The Great Chinese Debt Binge

The global financial system is in the middle of a manufactured boom. Earlier, the economies would boom on their own based on the underlying fundamentals. However, in the present scenario, the boom is 100% manufactured by central bankers that are using every trick in the book and some more to create the perception that the sales are rising!

This availability of easy credit has led to a credit binge worldwide. Nowhere is this credit binge more pronounced than in the world’s fastest growing economy. Also, the heavy influence that the Chinese state has on their media has made this topic somewhat of a secret. Fudged numbers, that China reports to the world, have also led to these facts being shrouded in mystery.

The global financial system is ignoring the great Chinese debt binge at its own peril! If critics are to be believed the debt bubble is about to burst and in less than a year, the world will see the catastrophic consequences of letting its fastest growing economy unmonitored.

Unprecedented Levels of Lending

China saw an unprecedented credit expansion in the past 5 years since the 2008 crisis. China now has a debt which stands at 250% of its gross domestic product. Now consider the fact that Chinese GDP is in trillions of dollars and let the magnitude of numbers sink in. Huge expanses of corporate credit have literally been handed out to Chinese corporations. The most recent numbers suggest that the rate of credit expansion is twice the rate of economic growth. This suggests an economy that is at the helm of a massive economic bubble.

Economists have started expressing their discomfort with the Chinese binge in mild terms. Anyone who is looking at the numbers carefully knows that this could very well be the beginning of the end.

Opacity

Public sector banks dominate Chinese banking. Hence, lending in China is more or less dominated by the government. The government being a one party set up virtually runs the banking system unregulated. As a result, the numbers released by them are often incomplete and have a reputation of being untrustworthy.

The world, therefore, faces a unique challenge. Not only is the magnitude of the debt huge, but the opacity of policies followed by Chinese banks also makes it worse. Economists have no idea and no experience of predicting how an asset bubble burst unfolds in a complex economy like China.

Unviable Lending

Trillions of dollars have been lent out in China in the span of five years or so! The breakneck speed of this credit expansion is mind-boggling! However, since the lending has happened so fast, there is a chance that lenders may not have conducted due diligence.

The sheer scale of the lending mandates that some of the money has gone to cronies of Chinese government officials, sub-optimal projects and marginalized borrowers. The existence of several unoccupied ghost towns in China is the testimony to this fact.

The single-minded focus on keeping the GDP growth rate above a certain percentage has led to this credit binge. IMF reports have suggested that a large portion of this debt binge can be attributed to the unregulated shadow banking system in China. Also, they have issued a warning that urges the Chinese government to “urgently” tackle this issue.

A small percentage of the Chinese debt is also a huge amount. In many cases, it is greater than the GDP of smaller countries! Hence, if this debt goes wrong, the results can be damaging to economies worldwide.

Interconnectedness

We have already seen that an American crisis can become a global crisis is no time at all. The Chinese crisis can have a similar impact. This is because a Chinese crisis is capable of triggering an American crisis as explained below.

The interconnectedness of the Chinese economy is what makes this crisis truly global. The United States is China’s largest partner. China is also the number one buyer of the United States Treasury bill. This means that a Chinese crisis would force them to dump a huge amount of treasury bills and notes in the market making it difficult for the United States to borrow more money. Since American economy cannot survive without credit, this seems like a perfect storm!

Other developed regions like the European Union and Australia are also connected with the Chinese economy. China being a part of the BRICS nations, changes in its economy also have an impact on developing economies as well. The impact of Chinese debt binge will not be local.

Difficult Measures

The writing on the wall is pretty clear. Remedial measures are the only way forward. However, remedial measures are politically unpopular even in a communist regime like China! These jobs will require displacement of workers in numbers that the world has never seen. In fact, some of it has already begun. Thousands of workers have been laid off in Chinese mining companies. They are finding it difficult to adapt to this layoff culture since they were part of a communist regime before this.

However, delaying the essential measures will only make matters worse. The effects will be far more pronounced as market imbalances will be sustained for a longer duration making them even bigger in magnitude.