Streetwise Professor

November 20, 2012

Turning Japanese

Filed under: Economics,Financial Crisis II,Politics — The Professor @ 9:58 pm

One of the things that turned Japan’s initial early-90s crash into Double Dip Lost Decades was the refusal to let failing firms die and the failure to force other firms to restructure or reorganize.  Zombie banks were allowed to live on, rather than being wound up or recapitalized.  Zombie banks continued to lend to inefficient loss making firms in desperate need of reorganization, restructuring, or seppuku, letting them stumble on unreformed, half-alive, half-dead.   The overwhelming urge was to retain the status quo to the greatest extent possible, and to resist the forces of creative destruction by all means available.

We can see the results, with a Japanese economy lurching along, also half-alive, half-dead.

A Reuters article suggests that the social and political pressures to maintain the status quo, to prop up existing firms (that just happen to have political connections), are leading China down the Japanese path:

The problems at China’s Yingli Green Energy Holding Co Ltd (YGE.N), the world’s No.3 solar-panel maker, are going from bad to worse as the company struggles with mounting losses, collapsing product prices and a stock in free-fall.

And yet, despite a government directive to rein in loans, Chinese banks keep extending credit to the New York-listed firm, and at below-market rates. Outstanding short-term borrowing has almost tripled to 8.2 billion yuan ($1.3 billion) since 2009, according to Yingli’s 2011 annual report.

. . . .

Yingli is one of many companies in China receiving life support from the country’s banks. That support – at a time when China’s economy and financial system are also under pressure – is raising fears that a spike in bad loans will push Chinese lenders into default.

“Banks like lending to us,” said Yingli’s Chief Financial Officer Bryan Li in an interview. “They feel that we are a potential winner if there is any consolidation in the industry.”

That feeling may come back to haunt the banks.

A Reuters News analysis on 40 of China’s most indebted companies – most of them from sectors already reeling with overcapacity such as wind-turbine maker Xinjiang Goldwind Science & Technology Co Ltd (002202.SZ) and COSCO Shipping Co Ltd (600428.SS) – showed debt levels rising as profits decline across industries that Beijing has said it wants to promote.

On average, operating profit at these companies dropped 15 percent in 2011 as their debt piles grew by the same percentage, according to company and Thomson Reuters data.

. . . .

Goldman Sachs & Co (GS.N) estimates in a research note that the NPL ratio is more than six times the official rate. [Gotta love that official Chinese data!] That’s already less pessimistic than most investors, who expect NPL levels of at least 10 percent, according to the bank.

Much of the pressure to lend to unprofitable firms comes from the government’s desire to prevent a total collapse in industries struggling in an economy that has slowed for the seventh consecutive quarter.

“If you run a bank’s operations in a certain province and the governor tells you to roll over a loan, you are going to do it even if it doesn’t make commercial sense,” said Arthur Kwong, head of Asia Pacific equities at BNP Paribas Investment Partners.

Japan misallocated capital for years, and is paying the price now.  China, through its stimulus programs, showcase projects, and now these efforts to prop up politically connected losers, is also wasting capital on a colossal scale.  When originally “invested”, this money shows up as GDP, and props up the growth rate.  But if that capital is used unproductively, that GDP gold turns to dross.

The Chinese hatred for everything Japanese-a hatred that is waxing particularly hot right now-will likely prevent them from learning something from the Japanese experience.  But by failing to heed the Japanese experience, China is running the very serious risk of repeating it.

It is far better to submit to the gales of creative destruction than to attempt to preserve an unviable structure and unviable firms.  Japan tried otherwise and failed.  China seems intent on making the same mistake.

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