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My article in last week's edition of BusinessWeek on the massive problems facing Chinese banks, whose nonperforming loans total an estimated $700 billion, drew some strong responses. Before getting into one in particular, let me explain the issue in a nutshell. China isn't acting quickly enough to clean up the bad debts that have made its biggest banks technically insolvent. The problem is camouflaged by high investment rates, especially in infrastructure, but the slow pace of lending reform is sowing the seeds of bigger problems in the future (see BW, 11/25/02, "Are China's Banks Caught in Quicksand?").
Many readers agreed with this article. One prominent skeptic about the soundness of the Chinese economy posted it in a China-watchers' chat room with the heading "BusinessWeek finally gets it." But some doubt that the situation is as bad as I said it is. They wonder why China should take action. The country seems to be doing just fine, recording high economic growth in recent years. They raise some interesting points but also showed a lot of muddled thinking about why a decade of growth spurts doesn't make for a sustainable long-term economic model.
Here are some edited excerpts from one lengthy e-mail, apparently sent by an ethnic Chinese man living in New Jersey. (My correspondent's remarks are in italics.):
In a communist financial system, money issued by the government to state institutions needn't be regarded as loans. It needn't be repaid, but won't cause inflation because wage-and-price controls are in place. One cannot force capitalist accounting methods onto a communist financial system.
My correspondent has the first part right: Chinese banks lent money and didn't expect to be paid back. That's the root of the problem. To print money and just give it out isn't a recipe for a healthy economy. It's a recipe for disaster. It recalls the joke that used to circulate among Soviet workers, "They pretend to pay us, and we pretend to work."
China's challenge is to move from a planned economy (call it communist, call it socialist, I think it's a mess) to a robust market one. This is a goal that Chinese leaders have made very clear. No banker in the country today thinks credit he extends to other state institutions is anything but a loan. If he's lending money without the expectation of getting paid back, he's liable to be summarily fired (or executed, if corruption is involved, which is still too often the case).
True, the government retains the right to impose wage-and-price controls, but the practice has withered. Most prices in China are now set by the market. Inflation isn't a problem, thanks to massive investments in new factories in recent years. If the West cannot, as my correspondent says, "force capitalist accounting methods onto a communist finance system" then forget about development in China.
Instilling capitalist accounting methods is precisely what Chinese leaders are trying to do. That's why Premier Zhu Rongji made a rare visit to Hong Kong this week, to give a keynote address at a world accounting convention in which he underlined the importance of sound accounting -- and he wasn't talking about the communist kind.
The U.S. itself had a bad-debt affair, the savings-and-loan crisis, and solved it in a similar way, by offloading the bad loans onto sacrificial companies.
As noted in the article, China's best bet would be to follow the U.S. model. That's what the asset-management companies were designed to do. But they haven't made good on their promise.
One scary difference between the U.S. and China is that the S&L crisis ended up costing the U.S. about $160 billion, equivalent to about 3% of annual gross domestic product. By contrast, writing off China's bad debt is likely to cost closer to 40% of annual GDP, or $500 billion. And the longer China delays, the higher the final price tag is likely to be.
Even if China's bad debt had to be repaid, the debt -- like Japan's and, I believe, Italy's -- is internal. That is, it is owed by some Chinese to other Chinese, but doesn't impact on China's external position. The Chinese are avid savers, saving upward of 25% of income. China's banking system is flush with liquidity. In fact, China is now a net capital exporter with the central bank holding $250 billion in foreign reserves.
Absolutely. The burden will fall squarely on the shoulders of Chinese taxpayers, and it's unlikely to spark an international crisis, at least if it's dealt with in the next several years. (Economists are debating whether China's international borrowings will increase in the coming years, so it's too soon to dismiss the possibility of an international crisis.)
It is a burden, however. The average American paid about $640 to clean up the S&L mess. Because China's population is bigger, the average Chinese will pay less, just $380. But $380 is a lot of money in China. It's roughly half of per capita annual income. For many farmers, it's more cash than they make in a year.
