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Posted by On Feb 26, 2009

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Monday, May 23, 2011

Richard Koo On China: There Will Be Blood

In Richard Koo’s view, China was a perfect candidate for balance sheet recession after the Lehman Brothers’ collapse. 

The difference between China and the West, in his view, is that the Chinese government is a dictatorship, such that they can get a massive fiscal stimulus going very quickly, which is not possible in the Western democracy.  Of course, the Chinese government has a huge incentive to keep the economy growing at rapid rate because the government was not elected, and the main thing that keeps them in power is a growing economy, in which most people feel richer.

In danger of a balance sheet recession after Lehman Brothers’ collapse, the Chinese government implemented a massive fiscal stimulus package which has quickly reverted the effect.  The government also told the banks to lend as much as they wished.

Interestingly, under Richard Koo’s balance sheet recession hypothesis, there should be weak demand for credit for an economy under balance sheet recession.  Yet loan growths were massive in China after the Lehman Brothers’ shock.  Richard Koo attributed that to lending to local governments.  Of course, lending went to many different sectors as well, so I am a little bit reluctant to say that there was any sign of a balance sheet recession.

But whether there was any signs of balance sheet recession is beyond the scope here.  Now, he thinks the stimulus has gone so much overboard that the real estate bubble has become a serious problem.  He believes the curbs in home prices are for real, and “we could see some blood” in the real estate sector.


I don’t think any one should be surprised to see some blood.  Even though debts are relatively low for the households, I have repeatedly stressed that real estate developers have much higher debts, and with the increasingly aggressive curbs in home prices, I don’t think anyone should be surprised to see some blood here.

I have repeatedly warned that one should not false assume that the Chinese government is omnipotent.  To slow inflation and curb home prices, the Chinese government and the People’s Bank of China have tightened the economy to a point that a slowdown is almost inevitable.  Interestingly, the discussion here shifted from arguing if the Chinese economy will slow down to what the government can do if the economy slows.

The conclusion here by Richard Koo is, interestingly, that in the event of a collapse in the real estate market in China, the Chinese government, because its regime’s legitimacy is based on the fact that it can deliver a fast growing economy in which people are better off over time, the government will once again deploy massive fiscal stimulus in other parts of the economy which offset the collapse in other parts of the economy.

This article originally appeared here: Richard Koo On China: There Will Be Blood
Also sprach Analyst - World & China Economy, Global Finance, Real Estate

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