China’s Central Bank Chief Warns of “Minsky Moment”
Zhou Xiaochuan appeared to be talking about China, given his contextual warnings about the country’s high corporate and rising household debt loads. But the message may apply to frothy and debt-laden markets globally.
Investors have looked beyond divisive, populist politics in the U.S., the U.K., Spain, and elsewhere in Europe, focusing instead on accelerating global economic growth and surging industrial metals prices to push benchmark stock indices to, or near, record highs. One top central banker has warned of a “Minsky Moment,” suggesting the bull runs could quickly collapse as risks building under excessive optimism and debt-fueled, but sub-par investment, suddenly break out.
Interestingly, the central bank governor, Zhou Xiaochuan, hails from the People’s Bank of China, and he didn’t point to any particular asset class. Financial media broadly reported his warnings that speculative investment from spiking corporate debt in the Middle Kingdom is “very high” and household debt is climbing precipitously, suggesting he was talking about Chinese markets. But Robin Xing, Morgan Stanley’s chief economist for China, said Zhou was referring to global asset markets generally, not China specifically.
Whatever the case, unlike top-heavy U.S. and European equity markets, the Shanghai Composite Index is up some 8.9% so far this year at about 3380 points, which is nowhere near its October 2007 record high of 5955 points.
Alluding to U.S. economist Hyman Minsky’s contention that long market rallies can suddenly end badly if speculative malinvestment grows too much, Zhou said that “when there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified,” according to Bloomberg. “If we’re too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a Minsky Moment. That’s what we should particularly defend against.”
Zhou is slated to retire in the months ahead, and the South China Morning Post, citing sources, has reported that he is likely to be replaced by Guo Shuqing, the current, technocratic head of the China Banking Regulatory Commission. If confirmed, that should be seen as a market-positive by investors.
Zhou made his Minsky comment on the sidelines of the 19th Communist Party Congress, marking the beginning of President Xi Jinping’s second five-year term. At nearly the same time Zhou spoke, China reported third-quarter annual growth in gross domestic product of 6.8%, meeting expectations but representing a slight slowing from the 6.9% pace in the previous quarter.
Beijing has no doubt ensured that its anti-pollution campaign, which is part and parcel of its efforts to reduce excess capacity and push consolidation in its state-owned heavy industries, particularly coal and steel, wouldn’t sharply undercut broader economic growth—especially during the twice-a-decade Communist Party conclave. Some 200 Central Committee members, a slew of whom were replaced in Xi’s recent anti-corruption campaign, are electing the two-dozen-plus Politburo and the all-powerful Politburo Standing Committee, which sports seven to nine members. After his purging of the ranks—including loyalists to his predecessor, Hu Jintao—Xi’s consolidation of power appears set.
Indeed, the fractious politics on display in the U.S. and Europe are nowhere to be seen in China, where “Xi Thought” looks slated to be enshrined in China’s constitution, giving him a place alongside Mao Tze-Tung and Deng Xiaoping as China’s pivotal modern leaders. One Chinese academic notes that Xi has been tagged “Chairman of Everything” because he runs a dozen-odd “central leading groups” mainly overseeing security and economic affairs. A state-orchestrated cult of personality champions Xi and his “China Dream,” which he described in his three-plus-hour speech at the Party Congress as China’s transformation by 2050 into a “prosperous, powerful, democratic, harmonious and beautiful socialist modern country.”
At least near term, the road there may be a little bumpy. Many observers point out that Xi is quick to reverse market-friendly reforms that threaten the party’s grip on power or generate too much volatility, such as the equity market crash in the summer of 2015 or the currency liberalization that led to a swoon in the yuan in the first quarter of 2016. But it may be a case two-steps forward and one-step back.
At close to an estimated 300%, China’s total debt-to-GDP is reaching dangerously high levels. But the government has made progress in tamping down the shadow banking sector and moving those “assets” back on to bank balance sheets. And though loan growth has re-accelerated since March in advance of the Party Congress, it may resume the declining trend that started two years ago.
China will easily reach, and likely surpass, its 6.5% growth forecast this year, and should also easily hit its target of doubling GDP from 2010 by 2020. Consumption is already driving some two-thirds of the economy: in the latest quarter, the services sector and exports were again the main growth drivers, as property development and investment spending slowed.
The future pace of China’s growth will certainly decelerate relative to its recent history as the economic “rebalancing” proceeds. But the quality of its growth is becoming more sustainable, reliant more on rising domestic consumption amid growing consumer incomes. And at an annual 6% to 7% pace, it should continue to support corporate earnings.
To be sure, with the Shanghai Composite Index’s current price/earnings ratio at 17.7x, three multiple points above its 14.7x seven-year average, it’s not exactly cheap. But it’s far from its historical high, and cheaper than equity markets in the U.S. and Europe, where debt levels—in both regions—are also lofty. Reforms in China have been somewhat erratic. But the overall rebalancing of China’s economy from fixed asset investment and exports toward domestic consumption continues to progress, and may accelerate now that Xi’s firmly in control heading into his second five-year term.
There could still, of course, be a Minsky Moment in China. The same could be said about most other equity markets around the globe. Investors would be well advised to focus on quality stocks with solid business models and attractive valuations. When broad markets do inevitably swoon, pulling the share prices of these types of companies down with them, it could be an excellent time to buy.