China’s industrial profits are up 24% year-on-year in line with rising industrial prices, in sharp contrast to price deflation and slumping profits in 2014-2015. Balance sheets are improving, leverage (as measured by the ratio of net debt to earnings before interest and taxes) is declining, equity prices are buoyant, and new equity issuance is at a record.
The sun is shining, in other words, and that’s the time to fix the roof. Chinese regulators at the ongoing party congress in Beijing indicated that they would take a tougher approach to controlling leveraged growth.
The long-serving head of the People’s Bank of China, Governor Zhou Xiaochuan, warned Oct. 18 that “excessive optimism” could give way to an eventual collapse in asset prices. According to Bloomberg, “Zhou cited a concept known as a “Minsky Moment,” a plunge in asset values following unsustainable gains or the exhaustion of credit growth, named for Hyman Minsky, an economist who argued that long bull markets can lead to major collapses.
The central bank chief told Bloomberg, “When there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified. If we’re too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a Minsky Moment. That’s what we should particularly defend against.” Zhou cited high corporate borrowing as well as corporations’ use of financing vehicles of local governments.