Monetizing debt does not relieve China’s debt burden
Special points to highlight in this issue:
• China’s GDP was 11.4 percent greater in the first half of 2017 than it was in the first half of 2016, and 6.9 percent greater at comparable prices, implying a GDP deflator of 4.2 percent. This is broadly in line with the prime lending rate for banks of 4.25 percent and with three-month SHIBOR of 4.27 percent, and is well above shorter-maturity SHIBOR rates of 2.7 to 2.9 percent, making Chinese interest rates roughly equal to or less than the GDP deflator and well below nominal GDP growth.
• The relative pick-up in nominal GDP growth and in the GDP deflator reduces the cost of servicing debt in real terms, and so relieves some of the pressure that overly-indebted borrowers face.
• This relief, however, revives a form of financial repression in which households absorb part of the cost of investment by providing borrowers with hidden interest-rate subsidies. It was the main mechanism by which China’s deep economic demand imbalances and cavalier attitude towards capital developed, and it is the combination of demand imbalances and the misallocation of investment that have made the Chinese economy overly reliant for growth on mechanisms that have caused the country’s debt burden to surge.
• Policies involving any form of monetization to manage debt, including low lending rates relative to nominal GDP growth, seem politically easy at first, which is why they have been proposed in recent years, but in nearly every case they worsen China’s demand imbalance, making the economy ever more vulnerable to debt.
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