BofA: China breakdown is 100% probability

Bank of America is spooking the analyst world with a near airtight case for financial instability in the Middle Kingdom in its most recent note.

As strategist David Cui explains


It’s widely accepted that the best leading indicator of financial instability is rapid debt to GDP growth over a period of several years as it’s a strong sign of significant malinvestment. Based on Bank of International Settlement’s (BIS) private debt data and the financial instability episodes identified in “This time is different”, a book by Reinhart & Rogoff, we estimate that once a country grows its private debt to GDP ratio by over 40% within a period of four years, there is a 90% chance that it may run into financial system trouble (Table 1). The disturbance can be in the form of banking sector re-cap (with or without a credit crunch), sharp currency devaluation, high inflation, sovereign debt default or a combination of a few of these (Table 2).

As Chart 1 demonstrates, China’s private debt to GDP ratio rose by 75% between 2009 and 2014 (i.e., since the Rmb4tr stimulus), by far the highest in the world (we suspect a significant portion of the debt growth in HK went to China). At the peak speed, over four years from 2009 to 2012, the ratio in China rose by 49%.


Other than sovereign debt default, China has experienced all the other forms of financial instability since the open-door reform started in late 1970s, including a sharp currency devaluation in the early 1990s (Chart 3) and hyper-inflation in the late 1980s and early 1990s (Chart 4). China also needed to write-off bad debt and recap its banks every decade or so. Banking sector NPL reached some 40% in the late 1990s and early 2000s and the government had to strip off some 20% of GDP equivalent of bad debt from the banking system between 1999 and 2005.


When debt problem gets too severe, a country can only solve it by devaluation (via the export channel), inflation (to make local currency debt worth less in real terms), writeoff/re-cap or default. We judge that China’s debt situation has probably passed the point of no-return and it will be difficult to grow out of the problem, particularly if the growth continues to be driven by debt-fueled investment in a weak-demand environment. We consider the most likely forms of financial instability that China may experience will be a combination of RMB devaluation, debt write-off and banking sector re-cap and possibly high inflation. Given the sizeable and unstable shadow banking sector in China and the potential of capital flight, we also think the risk of a credit crunch developing in China is high.

In our mind, the only uncertainty is timing and potential triggers of such instabilities.

To put things into perspective from an Australia viewpoint over the medium to long term, China can manage a bad cold, but the Chief Mine and Dodgy Money Laundry center to the Middle Kingdom will fall over on a sneeze. Fiscal stimulus is no longer an option as it increases the risk of instability and malinvestment, and material demand for goods from Australia will dwindle as the RMB depreciates.

Its going to be an interest year!

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  1. I am guessing that will impact Australian property markets in many ways, if there is a crash on their stock market which I think must happen as they have extended the ban on people selling their shares as its so dodgy it will full over on the first day, Chinese investors may have less to buy property over here. Then their is the demand side not needing all that dirt anymore. I noticed in the Brisbane times this morning that lessors are offering gifts to try get people so the rental market is starting to stall up here, maybe that’s because the resources industry is drying up

    • flyingfoxMEMBER

      I am guessing that will impact Australian property markets in many ways

      All on the upside 🙂

    • Yesterday on the channel 7 news another sydney harbour mansion in Vaucluse (Villa Igiea) sold for over $52 million dollars. Purchased by a 27 year old son of wealthy chinese (his father is China’s 92nd most richest person) who recently completed a university degree at Macquarie University. I get the feeling we will see more and more of this. Its all over the news

      • Don’t forget he does live here, has PR here and does run a mildly successful construction company in Sydney. This is an example of Chinese big man syndrome – flashy display of money to show everyone how rich and big he is, probably also competing with his father. This is purely an Australian affair, I don’t see it as a leading trend unless all the Aussie rich list decide to outbid each other for houses.

      • I get the feeling we will see more and more of this.

        By definition the number of children of China’s top 100 wealthiest people (or even China’s top 1000) wealthiest people is a pretty limited number.

      • Don’t forget he does live here, has PR here and does run a VERY successful MONEY LAUNDERING company in Sydney.

