66 Finance & economics The EconomistNovember 21st 2020
1
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
4
3
2
1
0
201020009080701959
RECESSIONS ↑hands more frequently Money changing