Rewriting China's Balance Sheet

How can this be normal? Twenty-nine countries with roughly 60 per cent of the world's gross domestic product have monetary policy rates of less than 1 per cent per annum. The world is awash with debt - over US$230 trillion, or roughly three times world GDP. To finance their large debt and deal with deflation, both the European Central Bank and Bank of Japan are experimenting with negative interest rate policies. If these do not work, look out for helicopter money, which means central bank funding of even larger fiscal deficits. Either way, at near-zero interest rates, the business models of banks, insurers and fund managers are broken.

The problem is that no one can ascertain whether exceptionally low interest is a symptom or a cause of deep chronic malaise. An exceptionally high debt burden can only be financed by exceptionally low interest rates. The Fed now feels confident enough to raise interest rates, which means that the U.S. asset bubbles will begin to deflate, spelling trouble for those who borrow too much in U.S. dollars. As Nomura chief economist Richard Koo asserts, the world has followed Japan into a balance sheet recession, with the corporate sector refusing to invest and consumer/savers too worried to spend. The solution is to rewrite the balance sheet, which most democratic governments cannot do without a financial crisis.

Like Japan, China's dilemma is an internal debt issue of the left hand owing the right hand, since both countries are net lenders to the world. The Chinese national balance sheet is almost unique because the financial system is largely state-owned, lending mostly (about two-thirds) to state-owned enterprises or local governments. The Chinese household sector is also low-geared, with most debt in residential mortgages.

Unlike the U.S. federal government, which had a net liability of US$11 trillion at the end of 2013, the Chinese central government had net assets of US$4 trillion. Thus, unlike the U.S. where households own 95 per cent of net assets, Chinese households own roughly half, with the corporate sector (at least half of which is state-owned) owning 30 per cent, and the state the balance.

Sceptics would say the Chinese statistics are overstated, but even if the state net assets are halved (land valuation is complicated), there would be at least US$7.5 trillion of state net assets (net of liabilities) to deal with any contingencies.

Furthermore, unlike the others, the People's Bank of China derives its monetary power mostly from very high levels of statutory reserves on the banking system, which is equivalent to forced savings to finance its foreign exchange reserves of US$3.2 trillion. Thus, the central bank has more room to deal with domestic liquidity issues.

What can be done with this high level of state net assets, which is in essence public wealth? My crude estimate is that if the rate of return on such assets can be improved by 1 per cent under professional management, GDP could be increased by at least 1.5 percentage points. How can this rewriting of the balance sheet be achieved? There are two possibilities. One is to allow local governments to use their net assets to deleverage their own debt and their state-owned enterprises debt. This could be achieved through asset management/debt restructuring companies.

The second is to inject some of the state net assets into social security funds, as a form of returning assets to the public. People tend to forget that one of the largest measures to create household wealth was the selling of residential property at below market prices to civil servants. This paved the way for boosting domestic consumption by giving many households the beginnings of household security.

At the end of 2014, social security fund assets amounted to 4 trillion yuan (HK$4.7 trillion), compared with central government net assets of 27 trillion yuan. Hence, this is clearly an affordable option. If the policy objective is to improve overall productivity by improving the output of public assets, the time to do so is now.

This article first appeared in the South China Morning Post on June 10, 2016 as How China can rewrite the balance sheet for its own gain

The views expressed in this article are the author's own and do not necessarily reflect Asia Global Institute's editorial policy.