Economics: A Chinese balance sheet recession?
Despite many economists’ claims that China is in a “balance sheet recession”, this view is refuted since no economic sector is reducing its debts, and aggregate demand is expanding.
Policymakers have studied Japan’s balance sheet recession of 1990 – hoping to avoid their own – with a focus on preventing financial excesses that could spark broad-based deleveraging. They learnt that 1) governments must sometimes borrow more to prevent a decline in aggregate demand, and 2) asset bubbles are best popped early, which is partly what motivated the 2017 “deleveraging” campaign, and why policymakers tried to deflate the property bubble in 2020.
We think both are the wrong lessons for China: 1) A large share of the corporate sector’s debts are really the government’s liabilities; thus, a larger fiscal deficit might shift some corporate borrowing to the government in the flow of funds, but it would change little in the real economy. 2) Japan’s crackdown on the property sector increased household financial surpluses because falling residential property investment appears as a decline in household investment in the flow of funds. And a sector’s financial balance roughly equals its savings less investment.
Chinese policymakers are trying to address the problem of excess household financial surpluses by encouraging more household consumption and inducing more corporate borrowing for preferred sectors, mostly manufacturing. But their plans to boost household consumption are underwhelming, and manufacturing is not as credit intensive as construction.
That leaves the economy in a lurch. If household confidence remains weak, savings rates will likely remain high. And if those savings cannot be intermediated into somebody else’s income, then aggregate demand may start to contract. If so, then policymakers’ efforts to avoid a balance sheet recession may very well be the thing that pushes China into one.