only 500 billion yuan during each of the remaining eight months of 2009, the year’s total would be more than 9 trillion yuan – more than all loans issued over the previous two years combined.
The industrial sector’s recent performance provides solid grounds for concern over this rapid credit growth. A National Statistics Bureau survey of 22 regions found industrial profits totaled only 323 billion yuan during the first quarter, down 32 percent from a year earlier. That means annual profits for all industries will amount to only about 1.6 trillion yuan this year.
Outstanding loans currently stand at 35 trillion yuan. Assuming companies have kept a moderate debt ratio averaging less than 50 percent, their capital investments now exceed 35 trillion yuan. And profits of 1.6 trillion yuan versus 35 trillion in capital investment means an annual return rate of only 4.57 percent, below the weighted loan interest rate of 4.76 percent we saw in March. In this sense, companies seem to be in a rather weak position to finance debt with earnings.
Although the writer of the piece, economist Lu Lei, thinks that continued expansion in the banking system creates enormous risks, he doubts that the PBoC will put the brakes on bank lending for a number of reasons, the most important being that commercial bank lending is at the heart (and lungs and nearly every other organ I can think of) of the fiscal stimulus program, and without it, there is no stimulus.
Looking at tax revenues, local governments nationwide were unable to collect as much in the first quarter as in the same period 2008. In fact, tax receipts fell 1.4 percent, in sharp contrast to the 34.7 percent increase posted a year earlier. Cursed with double pressure from a directive to invest and shrinking revenue, local governments have had every incentive to use banks as financing proxies.
Now we’re faced with the possibility of undesirable negative GDP growth. Banks, concerned about defaults, may grant only 300 billion yuan in new loans every month for the rest of the year. So we’re stuck with a painful choice between two losing scenarios: a more moderate monetary policy that would cripple fiscal policy, leading to an outright “hard-landing;” or continuing a loose monetary policy backed by fiscal spending, which risks future loan losses and a weaker market. To get around the problem, the central bank may be forced to fill holes at banks by pumping in money, in effect imposing an inflation tax on all consumers
Lu lei’s “painful choice” is exactly right, and what an inevitable worrier like me has been worrying about since last summer. In January I wrote about this “all but the kitchen sink” policy, of throwing everything they can into stimulating the economy, and said that although this would certainly result in higher than expected growth this year, it would come at a real cost. I wrote:
This strategy may be politically necessary but ultimately represents a gamble on the duration of the global slowdown. If the duration is short and the slowdown light, it will have been a winning gamble, and once the world takes off again China can get serious about resolving the internal imbalances.
Of course if the global slowdown is long and deep, the gamble will have failed. That means, dear readers, that if Chinese GDP growth in 2009 is higher than I projected – say 8% – I will not whip out the party hats and favors. Instead I will immediately begin whining about the state of the banking system.
To make matters worse there is a story that appeared a few weeks ago in an article in Australian newspaper The Age, warning about something that has been much discussed over the past year, that the fiscal stimulus package, or more precisely, the way it is being financed, could lead to rising contingent debt at the provincial and municipal level.
Beijing will have to jam on the economic brakes to save cities from bankrupting themselves, says a top Chinese adviser. He Fan, an assistant director at the Chinese Academy of Social Sciences who frequently advises top leaders, says as much as two-thirds of Beijing’s 4 trillion yuan ($A773 billion) stimulus program will be spent by local governments, financed mainly by state-owned banks.
“Some local governments will virtually go bankrupt,” Professor He told BusinessDay. “Previously, local governments got all their money from selling land. This is not sustainable. Some areas have already sold quotas from the next 30 years.” A number of large cities are thought to be at risk, including Kunming and Hangzhou, with their funding problems exacerbated by a slump in real estate sales.
Professor He goes on to worry that easy money has poured into asset markets as well as questionable projects that were previously rejected by the NDRC.
