Abstract: The principal issue in the current economy is not a series of long-standing deep-rooted problems but rather a “vicious circle” among the spending of households, corporations, and governments. The key to breaking this circle is expanding the “purse” of society and helping people make more money and dare to spend. Governments must take the lead in breaking the vicious circle. Reversing expectations requires policy support stronger than the market’s downward force. The clearer and fuller the policy signal and determination are, the fewer policy resources are required.
The principal issue in the current economy is not a series of long-standing deep-rooted problems but rather a “vicious circle” among the spending of households, corporations, and governments.
The key to breaking the vicious circle is expanding the “purse” of society and helping people make more money and dare to spend. Reversing expectations requires policy support stronger than the market’s downward force. The clearer and fuller the policy signal and determination are, the fewer policy resources are required.
I.WHAT IS THE PRINCIPAL CONTRADICTION?
At present, the economy is under pressure from various aspects, including the changes in the external environment, the impacts of the pandemic, the difficulties of innovation during the changes in industrial structure, the inability of industrial policies to keep pace with changes in emerging industries, and the incompatibility between land, public management, and public services during urbanization. Many of these are structural and deep-rooted problems with a bearing on the long-term development of China’s economy.
However, the combination of these problems has recently, led to a new independent problem that may hit the economy harder. In other words, The principal issuein the current economy is not a series of long-standing, deep-rooted problems but rather a “vicious circle” among the spending of households, corporations, and governments.
The current economy has three characteristics, namely, residents’ unwillingness to spend money due to the decline in income growth, local governments’ shortage of money and reduction in spending, and corporations’ reluctance to borrow and invest. These characteristics are interconnected. Residents’ unwillingness to spend money harms the sales and profits of corporations, which will further harm governments’ tax revenue, residents’ income, and employment. Without sufficient income, government expenditure will fall, and the income of residents and businesses will be affected, leading to a vicious circle of declining spending in the three sectors.
In the vicious circle, as the income of residents and corporations continues to fall, their expectations for the future will continue to weaken, reducing their expenditure and exacerbating the contradiction.
The vicious cycle of declining expenditures in these three sectors is like an immune storm. Initial viral and bacterial infections may not defeat people, but an immune storm can.
The Great Depression is a fine example: a variety of complex and deep-rooted structural contradictions did not bring down the economy, while a severe spending crunch did. Nothing is more serious to a market economy than a downward spending spiral and a credit crunch.
In this case, the vicious circle should be considered the primary contradiction. Once it is resolved, the economy will go back on track and provide time and space to solve various long-term and deep-rooted contradictions.
II.WHAT POLICY INSTRUMENTS CAN BE ADOPTED
The vicious circle of declining expenditures is mainly about “money”: residents are short of money and dare not consume; local governments are short of money; neither dare corporations to borrow nor are they willing to invest. The key to breaking the “vicious circle” is to help everyone make more money and dare to consume.
One of the three sectors must take the lead in breaking the vicious circle, and governments should take this responsibility since it is within their economic management function and requires policy resources only possessed by governments.
Specifically, governments should break the vicious circle mainly from three aspects.
First, lowering the policy rate. According to conservative estimates, a full reduction in policy interest rates will allow residents, corporations, and governments to reduce interest payments by no less than 6 trillion yuan per year and increase the valuation of financial assets by no less than 15 trillion yuan, substantially improving all sectors’ cash flows and balance sheets and helping everyone make more money and dare to consume and invest.
In terms of lowering the economic policy rate, concerns from various stakeholders revolve primarily around two key aspects: the exchange rate of the Chinese Renminbi (RMB) and bank spreads. While these concerns are valid, it's essential to recognize that the Chinese economy itself serves as the fundamental safeguard for both the RMB exchange rate and banking operations. The key to mitigating these concerns lies in preventing the economy from falling into a vicious cycle. Cyclical fluctuations in the RMB exchange rate and banking operations, though impactful, are unlikely to cause substantial harm to the broader Chinese economy. Addressing the main economic contradictions is the foundation for safeguarding the RMB exchange rate and banking operations.
Secondly, increase public investment spending. When the government boosts public investment spending, it effectively increases its purchases of goods and services from businesses, consequently raising the income levels of enterprises and households alike. Therefore, when enterprises and the household sector are short of spare money or are hesitant to spend it, this injection of income into the economy supports increased consumer spending and helps break the vicious cycle of economic stagnation.
Importantly, concerns about excessive government debt are largely unwarranted in this context. Sustainable government debt levels are more closely tied to economic growth than borrowing reduction. A robust economic situation serves as the best insurance policy against mounting government debt. Furthermore, China's private sector boasts a high savings rate, with savings far surpassing investment. Given this surplus, government debt incurred to fund increased spending efficiently utilizes underutilized private-sector savings and does not exert significant inflationary pressures. In comparison to developed and many developing countries, China's government debt burden, even accounting for local governments' hidden debts, remains relatively low, leaving ample room for additional borrowing.
Thirdly, stabilize the real estate market. An analysis of the creation of social financing and financial assets reveals that over the past decade, two-thirds of increased income for enterprises, the government, and households originated from new loans and debt raised by real estate and platform companies. The health of the real estate sector has a direct impact on the overall economic purse. Consequently, unless a new credit locomotive is found, a decline in the real estate industry results in a credit crunch affecting society as a whole, causing reduced incomes for the government, businesses, and households alike.
Stabilizing the real estate market necessitates a multifaceted approach. Challenges in the sector encompass liquidity issues, debt repayment difficulties for real estate enterprises, insolvencies among real estate companies, and the emergence of a market inflection point.
Implementing two sets of policies aimed at supporting market demand and stabilizing market players is imperative to stabilize the property market. The first includes lowering home mortgage interest rates, providing tax incentives for new citizens and migrant workers to purchase homes, and gradually removing home purchase restrictions on a city-by-city basis. Additionally, policies aimed at stabilizing market players involve establishing a real estate stabilization fund to facilitate the reorganization of troubled real estate companies and adjusting pre-sale fund management to support companies and projects effectively and simultaneously.
III. FOCUS POLICY RESOURCES
Policy intervention should target the core issues. Breaking the vicious cycle does not necessarily require too many sectors or excessive policies, and the heart of the problem lies in addressing financial constraints. Through policies centered around interest rates, public investment, and the real estate market, we can boost credit and the financial well-being of households, businesses, and the government, ultimately breaking the vicious cycle.
Other policies aimed at boosting morale and confidence can play a supportive role but are secondary. Reliance on auxiliary measures can erode market confidence in government decision-making without decisive action on key policies.
Policy actions must exceed market expectations in strength. Policy support must outweigh market downward pressures to reverse the situation effectively when confronting a downward-spiraling market. Incremental policy adjustments akin to “adding drops of oil to a fire” won't suffice: at first, several policies are implemented, and the situation remains unchanged; then, more policies are put forward and still don’t work. In the end, excessive policies have been placed with minimal effect, and the vicious cycle continues. What’s worse, “oil-adding” strategy only causes the market to question policy effectiveness, leading to diminishing policy space.
Apart from policy measures, effective communication with the market is also crucial. Decision-making bodies should refrain from constantly stressing difficulties and concerns or reserving policy space, which only impresses upon the market that the policy action taken is not in full play and is less effective than expected. Currently, breaking the vicious cycle should be prioritized, and they must convey a clear commitment to using the full spectrum of available policies to achieve their objectives. By doing so, it is possible to guide the market in tandem with policy direction and reduce required policy resources.
The views expressed herewith are the author’s own and do not represent those of CF40 or other organizations.