  2. The BIS and Rogoff etc may have limited application to a country where the govt controls the banking system and fiscal policy.

    It is unlikely that the CCP govt will allow a credit crisis to produce a prolonged contraction in the money supply the way the west does when the FIRE sector drives the economy off a cliff. Adoration of fiscal austerity when credit creation collapses is a peculiar affliction of western econmists.

    Unless of course the CCP puts following a western bank centric model ahead of political survival.

    Nothing above should be construed as giving comfort to commodity producers like Australia.

    • Basically agree with the cognitive capture premise tho there is that hyperball of capital noone seems to be able to control or the bond vultures that swirl over it. Not to mention the parallels with the west once 2nd, 3rd removed from central power corruption.

    • Central control of a financial system gives the CCP the ability to suppress volatility. It doesn’t give it the ability to eliminate it. Volatility in respect of underlying economics will assert itself, just in a more dramatic (i.e. regime shattering way) when suppressed over long periods.

      • The CCP will only put itself first especially white such an insecure & power hungry personality like Xi in charge. And yes when the system breaks it will be sudden and verry messy, I suspect.

  3. If the GFC was good enough for the USA its good enough for China, I’m beginning to think its a requisite for the IMF table… sort of a wetting down initiation….

  4. If there is a big devaluation in the Yuan, their investors will have to pay a lot more for Australian property.

  5. Josh MoorreesMEMBER

    who called the can kick for the ban on selling?

    Josh Moorrees
    January 5, 2016 at 6:03 pm

    yeah but then the NT saved the day. I agree though, I see them backtracking and kicking the can further by continuing the ban on selling.

  6. Interesting problem, no doubt about it.
    Lets see IF China wants to devalue significantly it’ll need to return to the policies of the early 2000’s when accumulated foreign earnings were aggressively exported/recycled. These were the years when China’s foreign reserves increased by almost $1Tpa.
    Now let me see, Do I know a country that’ll willingly import anyones excess capital to keep their own ponzi scheme alive?
    Will they allow their own industry to be crushed by the currency over valuation that comes hand in hand with large scale capital account transfers?
    Hmmm this will likely result in the biggest can kick Australia has ever experienced….all funded from the Middle Kingdom …now where do you think Aussies will invest this cash stream?

    • @CB – times have been a changing since earlier 2000’s. We may still get a trickle here but the bulk will move to the US where policy changes for big corporates makes it more appealing, combined with a currency that is still for the moment the most liquid and an economy that is moving at least.

      • No argument from me, to be effective most of the Chinese capital must return to the US, however what will the US do with this excess capital windfall? my guess is that they’ll export it yo the rest of the world. Australia is still one of the least ugly ROW inhabitants, so we’ll see a goodly slice of this money coming our way. Many would trace Europe’s competitive problems to the mid 2000 Euro over valuations that accompanied a shift in Chinese policy away from strictly holding US reserves to a more balanced EU/US reserve policy. If memory serves me correctly the EU/US exchange rate was about 1.6 dollars per Euro in 2008.

      • Yea I did see that, strikes me as a blog taking a deep dive into the Triffin paradox. The broader consequences of this paradox are well understood by toes in charge of the PBoC. look back around 2009/10 for a whole series of articles (mainly in Chinese) finding that the GFC is the inevitable consequence of this paradox beginning to unravel.
        Personally I call it the Master/Servant dilemma, while the servant gets richer providing the Master with over priced services the Master gets poorer. logically at some point in time the roles must reverse but they cant because both men are locked into their respective roles and unable to see anyway forward. As a consequence the Servant loans the master money so that the master can afford to pay the servants wage. The servant needs his job, the Master needs his status.

    • The ability of the US to sustain such a large deficit is coming to an end (on both an economic and political level). if the Chinese devalue and seek to return to export driven growth the WTO will break as the US and Europe are forced to protect themselves.

      The Rhetoric of Donald Trump r.e. China demonstrates this in spades.