“Banks have strong incentives to lend to NDRC-approved projects because if they end up as a fiasco, there is no political risk,” he said. “They can say ‘it is not my fault, the NDRC told us to lend’.”
When banks are encouraged to lend huge amounts, and with an implicit guarantee against any losses, it is pretty hard to imagine their not embarking on a wild lending spree. On a related but very different subject, I have been corresponding with Steve Keen, a professor at the University of Western Sydney and someone whose blog I often read and whose unconventional insights I find very valuable and persuasive (the fact that he is an expert in and admirer of the works of Hyman Minsky doesn’t hurt either).
I wrote to him to ask his thoughts on the implications on monetary policy and debt structures of China’s rising savings rate. It seems to me that as savings rise as a share of GDP, this must have dampened the impact of the very loose monetary conditions in China over the past several year. If this is the case, and if savings rates do indeed decline in the next few years, there could be important consequences for monetary policy. I plan to think about this a little more and, if I come up with anything interesting to say, I will write about it. Maybe some of the readers of this blog might have some interesting ideas. Steve Keen’s initial response included the following:
Now that the American private sector has stopped borrowing, but both American and Chinese governments are pumping base money into the system, and American consumers and businesses are desperately trying to delever, the dynamics alter considerably. But I expect the overall result will be a relative fall in the Chinese “savings rate” and a rise in the American one.
Obviously I think looking at this from the point of view of savings rather than debt is why we haven’t worked this out to date. A lower consumption rate is definitely part of it, but the debt flows themselves-which generate the monetary flows that then accumulate in accounts depending on consumption rates–are the driving part of the story, not the consumption rates themselves.
You indicate that the Chinese are continuing to subsidize their export-driven model. That seems to imply that there is little chance that the Chinese will refuse to buy US treasuries since that is part of the export model they have used.
Is this correct?
Great post.
I was wondering how much of the dramatically increased personal “savings” in the U.S. isn’t really people saving more, just unable to borrow as much. Even people who are making their debt payments are having their available credit reduced. The jump in unemployment has credit card issuers very worried.
Another point on U.S. personal savings. The numbers released for April showed disposable personal income up 1.1% (an annual rate of about $125B). This was almost all increases in benefits like unemployment extensions and tax cuts from the stimulus bill. In fact, this accounts for a lot of the personal income effects from the bill.
Yet personal spending FELL .1%.
http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm
…and that was before the 25% jump in gasoline prices in May.
Michael,
I might to say thanks for the post, as usual, very insightful.
Hi Michael,
You mentioned that the fall in export has been less severe in China than in other export-dependent countries. I wonder if it is indeed the case. If you look at the year-on-year fall in exports, China’s has certainly fallen less than other countries in northeast Asia. However, I don’t have the statistics with me, but my gut feeling tells me that exports in China have grown faster in recent years than those of its neighboring countries. Therefore, I wonder if the the year-on-year change in *growth rate* of exports in as large in China as it is in other north east asian countries. I would imagine that a lot more export capacity has been added in China in recent years than say, Taiwan, Korea, or Japan…
“Assuming companies have kept a moderate debt ratio averaging less than 50 percent, their capital investments now exceed 35 trillion yuan. And profits of 1.6 trillion yuan versus 35 trillion in capital investment means an annual return rate of only 4.57 percent, ”
In 2008 fixed asset investment was 3.5 times bigger than total loan growth (altough included depreciation), so this number might even be 1.6 trn versus 70 trn…
“As badly as Chinese exports have been hurt, and exports were down 22.6% year on year in April, Chinese exporters have still done much better than other exporting countries in Asia and elsewhere, …”
Could a reason for this be that China is exporting in average more cheap products than other countries? If people are getting poorer because of pay cuts or because they are loosing their jobs, they will rather buy cheap products than expensive ones. And formerly relative rich people may be now also buying cheap things which they in the past wouldn’t buy. And of course it is often already enough that people are afraid about the economic situation and try to spend as less as possible.
