China repeating Korea’s mistakes?

Many observers assume that China is on a path to become the next Japan - a major economy mired in a multiyear deflationary funk that deflates its global clout. And it’s certainly true that the way that Beijing has been downplaying its debt problems is eerily reminiscent of Tokyo’s public relations strategy from the 1990s.

But take a closer look at China’s situation, and you’ll realize a better analogy is South Korea. China’s expanding effort to pile debt risks on individual investors is straight out of Seoul’s playbook.

South Korea’s economy crashed in 1997 under the weight of debts compiled by the country’s family-owned conglomerates. The government’s strategy for dealing with the fallout consisted of shifting the debt burden to consumers. With a blizzard of tax incentives and savvy PR, Korea shrouded the idea of amassing household debt to boost growth in patriotic terms.

That push still haunts Korea. Today, the country’s household debt as a ratio of gross domestic product is 81 percent. That far exceeds the ratios in U.S., Germany and, at least for the moment, China. As a result, Korea has been particularly susceptible to downturns in the global economy, which is why the country is now veering toward deflation.

Is China repeating Korea’s mistakes? Granted, the specific of Beijing’s economic strategy vary greatly and China’s $9.2 trillion economy is seven times bigger than Korea’s. But the Chinese government’s efforts to prod households to buy stocks and assume greater financial risks are highly reminiscent of Korean policy.

Beijing has been encouraging everyone in the country, from the richest princelings to the poorest of peasants, to buy stocks. And China’s markets have been booming as a result: Over the past 12 months, the Shanghai exchange is up 141 percent, and the Shenzhen exchange is up 188 percent. Margin trading, which has fueled these rallies, seems to have jumped another 45 percent in May, to a total of $484 billion.

Chinese companies have been the greatest beneficiaries of these stock rallies. The higher equities are driven up, the easier it is for companies and banks to issue shares and improve their debt situation. Companies have raised $42 billion from share sales in 2015, on pace for the busiest year ever.

But who will suffer when stocks inevitably swoon? Beijing is making a risky bet, by assuming Chinese savers will be capable of dealing with the burden of a stock market downturn. This strategy is morally questionable - it’s another instance of Chinese savers being set up to take the fall for government policy, as they were during the hyperinflation of the 1940s, and in modern times, when they faced strict limits on deposit rates.

Moreover, it would be far easier for Beijing to bail out a handful banks and dispose of bad loans that are concentrated at a few dozen companies, than deal with debts that are distributed to households across the country. Increasingly, there are signs that a reckoning will soon be in the offing. On May 28 alone, Shanghai lost $550 billion in market value - a reminder stocks can’t surge 10 percent a week forever, not even in China. Why would the government want to risk the possibility hundreds of millions of aggrieved day traders heading onto the streets with protest banners?

Korea isn’t a perfect comparison for China’s present situation. Its household debt bubble was arguably an unintended consequence of a larger economic strategy; China’s, by contrast, seems more purely cynical. But in some ways, Korea can now be a role model for Beijing. Seoul quickly acknowledged the severity of its troubles in 1997, and it started letting some dodgy companies fail, increasing corporate transparency and liberalizing its economy. China should emulate that strategy now.

Unfortunately, Beijing’s ongoing attempt to swap one debt trap for another speaks to a worrisome lack of political will. Rather than forcing inefficient companies to trim excesses, Xi is letting them escape the consequences of their actions. One year ago, Xi claimed “market forces” would play a “decisive” role during his tenure. For the sake of normal Chinese savers, he should stick by those words and reverse his present policies.

*The author is a Bloomberg View columnist based in Tokyo and writes on economics, markets and politics throughout the Asia-Pacific region.

by William Pesek