The Economist - USA (2020-11-21)

66 Finance & economics The EconomistNovember 21st 2020

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C

hina’s credit-ratingagencies do not

disguise their love for the state. Yong-

cheng Coal and Electricity’s state pedigree

was at the top of a list of merits in a recent

credit appraisal by ccxi, one such agency,

which expressed its confidence in the

group on October 10th with a top-notch aaa

rating on a 1bn-yuan ($152m) bond.

Yongcheng’s default a month later on a

different 1bn-yuan bond has sent a shock-

wave through China’s $14trn bond market.

The company paid overdue interest three

days later, but not before investors dumped

state-backed debt with links to Henan

province, the region in central China where

it is based. The jarring news that a state

group with a recent aaa-rating had de-

faulted halted at least 20bn-yuan-worth of

planned debt issuance over the following

week, as yields on state debt surged.

The concern was so great that a large

state-owned company in neighbouring

Shanxi province was forced to issue a rare

statement to investors on November 14th

pledging that the companies it controls

would not default. “The particular thing

about this case was that it was completely

unexpected,” said Charles Chang of s&p,

another rating agency.

Investor panic has focused on Yong-

cheng, but there are signs of wider tumult.

Huachen Automotive, a carmaker owned

by a provincial northern government, said

on November 16th that it had sought re-

structuring after defaulting on a bond in

October. Tsinghua Unigroup, a technology

firm controlled by Tsinghua University,

failed to repay a 1.3bn-yuan bond on the

same day. The companies had enjoyed aaa

and aaratings, respectively.

That state firms can default is no sur-

prise. Yongcheng is one of ten to have done

so this year. Regulators have realised they

can no longer afford to bail out inefficient,

loss-making companies. A small but

steady stream of weak state firms have

been allowed to default since 2015, part of a

government plan to impose discipline on

the market. Defaults also make it possible

to price in risk better, something foreign

investors have struggled to do. As defaults

have risen over the past three years, foreign

investors have ploughed record sums into

China’s bond market.

But Yongcheng’s default has alarmed

investors because it throws out the old

rule-book that helped determine which

groups would receive state support and

whichwouldbeallowedtogobust.Parent

companieshavebeenthestrongestguid-

inglighttodate.Yongcheng’sparent,for

example,isoneofHenan’slargeststate-

ownedgroupsandiswhollyownedbythe

province’s asset administrator, making

Yongchengstateroyaltyintheregion.Hua-

chenAutomotiveisownedbya similaren-

tity.Suchproximitytopowerfulassetad-

ministrators used to give investors

confidencethatthestatewouldswoopto

therescueatthefirstsignofdistress.Not

anymore.

Scalealsousedtobeimportant.Large

stategroupshavebeenvaluabletocities

and provincesbecause they givesecure

employmenttotensofthousandsofpeo-

ple.HuachenAutomotivealonehasmore

than 40,000 employees. Restructuring

themwouldthreatenjobsandsocialstabil-

ity,butthesearerisksthegovernmentap-

pearsincreasinglywillingtotake.“Parent

company,size—thesearethereasonspeo-

pleargueyoushouldbuy,”saysEdmund

GohofAberdeenStandardInvestments,an

assetmanager.“Thisisstartingtochange,

andpeoplearegoingtobereadingmoreof

thedetails.”

Investorsandratingagencieswillhave

tostudystatefirms’fundamentals,instead

ofrelyingonperceivedgovernmentback-

ing.s&pexpectsmoredefaultsamonglarge

stategroupsthatwereonceconsideredun-

touchable.Zhu Ning,a professoratthe

ShanghaiAdvancedInstituteofFinance,

saidthatregulatorsmayeven launch“a

crackdownontheratingagenciesforbet-

ter-informedratings”.Theshiftwillprove

awkwardforlocalagencies,suchasccxi,

which are under pressure from state

groupstohandoutasmanysparklingaaa

ratingsaspossible. 7

HONG KONG

Investors are jolted by the default of a

highly rated state-owned firm

China’s bond market

No guarantees

I

nforming a customer“I’m sorry, I can’t

give you your money” is the stuff of bank-

ers’ nightmares. But in June the Federal Re-

serve had to tell commercial banks just

that: it was running out of spare change. As

parts of the economy shut down, the flow

of coins from wallets to deposits gummed

up, leading retailers and banks to demand

more. The Fed was forced to ration the sup-

plies of pennies, nickels, dimes and quar-

ters based on banks’ previous orders.

The speed with which money, both

physical and digital, moves is an important

indicator of economic activity. Money’s

“velocity” is calculated by dividing a coun-

try’s quarterly gdpby its money stock that

quarter. The Fed tracks velocity for several

definitions of money. The measure that is

most popular with economists is “money

of zero maturity” (mzm), which includes

assets redeemable on demand at face val-

ue—such as bank deposits and money-

market funds. The bigger gdpis relative to

the money supply, the higher the velocity.

Velocity has plummeted this year (see

chart). In the second quarter, the velocity of

mzm dipped below one for the first time on

record, meaning that the average dollar

was exchanged less than once between

April and June. The decline stemmed from

both economic shutdowns and heightened

uncertainty early on in the pandemic, as

well as a money supply dramatically in-

creased by stimulus efforts.

Recessions tend to dampen the velocity

of money by increasing its attractiveness

as a store of value relative to alternatives.

Uncertainty pushes up demand for money,

explains David Andolfatto of the St Louis

Fed. In a weakening economy, consumers

prefer to save rather than shop; investors

cling to the safe assets that make up mzm.

Both the Depression and the Great Re-

cession began with sharp declines in veloc-

ity. Where it recovered its pre-Depression

levels by the mid-1930s, though, velocity

continued to fall after the 2007-09 crisis.

Some economists attribute that to the

Dodd-Frank act, which took effect in 2010

and put regulatory pressure on shadow-

banking activities, increasing demand to

hold money in the formal banking system.

As covid-19 spread earlier in the year,

anxiety about the economy sent velocity

tumbling further. In April personal savings

shot up to a record 33.6% of disposable in-

come, not only because of worries about

the future but also because shutdowns lim-

ited the ability to spend. October’s rate of

14.3% was still higher than in all pre-pan-

demic months since 1975.

Meanwhile, stimulus measures have

pushed up the money supply, in order to

prevent the economy, and inflation, falling

WASHINGTON, DC

Why money is changing hands much

less frequently

The velocity of money

Changing down

Free fall

United States, velocity of money*

Source: Federal Reserve Bank of St Louis

*NominalGDPdividedbythestockofmoneywithzero

maturity(MZM).MZMincludesnotesandcoinsincirculation,

some travellers’ cheques, demand and savings deposits,

and money-market funds

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201020009080701959

RECESSIONS ↑hands more frequently Money changing