A proprietor of Aldi, a cheap supermarket chain, said sometime in the past something like this: “When people are having a bad time, it is good for us.” I think the same principle could be here true, too. Exporters of cheap things will have it easier to sell their products than the exporters of expensive things.
I don’t know what all kinds of countries in Asia and elsewhere are exporting and especially I don’t know how big their share of cheap products is, but I guess that for example Japan and Germany will surely have a bigger share of expensive products they are exporting than China. It would be interesting if you know, what the other Asian countries, which exports are more affected than China’s, are exporting. Do they perhaps have exported more expensive products than China in the past? Of course not in absolute numbers, just in percentage of their complete exports. For example you could say that one country is exporting to 70 % products you could say are cheap. And another country’s exports only consist of 50 % cheap products.
Hopefully everything is understandable. My English isn’t so good so I can’t really write eloquently.
[...] China: Stimulus – at what cost? – Michael Pettis [...]
Prof. Pettis
I too pity those Gaokao students, i hope they are enjoying the sunny day today better than yesterday’s storms.
About the “implicit” guarantee of the bank lending:
I spoke to the Dongshizhang of BOC about this two weeks ago, he was (not suprisingly as a corporate spokesperson) very dismissive about the chances of lending going bad in his house, stating that their lending is targeted to projects with cash flow. I think you can read similar comments from him in Caijing a week or two back anyway. “There is no guarantee of lending, and none is necessary” kind of thing (for them at least)
Do you think that Local level banks are going to be more at risk of requiring this implicit government guarantee, given their closer ties to local governments? (i heard hints of this during my discussion). I personally think a bit of consolidation at the city bank level would be good for china’s cohesiveness, especially if well regulated.
Some observers have noticed that the central government have been “recentralising” power over the last few years. Is this stimulus and the associated recentralisation of control if local banks / governments need bailing out what some in the central government may actually want? Regionalism in China has been a threat for hundreds of years, especially during periods of economic turmoil.
I remember that the stimulus plan prevented local governments from directly issuing bonds (although my memory is fuzzy).
One last point, in November before the lending picked up, there was talk of “subsidised interest schemes” whereby local governments may take on a portion, or all of the interest burden associated with stimulus lending on certain projects in their locale. Have you heard any more about this? I suspect that it has been scrapped (or at least kept under the table).
Congratulations, Prof. Pettis! You have finally become a prominent figure among Chinese readers without sufficient English skills to understand your brilliant comments in their original language.
This weeks issue of the online version of the Caijing magazine includes a lengthy interview with you titled “??????“???”(China needs more “net consumption”)! The file is accessible here: http://file.caijing.com.cn/flash/pdf/hgzb200900608.pdf
My first impression is that it pretty accurately reflects the views you’ve already laid out on this blog.
I can only encourage you to strengthen your collaboration with Caijing as this is one of only a few rare options to disseminate your thoughts in a relatively unfiltered way to the non-English speaking Chinese audience in China.
Professor Pettis: Thanks again for your insight blog.
Bob in Ma, you like myself may be too impressed by the National Income data that show the impact of tax cuts and benefit increases on US household income and spending.
But, you should also look at the big shift in cash-flow engendered by rock bottom (until recently) long-term interest rates.
As long-term Treasury paper hits record low yields highly indebted households have rushed to refinance their mortgages at the lowest rates in I think 50 years. These cash-flow effects are probably greatest in the USA and UK where household gearing is highest (these data are in the OECD/IMF World Economic Outlook). This impact will also vary according to the proportion of fixed vs. variable mortgages and consumer/corporate debt.
