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Quotas? We don’t need no stinking quotas …

You know how you just roll right on through stop signs with nary a hesitation … when you’re in residential areas, parking lots, or anytime you’re the only vehicle around. You know exactly what that big red and white sign means. But you also know there is no one around to slap you on the wrists for your little rule breaking.

Well, the limits placed on China’s lending system over the past few years have come to mean the same thing as that inconvenient octagon: a suggestion.

For the years leading up to 2008, when China was at risk of overheating, we kept being told that new lending would be capped. But every new year would roll around, with new lending quotas, to see a surge in record-setting lending to kick off the year. And now we’re back to that same place even when the potential impact of reserve requirements and interest rate hikes in China are almost all anyone can ever talk about …

From Reuters:

The China Business News said that banks had already lent 1.2 trillion yuan ($182 billion) as of January 24, putting them well on track to blow past limits that regulators had wanted to set for the first month of the year.

Yeah — that 1.2 trillion yuan amounts to 17% of the annual quota for 2011. Better slow it down, as the yearly quota is the same as last year, a year in which the quota was exceeded by 450 billion yuan, officially. [Some estimates put full-year lending at 9.6 trillion yuan, or 2.1 trillion yuan above the 2010 quota. That is quite an overshoot, hmmmm?)

Go ahead – run right through that stop sign.

Michael Pettis is well aware of how the system works in China:

But would I have taken seriously a quota on new lending? Not really. It seems to me that if Beijing wants GDP growth in 2011 to come in at the expected 9%, the amount of new investment in China – which is determined in large part by the banking system – is really not something they can decide today. It is going to be whatever it needs to be given developments in household consumption growth and the trade surplus.

This is why I argued a few weeks ago that at whatever level the new loan quota was set, I was not going to think of it as constraining new lending in any way. Either the loan quota would be adjusted (upwards, almost inevitably) or more new lending would occur outside the banks’ balance sheets, as it did in 2009 and 2010.

Hmmm. Unwillingness to abide by lending quotas? I would not imagine this is a foreign concept to any banking system, much less when near-arbitrary caps are imposed by the government. Fractional reserve banking and loopholes, more or less, allow banks in the United States to lend out money well beyond the reserves on hand. This excerpt from a couple of guys at the Bank of International Settlements explains the actual lending dynamics:

“… the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans.”

As referenced earlier, Michael Pettis went on to also predict that the investment binge in China would continue as the only way to keep the much-anticipated Chinese GDP near the much-anticipated double-digit levels. In other words, the recently-popularized and all-important global imbalances will remain that way for now.

It is funny, because here are two news summaries taken from Reuters yesterday (26 Jan 2011):


BEIJING, Jan 26 (Reuters) – China will renew its efforts to rein in overcapacity in its sprawling steel sector in the next five years, the official Economic Information Daily reported on Wednesday, citing a senior industry official.
The paper, run by state news agency Xinhua, quoted an official with the Ministry of Industry and Information Technology as saying that China would focus on satisfying domestic steel demand over the 2011-2015 period.



SHANGHAI, Jan 25 (Reuters) – China steel prices are expected to rise after the Lunar New Year holidays as demand recovers, but profits for steel mills will be squeezed by surging costs, the China Iron & Steel Association (CISA) said in its monthly report on Tuesday.

"Overall demand for steel products will still remain strong this year as China has planned to raise investments on affordable house projects and water conservancy projects this year," CISA said.

Do you maybe notice a little bit of a conflict there?

The above news items say two things:

1) Michael Pettis is right – China will continue its investment craze as a way to support GDP.
2) China is not learning enough from the real estate collapse in the US.

Wen Jiabao, following up on a pledge to prevent a property bubble, yesterday unleashed a plan to tackle the issue once and for all. The headliner of the plan: the minimum down payment on second-homes jumps from 50% to 60%. What do you call it when there is too much money chasing too many goods? Chinflation.

I can’t help but wonder if a 10% increase — particularly from an already very high 50% — in the down payment on a second mortgage will do anything to hold back those looking for such an investment from making such an investment. Now, the other parts of the Premier’s plan could add up to something of substance, something effective …

But this cannot help the broader situation:

The [Chinese] central bank put cash worth 1.268 trillion yuan ($192 billion) into circulation from Jan. 1 to Feb. 10 in 2010, which was 3.15 times China’s total net cash issuance in 2009. (Reuters)

Could it?