The former CEO and co-chief investment officer of US investment giant PIMCO says that the Chinese economy is unlikely to meet with a Minsky Moment financial crash.
Zhou Xiaochuan, the head of China’s central bank, recently triggered headlines when he warned of the possibility that the Chinese economy could experience an asset bubble crash in the manner described by economist Hyman Minsky.
The term “Minsky Moment” was first coined by PIMCO’s Paul McCully, and refers to a financial crash resulting from the sudden collapse of a debt-fuelled asset bubble, following a protracted period of overconfidence amongst both lenders and leveraged investors.
The term gained currency in the wake of the 2008 Great Financial Crisis, when its as used to described the dysfunction that afflicted markets in the run up to the crash.
Writing for Bloomberg View Mohamed A. El-Erian, former PIMCO CEO points out that Zhou’s concerns about China’s burgeoning total debt levels and in particular surging leverage amongst households, corporations and local governments.
While China has enjoyed robust economic growth since the GFC, this has been driven by a vigorous stimulus program that has since nearly doubled its debt to GDP ratio, and led to sovereign credit downgrades by both Moody’s and S&P’s since May.
In China’s case, however, these burgeoning debt levels will not necessarily result in a asset crash given the low likelihood of the forced deleveraging that is the the key trigger for a classical Minsky Moment.
According to El-Erian the forced deleveraging that typically precipitates a Minsky Moment is the result of skittish foreign investors and undercapitalised banks become skittish, under circumstances where exchange rates are overvalued and foreign reserves at low levels.
In China’s case, however, these circumstances are currently absent, largely due to the highly regulated character of its economy.
“Banks are subject to heavy regulation and moral suasion,” writes El-Erian. “The amount of foreign portfolio money invested in China is relatively low and difficulty to move rapidly…and the authorities have also already shown a willingness and ability to manage capital outflows in an orderly fashion through the use of a range of instruments”
In addition to the tight reins imposed on overseas capital and domestic financial institutions, China also possess a large volume of foreign, reserves – having recently re-emerged as America’s biggest nation-state creditor, while in El-Erian’s estimation the yuan is “not overvalued in a fundamental sense.”
While a Minsky Moment crash may not be on the cards for China in the near-term, its rising debt levels will translate into exacerbated financial risk if Beijing fails to successfully transition to a more efficient economic growth model.
“It takes China too many units of debt to generate a unit of growth,” writes El-Erian. “The longer this continues, the greater the doubts as to whether the increment income generated in future will prove sufficient to meet the ballooning debt service obligation.
“Should such circumstances prevail, both actual and potential growth would be negatively affected over the longer-term.”