All in all, I guess that the reflationary impact of cheap US/UK money (including wealth effects via putting a floor on asset prices) is far greater than their fiscal stimului. Next to zero short-term rates are also conducive to recapitalising the banking system (via a positive yield curve) as you don’t need to pass spending bills through Congress/Parliament to bail out nasty bankers — you just tax your kids and unborn grandchildren — as well as passive foreign holders of your sovereign debt. best regards James
Quote Michael: “It seems to me that as savings rise as a share of GDP, this must have dampened the impact of the very loose monetary conditions in China over the past several years.”
I would argue that a very high savings rate implies a lower equilibrium real interest rate, all other things being equal.
Because somebody needs to be willing to pick up all those savings and invest them in something, and the only way to get enough investment demand to match those massive savings is via low interest-rates to make investments of all kinds seem cheaper.
Otherwise, there is not enough overall demand, and the economy will contract.
[...] Pettis, quoting Lu Pei, an economist writing for Caijing. And that while companies seem to be in a rather weak position to finance debt with earnings. The banks may continue to pump money into the economy, putting up with defaults and inflation [...]
Jen’s point seems correct. We import cars and expensive electronics for Japan, Korea and Taiwan. But From China we import all sorts of everyday items. You can put off buying a car, but not shoes for your children.
Chan-Lee James, if the refinancing were spurring consumer spending, and hence inflation, why did personal spending fall when personal income rose? When people here were serially refinancing in 2002-7, personal spending rose faster than personal income, and we even had a negative savings rate some months.
I would say categorically the current rise in commodity prices is not spurred by demand in the U.S., there are no inflationary pressures here. The people refinancing to save $100/month are saving that money, trying to repair damage done to their assets last year, or just get their mortgage payment to a more affordable level.
The problem for the U.S. is that we have none of the positive benefits of inflation (rising income relative to debt levels), but the negative consequences of a perception of future inflation: rising rates and commodity prices. The main mortgage bond here has gone from a yield of 4% to 5% in less than a month. That raises the monthly payment of a new home buyer by 10% and is nipping the refinancing boom in the bud.
Meanwhile, gasoline prices are up 25-30% since the beginning of May. Even after seasonal adjustment, that’s about $5-6B/month and wipes out a lot of the stimulus tax cut.
Krugman is right, there is no threat of inflation anytime soon. But he is wrong to discount the fears of those who have to worry about the longer term, like bond holders and big consumers of commodities.
While the thesis behind using borrowing and profit figures to determine interest coverage is sound, I take issue with the annualization of first quarter profits. Given that the first quarter includes the New Year and is seasonally a slower quarter, I think it would be more reasonable to multiply Q408 and Q109 figures by two to get an annual estimate, or better yet assume the same Q109 contribution to the year’s total as in previous years and extrapolate from there.
Bob_in_MA. I agree with what you say about US household spending being weak. That said, US household income has been substantially boosted by lower interest rates, which is a big channel of monetary policy. The fact that households are saving this increase in cash-flow is un-surprising given the drop in asset prices and weak balance sheets.
The issue you raise about commodity prices is vexing. If recent sharp rises are sustained that means a big transfer of net wealth to oil and other commodity producers. But given their recent dire straits, this may perhaps have a smaller impact on damping world aggregate demand than in the past?
The killer question you raise is: “the future path of US long-term interest rates”? If the recent rise is a “normal” cyclical response to higher growth (the Fed’s line) then the game plan holds; but if it is rising inflation expectations — then buckle your seat belts! regards James
Hi Mike,
i met you several times in Beijing back in 2007/08, albeit very briefly.
Was interested in the hunch that Gaokao numbers have fallen. We really need some good quant analysis on this. However, there are alternative theories on why the rate has dropped.
1970 saw the intro of the “late, long, few” policy, the voluntary pre-cursor to the birth control policies enacted in 79/80. Interestingly the govt suggested that the number of gaokao students is set to fall further next year (by almost twice the amount it has fallen this year). However, the Chinese are nothing if not meticulous and its hard to believe they would miss something like this.
The other is that, with much lower exchange rates, many students could be looking to get a cheaper degree overseas. Though it is hard to see an extra 300k students applying to UK, US, Canadian, EU, OZ&NZ uni’s (but possible that this explains at least some of those).
