"The Ministry of Finance said government-backed entities would be strictly prohibited from purchasing land by raising debt last week, describing the practice as a 'sham'."

The MoF is right, of course, but this doesn't address the original problem.

Allowing local governments to reverse the decline in land-sale revenues by setting up SPVs to buy land from themselves was simply a way for them to borrow money and pretend the proceeds were actually land-sale revenues.
This was extremely risky because among other things it meant that local governments were effectively doubling down on their already-excessive exposure to the real-estate market. The MoF was absolutely right to clamp down on this practice.
But local governments are desperate. Their revenues have dropped sharply even as their expense have risen. What is more, they are expected to fund a wave of growth next year. The MoF stopped them from faking revenues without addressing the reasons they had to do so.
Beijing must know how difficult the circumstances are that local governments face, and yet isn't doing much to help. I think we are probably seeing the beginning of what over the next few years will be a very contentious relationship between local governments and Beijing.

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More from @michaelxpettis

Oct 20
"Analysts expect a wider array of taxes to support poor families, create job opportunities, bolster the social safety net and provide public services. Excessive income could also be adjusted."

sc.mp/7b7q?utm_sourc… via @SCMPNews
China has faced the same problem for over a decade, and while this is certainly a step in the right direction when it comes to rebalancing income and the distribution of demand, Beijing will soon find that the arithmetic doesn't work.
China's problem is not like that of the US or Europe, where the wealthy have too large a share of national income. In China, the wealthy may indeed have too large a share of household income, but the real problem is that households have too low a share of national income.
Read 6 tweets
Oct 17
"The power to control the creation of money has moved from central banks to governments. By issuing state guarantees on bank credit, governments have effectively taken over the levers to control the creation of money."

themarket.ch/interview/russ… via @TheMarket_CH
Russell Napier argues among other things that governments will try to resolve debt by raising the nominal GDP growth rate, and that we should get used to 4-6% inflation as part of that effort. If he's right, this could have important medium-term implications for China.
Resolving debt through financial repression or inflation effectively mean passing debt-servicing costs onto ordinary households, who generally aren't able to protect their savings from inflation. This is bad for domestic demand, but it will be very unevenly distributed.
Read 9 tweets
Oct 17
"Local governments have resorted to cutting salaries, reducing headcounts, lowering subsidies and even imposing disproportionately hefty fines to meet budget shortfalls."

This is what we should watch most closely in the next couple of years.

Given the very important role of local-government spending in generating economic activity, this response to slowing growth is highly pro-cyclical. All of these actions are likely to reduce "high quality" lower. i.e. consumer spending and business investment.
This will in turn reduce tax revenues further and perhaps even raise social transfer costs, forcing local governments to rely even more on infrastructure spending and thus surging debt to maintain employment.
Read 6 tweets
Oct 16
I was asked many times today for my comments on Xi’s speech, but I really don’t have much to say. Because my focus is on the economy, I am less concerned with broad policy objectives than with the constraints on what Beijing can do to achieve them.
For example Xi spoke about raising the income of low-income groups and also about encouraging higher-quality growth. These are important objectives that Beijing has long promised, but depending on how policies are designed, they may actually be mutually inconsistent.
For example if Beijing continues trying to increase the income of the poorest groups primarily with supply-side measures, as it has so far, rather than with demand-side measures, the household income share of GDP will most likely continue to stagnate or even decline.
Read 7 tweets
Oct 14
"It is quite possible that optimists on China’s growth are correct, that Beijing will change course and make the reforms it needs to sustain growth.'

I think the "optimists" here have completely misunderstood China's economic developments.

They believe that everything was more or less fine until shifts in policymaking in the past 2-3 years towards more state and less market caused growth to slow, and that if only Beijing chooses to reverse these shifts, everything will once again be fine.
But this is simply not true. China's problems began 10-15 years ago, when the success of its high investment model had reached its limits, but like every other country that followed this model, China found it too difficult to shift to a new model of growth.
Read 7 tweets
Oct 14
This is a more important point than it might at first seem: "Businessman Brody Shores’ furniture business in China grew on a model that leaned heavily on the promise of an enduring property boom and homebuyers desperate for furnished new apartments."

It is important because not just this business but a substantial share of all businesses in China were built around an implicit assumption of never-ending property price rises and an indefinites property building boom. This assumption was baked into their business models.
It's not that these businesses were stupid. It is just that a 2-3 decade property boom created a sorting mechanism by which businesses that bet heavily on the property boom automatically outperformed and, after so many years, replaced those that didn't.
Read 9 tweets

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