Chinese Debt

Here is a compilation of point on Chinese debt and some discussion to follow.

The Western media have made much of Chinese economic pessimism as of late. The Economist laments that that total Chinese household, government, and corporate debt “has soared by 100% of GDP since 2008, and is now 250% of GDP.”

The level, though high relative to other emerging market economies, is not so much a concern as the rapid increase. Alair Turner writes that Chinese investments which rose to 47% of GDP, is “dangerously unbalanced and heavily dependent on infrastructure construction and real-estate development.” Kenneth Rogoff estimated that 60% of Chinese GDP relies on construction.

People's Bank of China

A study by the Chinese Academy of Social Sciences, found that China’s nonfinancial corporations alone had debt 113% of GDP by the end of 2012, which, a year later, would stand at $14.2tn making China the largest issuer of corporate debt. Much of that has gone to largely state owned enterprises (SOEs), which enjoy implicit government backing. Even private companies, such as Chaori, had creditors bailed-out after a bond default.

The situation in China today reflects many of the characteristic traits that Austrian business cycle theory attributes to a credit induced boom. In short, the story goes that there is an exogenous shock to the availability of credit which artificially lowers interest rates and signals to entrepreneurs that marginal investments are now profitable. This leads to an endogenous misallocation of production resources to higher-order goods (i.e. more “roundaboutness”) which is inconsistent with consumer time preferences. While production processes must return to be in line with “consumer sovereignty,” evident by a depression, ever more credit creation can forestall that inevitability.

Although China has a relatively high national savings rate of 50% (compared to less than 20% in the U.S.), there are a number of reasons for concern that the ease of credit access is artificial. For one, central bank policy in the West, including the Federal Reserve’s rounds of quantitative easing, may have had a knock-on effect on emerging market economies. Paul Davies writes that “Between 2008 and 2012, the [growth in East Asian country balance sheets] almost exactly matches the growth in the US Federal Reserve’s balance sheet due to quantitative easing.”

Easy U.S. credit sought the high expected returns from East Asian capital markets and bid down the interest rates, which signaled to firms to lengthen the structure of production. The People’s Bank of China is reported to have injected as much as $294B into the economy, which has covertly gone to select banks and forced borrowing to certain sectors like public housing.

The ultimate test will be whether China can avoid a balance sheet recession from debt overhang. A bad omen is the startlingly low growth in Chinese productivity, only 1% per annum between 1978 and 2012, which further points to growth being investment-driven. Chinese banks report that bad loans are only 1% of their assets, though investors price them as though it is closer to 10%.

The Financial Times writes that Chinese officials were “pleasantly surprised” when it was revealed that 20% of local government debt would be in default. Standard Chartered bank estimates “some 32 per cent of new credit these days is used simply to pay off the interest on existing debt,” and China will pay $1.7tn in 2014 on interest payments alone. China does have the advantage of its financial system being largely under government control, meaning panic induced fire-sales and deflationary spirals are less likely. But this also means that financiers are relatively protected from market disciplining losses and can continue injecting larger amounts of credit stimulus to keep the boom going with potentially larger negative future consequences.

The reality is that Chinese economic opacity may hide the true size of debt burdens until some critical point. It was not so long ago that officials systematically misreported their output during Mao’s Great Leap Forward with horrifying results for the Chinese people.