I just cannot buy this argument based on high graduate unemployment.
Michael, savings is debt. The whole game is nonsense, as the savings balance of one person or one group is created out of the debts of another group. Only the government doesn’t recognize their debts as real, but they are very real. In any case, if you take your cash and put it in a hole in the ground, it is in the form of notes, which are secured by borrowed funds. If you put it in the bank, it is secured by a liability the bank has already created. The credit crunch was basically 2 or 3 really large banks that so exceeded their deposit attracting capacities by their lending that they couldn’t borrow enough to balance the books. Outside of commodity money, if you can present any increase in savings that isn’t backed in some fashion by more debt, show me. The only solutions to this problem are fraudulent promises to pay. The solutions right now are nothing but more bubbles.
Michael,
When you say that the Chinese don’t have an “inherent” competitive advantage, I disagree. It’s partly a semantic issue, but one that I think is important to understand. The Chinese have a competitive advantage in that they are, at this stage of their development, willing to work more for less.
Let’s take the case of a Chinese exporter and his workers. Nominally, they are paid $100 for their services. But in reality, the economic cost is less. Ordinarily, the value of the USD would fall. But, at the micro level, they take the $100 and save almost half of it. Then, at the macro level, govt policy purchases US dollars to keep costs down for the US consumer. In other words, China does have a competitive advantage not because Chinese are inherently better at producing certain goods/services, but that some people are willing to work 10-12 hour days, then squirrel away their money to do effective vendor financing and fund top-rate infrastructure (billions for coastal ports, but how much for rural healthcare?). My point is that where you see some of this “inherent” competitive advantage implemented is at the macro level.
Of course, it is also obvious (as you have pointed out) that macro policy also influences micro behavior. But I believe it is like most chicken-and-the-egg problems — it’s nearly impossible to say that one “causes” the other but as is often the case, both micro and macro go hand in hand.
Certainly, the key takeaway is that government policy NEEDS to shift and indeed HAS artificially boosted household savings rates, BUT I believe the savings rate would still be high if you note the cultural ethic and savings mentality of your average Chinese household.
I hope this has not been a mindless exercise in semantics.
-Randy
Michael, I now am running my own blog http://nemoincognito.blogspot.com.
Hey Michael,
Your interpretation of the People’s Daily article seems to be a little off – rather than “raising the rebate of export taxes by around 15%” the Ministry of Finance actually shifted the rebates up by about 8% on average.
Although the export tax rebate on some goods climbed to the maximum of 17% (i.e all of the export tax was refunded), other goods had a lower percentage of the tax waived. According to a report in this week’s Economic Observer, The composite rate increased from 12.4% last time the rate of export rebate was raised in April to 13.5%.
Summary of article referred to available here: http://www.eeo.com.cn/ens/Today_Media/review_print/2009/06/09/139702.shtml
Regarding the drop in gaokao takers:
If I understand correctly, the typical age for the gaokao exam is 16-17. And China’s population pyramid does suggest a significant drop in the number of 16-17 year-olds (the pyramid I have at hand only shows a breakdown into five-year-brackets, but the current 15-19 year bracket appears to be much smaller than the 20-24 year bracket). So at first glance, the “there are simply a lot fewer teenagers around” argument sounds like a valid point.
[...] Stimulus – at what cost? [...]
I have heard 3 arguments for this gaokao drop.
1 – slight population dip anyway
2 – Unemployment amongst graduates
3 – The exam changed. So those who would normally have retaken the exam (cos they messed up last year) have not done so on the usual scale – the textbooks etc changed.
Mike,
Any comments about the latest FDI stats?
http://tinyurl.com/nj5duo
Carlo
[...] Also, if you have the time to indulge on more reading, here’s another interesting article from Professor Pettis. Stimulus – at what cost? [...]