Is China really different from Greece and Puerto Rico?

In the past few weeks, Greece has been front and center, pushing two other big stories to the sidelines.

While Greece was voting “no” in an historic referendum over the weekend, Puerto Rico is barely staving off a default and Chinese stock markets are taking volatility to another level.

A note out from Viktor Shvets and Chetan Seth at Macquarie draws important similarities between the three countries, and how their unraveling may be the “the opening scenes of the last act in a global leveraging drama” that began way back in 1990, during the bursting of Japan’s asset price bubble, and then continued during the global financial crisis of 2008. Are Greece and Puerto Rico just the weakest dominoes that are the first to fall in a three-act play? Could China be the next? The analysts note that both Greece and Puerto Rico have had a hard time competing in the global market. Both economies are tarnished by corruption, bloated public sectors, and unsustainable debt levels. Most important, neither has an independent monetary policy but is instead linked to the euro zone or the U.S.

So how different is China? The analysts say that in the short term, there are many differences. One is that China’s economy remains relatively competitive and is still running current account surpluses instead of deficits. Another is that China has a much higher “degree of monetary and fiscal flexibility” than Greece and Puerto Rico, for obvious reasons. That means China still has a lot of firepower left when it comes to lubricating its financial markets and its wider economy, the analysts say. But in the longer term, China — just like Greece and Puerto Rico — will have to think about structural reform.

Here are the analysts:

First, we have argued for some time that growing overcapacity in every facet of China’s industry and economy requires a rapid reduction in interest rates. China currently is the only major economy that operates with strongly positive real interest rates. Second, we maintain that current [reserve requirement ratio] restrictions are completely obsolete and should be rapidly reduced towards historic levels (~5%). Third, the [People’s Bank of China] has to accept that deleveraging is no longer possible or desirable and it should embark on aggressive QE (including acquisition of private sector instruments). … In our view, the case of Greece and Puerto Rico highlights that deleveraging requires significant upfront cost that most societies are unwilling to bear. Whilst moving monetary policy into a neutral gear and allowing business cycle adjustment is the best strategy, in reality any structural reform and deleveraging requires massive monetary and fiscal lubricants to ensure societal consent. However the experience has been that monetary lubricants, instead of accelerating structural changes, tend to delay them. The question for China therefore is not whether it will stimulate (this is a given, it [is] just a question of size) but could it simultaneously pursue structural reform?

The jury is still out but in the short-term we remain overweight MXCN, expecting a much more robust policy response.

Stopping the stock market rout and simultaneously embarking on structural economic reforms seems like a tough ask. Over the weekend, the China Securities Regulatory Commission said the country’s central bank would seek to maintain market stability. Meanwhile, China’s largest brokerage firms said they’ll keep buying stocks until the Shanghai Composite reaches 4,500. It closed at 3,775 on Monday.