The Coronavirus Shutdown Slashed China’s Household Finances

Xi Jinping is desperate to get the economy back to life.

By Christopher Aston

Two men wear protective masks as they sit in a nearly empty Starbucks in Sanlitun, Beijing, on March 10.

March 18, 2020, 7:00 PM

COVID-19 spreads fast, and it spreads easily—through kisses, cash, and hospitals. But in China, fear spread even faster than the virus—resulting in a mass lockdown of villages, towns and cities. That made new cases drop sharply, but the economy ground to a halt, with no workers to produce goods, no logistics to transport them, and no customers to buy them.

This gave President Xi Jinping, the general secretary of the Communist Party, a capitalist migraine: If the government kept implementing draconian measures to reduce infection rates, it would risk the economy and legitimacy of the Chinese Communist Party, which rules on the promise of economic prosperity. But as the goverment sends people back to work, it risks the virus spreading even further.

It is no surprise then, that the state-run Xinhua News Agency described leaders as saying it would be “a major test of China’s system and capacity for governance.” That test comes back not just to the virus, but to the government’s credit—financial and political. And it’s a problem that Western countries are going to be facing in a few weeks, if the initial strategy of containment works but the economy falters.

Faced with a stark choice, the central authorities have warned local officials not to let virus containment measures harm the economy. That’s a risky measure, given the number of unknowns surrounding virus transmission and infection rates, and one tough to implement when entire communities are gripped by fear.

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Xi also reiterated that China will strive to achieve this year’s development targets—and above all else to meet its goal of doubling gross domestic product from 2010 to 2020. That arbitrary goal was set by the CPC in 2012, but Xi, who from the start promised “a moderately prosperous society,” is determined to stick to the timeline. Most critically, though, as the country gets back to work and the virus seems contained—for the moment—Chinese households currently face grimmer financial prospects than medical threats.

While bodies turn to ash, China’s leaders are managing the crisis in Zhongnanhai, close to the mummified body of Mao Zedong, whose image validates the party and adorns every note on the renminbi, “the people’s currency.” Yet the leaders preside over a financial system looking mummified itself. Stalled reform has left capital markets and a banking sector on hold since 2013. State banks are reluctant to lend to the private sector, so stimulus will not reach it. The policy of inclusive finance, designed to support small businesses and provide poverty relief, lies buried under the 2018 peer-to-peer industry collapse, when hundreds of platforms went bust following fraud and mismanagement. This matters when small- and medium-size enterprises contribute nearly two-thirds of the country’s economic output and employ 8 out of 10 urban workers.

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The same money system that diverts bank savings to government projects via financial repression is the one that binds the people to it. Households and businesses are financial institutions in their own right, ones which connect to the wider system through cash flows. For the vast majority of people, the goal more pressing than freedom of speech is meeting the daily “survival constraint,” a term coined by financial economist Hyman Minsky: the assurance that their cash inflows are sufficient to meet their cash outflows.

People place their faith in the money system, which means faith in the party. The party underpins national credit—and the financial well-being of a country that has only just adjusted to (some) people being well-off. That, more than anything else, is what keeps people from protesting the many iniquities and annoyances the party forces upon them; they have too much to lose. But if financial credit starts to fall apart, the party’s credit goes with it.

Usually outsiders are not privy to how the Chinese government handles a financial crisis, but a financial system is money in motion—when it stops during a lockdown, it is difficult for the government to mask the impending crash. As the chains of cash snap, the financial system breaks. Real estate sales in major cities plummeted 83 percent in February, car sales dropped 80 percent, and the Caixin/Markit services purchasing managers’ index collapsed to 26.5 from 51.8 in January, the first contraction in China’s service sector since the survey began in 2005.

The first response in a crisis is to spend any cash balances, but firms and households are highly leveraged and living on borrowed time. In a joint Tsinghua University and Peking University survey of 995 companies, 34 percent of respondents said they can survive for only one month with their current savings; 33 percent said they can survive for two months; and only 18 percent said they can last three months. The central government is pushing small- and medium-size enterprises to resume business and hire recent graduates to soak up unemployment pressure. In echoes of the Great Leap Forward, ghost staff “clock in” and machines buzz in empty offices, in order to maintain the illusion of economic activity.

That will push people to borrow, but from whom? China’s banking system is already laden with bad loans, and funding liquidity for small businesses is tight. A 2019 People’s Bank of China liquidity stress test revealed that 7.7 percent of lenders were unable to withstand a light shock, while 13.6 percent were at high risk if a financial crisis hit. Like the virus, a financial panic is indiscriminate: Companies good and bad become untouchable as lenders retreat to safe-haven assets. S&P Global Ratings estimates the virus outbreak will add 5.6 trillion yuan ($800 billion) in nonperforming bank loans.

People will try to sell assets, but to whom? Not all assets are shiftable, and unless a company’s reserves consist of face masks, their asset values are more likely to drop during a crisis. Market liquidity dries up, which triggers a death spiral of falling asset prices and collateral values, weakening refinancing abilities.

As Walter Bagehot advised after the Panic of 1866, and Perry Mehrling after the 2008 global financial crisis, the central bank’s response should be to lend early and lend freely. This relaxes the survival constraint and allows firms and households to delay the day of reckoning. Otherwise, a temporary survival constraint grows into a long-term solvency constraint, requiring mass bailouts.

To preserve funding liquidity, the People’s Bank of China has executed liquidity injections and special lending to the banking system, while the China Banking and Insurance Regulatory Commission has ordered bank loans at ultralow rates, quick approvals for anti-virus bonds, and loan rollovers for companies struggling to repay their debts as a result of the outbreak.

To protect market liquidity, the securities regulator has urged stockbrokers to limit short-selling activities, and mutual-fund companies have been told not to cut net equity positions. The Ministry of Commerce is also coordinating efforts to maintain the flow of key products and commodities. Some companies have reconfigured production lines to produce masks, and e-commerce sites are banning price gouging on medical products.

These emergency policies are supported by the propaganda machine’s call for a “people’s war”—and by the world’s largest surveillance system. If all else fails, the threat of imprisonment for “disrupting social order” encourages market support.

Following years of slowing growth, the crisis exposes Chinese companies’ reliance on speculative finance, by which cash flows can only cover loan interest repayments (not the loan principal) and firms must rely on new loans to pay off the old. The China Banking and Insurance Regulatory Commission’s response has been to instruct banks not to include late loan repayments in statistics, and to relax standards for nonperforming loans. But back in reality, firms’ responses have been to cut wages and lay off staff.

The Chinese middle class once believed that their freedoms were expanding—as long as they didn’t cross political red lines. The last few years have already squeezed that idea; the betrayals and quarantines of the coronavirus may shatter it. If the economy goes, an even greater pillar of trust in the government goes with it. For Chinese people bereft of wealth, the opportunity cost of protesting will diminish, and crowds will begin swelling outside government offices. That is what the party fears most, and why Xi is calling everyone back to work.

Christopher Aston is a risk adviser based in Hong Kong and author of an upcoming book based on his experience working in a Chinese shadow bank.

Twitter: @keqiangCN