Policy Confusion in China

My favorite source for geopolitical news and analysis, Stratfor, carried a story yesterday about the mixed signals coming from economic policy makers in China.

Specifically, there seems to be an internal debate as to how to cool down the Chinese economy without throwing it into recession.

As I have covered on the blog before, the Chinese government has raised bank reserve requirements multiple times starting in November 2010.  Raising the reserves is another way of saying the Chinese government has limited the amount of money that the banks can lend out.  Less money lent out results in less money in the economy.  Less money in the economy means that there is less inflationary pressure, especially price rises in real estate.

Additionally, the government there has also raised interest rates.  Lastly, I reported last week that the Chinese government is requiring banks put their “off balance sheet” loans back on to their balance sheets.  Apparently, all of this activity is starting to have an effect.  There are reports in China of interest rates on loans being raised.  Which brings us to the pickle that the Chinese government finds itself in.

When interest rates on bank loans rise, thus making the price of money higher, corporate borrowers turn to other sources of money.  In this case, Chinese businesses have turned away from bank financing and are going directly to the end investor.  How?  By issuing bonds (i.e. IOUs) to investors.  In fact, a record number of these bonds have been issued so far in 2011: over $15 billion.

Another advantage to turning to the bond market is that the political entity in charge of loan issuance and bond issuance is not the same entity in China.  Thus, corporate borrowers (either via loans or bonds) have been turning to the regulator that is most amenable to corporate plans.  Effectively this is like a teenager asking first one parent if they can borrow the keys to the car on Saturday night, being turned down, and then asking the other parent the same question.  Thus thwarting both parents.

As Stratfor rightly points out, this regulatory confusion means that the policy prescription in China is less effective.  Meanwhile, the economy of China continues to explode in an unabated fashion.  Ain’t bureaucracy fun?

Jason