  7. ‘What could be the beginnings of a major global recession’
    Tyler Cowen, professor of economics at George Mason University

    “I believe China is currently in the range of 3 to 5 percent growth, and headed rapidly to zero. Some people take this to be a radical position, but is it? Is it so uncommon for countries to have recessions every now and then? It’s now China’s turn, due to debt buildup, excess capacity and problems in reforming their state-owned enterprises. Longer run, I think they can expect growth at 4 percent. At most. The big losers here are Brazil, Peru, Singapore and other parts of Asia, as well as Africa. The United States will chug along at 2 percent growth, and mostly ignore what could be the beginnings of a major global recession. We are about the most insulated from this of just about anybody.”

    Article has range of ‘predictions’ some interesting, some contradictory eg Ian Bremmer who believes China has not yet seriously begun to tackle its economic woes using its vast reserves, but will in due course. And if I were a Canadian I’d be disappointed that Chrystia Freeland, Canada’s minister of international trade and a member of parliament, could only extoll the joy of nations soending hundreds of billions on renewables seemingly oblivious to Canada’s fossil fuel export potential. Another mealy mouthed populist politician I guess.

    Read more:

    • As shown in a recent Bloomberg investigation into U.S.-Canadian pipeline negotiations, Canada’s hard-right bent and lax approach to environmental regulations has greatly damaged its relationship with the U.S., specifically Obama’s trust in its management of the Keystone XL project. As Bloomberg reports:

      In informal chats, U.S. officials suggested it would help Obama with his green constituency if Canada would move to regulate emissions from the oil and gas industry. The embassy in Washington, according to an official posted there, constantly relayed messages back home that Canada was being depicted as lax, almost indifferent on the environment. The message would come back that regulations were in the making. … The regulations didn’t surface because Harper and his closest advisers were dubious they mattered.

      Then there are the numerous issues with TransCanada, one of the continent’s largest gas storage and transportation companies and the company responsible for building Keystone XL. Noted for its aggressive scare tactics, launching eminent domain actions against Nebraska residents even before receiving approval for the pipeline, TransCanada has also had issues with quality and safety.

      Skippy…. you can only hope Hillary gets in 3d1k…

      • Well Hillary is a raging neocon, but will stay bought. Trump on the other hand has strong nationalistic tendencies too [hyper exceptionalism – his basic campaign platform] and basically a bag man for property sqillionairs that don’t have the same pathological desire to be in the spot light.

        Skippy…. Hillary or Trump could run with Oprah as VP…

    • If Chimerica unwinds expect the US to grow MUCH faster than 2 pc. The US’s biggest economic dead weight is the sustained trade deficit. If that is narrowed significantly the weight of productive investment returning to the US will lead to major upside in US growth.

      The Chinese export driven economic model is essentially parasitic and relies on soaking up international (significantly US) demand. If that comes to and end expect the US as a society to be a BIG winner.

  8. Ludwig Wittgenstein

    The chart is crap.

    The US credit has doubled in that period as a percentage of GDP – BIS – less trustworthy than Chinese state figures, perhaps even worse than ABS.

  9. Japan has shown that China’s debt problem might not cause a crisis for another 2 decades. Every 10% fall in interest rates makes a debt problem more manageable and maths is such that you can decrease interest rates 10% pa from here to infinity. A centrally controlled economy willing to run tanks over people and with a fiat currency can basically do most of what it likes for a long time, the exception probably being the independent third party valuation of its currency (but it can manage/control the purchases of foreign currency by its own citizens). I suspect the Chinese could continue to confound us for another 10 years.

      • On reflection I think you are correct. It could easily be argued that China is Japan in 1990, but the difference in their governments and now greater knowledge of how a government can use its fiat currency suggest to me that while there may be similarities to Japan 1990, the outcome could be completely different. I maintain my view that China might avoid crisis for another 5 years. For China, the demographics become very difficult after that in gross terms, but maybe not in per capita and maybe not in some areas. So many countries are facing demographic headwinds that macro global growth could become nigh impossible in 5 to 10 years. After India, what meaningful size country is left to enjoy rapid growth?

  10. Isn’t Cui referring to the Reinhart and Rogoff book that was torn apart after it was revealed the excel spreadsheet they used was wrong?