Because domestic government borrowing is relatively low, China can afford to pay off this bad debt, though I doubt Chinese taxpayers relish the thought of getting hit with higher taxes to bail out the banks. And the longer they wait, the steeper the bill.
Let's not forget that China isn't a net capital exporter, despite the common perception. It has high reserves, thanks to massive foreign direct investment (totaling over $50 billion this year) and healthy trade and current-account surpluses. But those reserves won't help in the event of a domestic-banking crisis.
The article, while condemning China's communist method of funding state institutions, should acknowledge that such financing had produced a more equal society in the world compared with other developing nations.
This reminds me of the saying popular during the chaotic, destructive years of the Cultural Revolution (from the mid-1960s until the mid-1970s): "It's better to have socialist trains that are late than capitalist trains that run on time." That way of thinking went out of fashion when the notorious Gang of Four, who had set the country's development back decades, were jailed in 1976.
I don't think everybody being poor together is the best way for China to take its rightful place among nations. What I do know is that 200 million people have been pulled out of absolute poverty since economic reforms began in 1978. That's a good thing for China and the world.
However, reforms have worsened things for many millions of other Chinese. Widening income differentials are on the rise in China. The Gini coefficient, which measures income inequality, stands at 0.40 in China, while in the U.S. it's about 0.34 (a higher number means more inequality). It will be interesting to see how China's new leaders balance the need for growth with the rising problems of poverty and inequality.
The so-called safety net demanded by Western experts seems to be the dole, whereas China's government is ensuring that, despite layoffs at state factories, public-works projects will maintain the employment level. The hidden message of the article is, "Let them be unemployed and on the dole."
The perception of this subtext comes up often in conversation: Many Asians think the West is trying to keep them down. Increasing numbers of Chinese are shedding this misconception, but the message doesn't seem to have reached New Jersey. For the record, I think thorough and rapid reform does more to promote growth than half-hearted measures that allow the cancerous rot of bad debt to keep spreading.
Zhu Rongji's audacious plan to spend heavily on infrastructure, or public works, over the past five years may go down as a masterstroke. It's a difficult balancing act: Can these projects stimulate enough new growth to generate the tax receipts needed to pay down the expanding government debt? That's still unknown, but I don't think Zhu can be faulted for trying.
China's dual-currency system, with its internal and external levels, and the nonconvertibility of the yuan, protect the country from foreign-exchange speculators associated with the Clinton Administration who precipitated the Asia Crisis, through which they acquired ownership of many enterprises in the Southeast Asian countries, home of the former economic miracle.
Hold on. China no longer has two currencies -- they were unified almost a decade ago. But yes, fortunately, controls protect China from massive and sudden fluctuations in capital flow. (Interestingly, it wasn't only foreign speculators, but also locals, who rushed to the door in 1997-98.)
I'm not sure how the Clinton Administration precipitated the Asian Crisis, unless it was through the misguided policy of pushing developing countries to open up capital markets far faster than they should have. But to suggest that this was done deliberately to sabotage countries and pick up assets on the cheap strains credulity.
Besides, the foreigners who have come in -- most notably in the banking system -- have helped develop Asia. Foreign bankers look at things like cash flow rather than connections. So they give credit to companies and consumers who can pay them back. That means more economic growth, more jobs, and more wealth.
A senior Chinese Finance Ministry official visited the International Monetary Fund in Washington, D.C., earlier this year. Citing Beijing's figure of 25% nonperforming loans and the goal of reducing that figure by several percentage points a year, the finance mandarin pointed to China's 7% annual growth rate. "You could see where he was going," says an IMF official. "They think they can grow their way out of the problem." But no nation has ever done that. Stronger steps are needed.
Now, I'm not predicting imminent collapse. And I would be happy to be proven wrong. But I will be proven wrong only if China's new leadership team steps up the pace of banking reform. That means getting rid of the bad debt and establishing a new credit culture that makes sure bank loans go to the deserving, not the connected. That would be a true revolution for China.
Clifford is Hong Kong bureau chief for BusinessWeek. Follow his China Journal column every week, only on BW Online Edited by Douglas Harbrecht
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