The Chinese debt time bomb

By Leith van Onselen

Fairfax’s Matt Wade is the latest to warn on China’s debt time bomb:

Many thousands of Australian jobs depend on the health of the Chinese economy…

For some years now China’s economic growth has been underpinned by an explosion in corporate lending. China has accounted for half – yes half – of all new credit created globally since 2005 according to the New York Federal Reserve. That’s a huge share for an economy that now only accounts for about 15 per cent of the global economy.

Alarm bells rang last August when the International Monetary Fund pointed out the trajectory of credit growth in China was eerily similar to countries that experienced painful post-debt boom adjustments in the recent past. This includes Japan in the 1980s, Thailand prior to Asian Financial Crisis and Spain prior to the European debt crisis.

The sheer pace of lending growth makes it likely many loans are going to marginal borrowers or unviable projects. A recent Oxford University study that evaluated 65 major road and rail projects in China concluded just 28 per cent could be considered “genuinely economically productive”.

The rapid expansion of China’s less regulated “shadow banking” sector adds to the complexity. The Reserve Bank has described China’s financial system as “increasingly large, leveraged, interconnected, and opaque”…

The best outcome is for what economists call a soft landing. Under this scenario Chinese authorities would accelerate reforms, somehow scale back credit growth and clean up bad debts while economic growth keeps humming along at a healthy rate…

But as economist George Magnus, an associate at Oxford University’s China Centre, says “you can’t resolve a debt problem peacefully”.

…slower Chinese growth… would hit Australia in two ways, first by reducing the price of the commodities we export but also by reducing Chinese demand for Australian goods and services.

To put China’s debt build-up into perspective, here’s a summary chart using data from the Bank for International Settlements:

Note the explosion in Chinese non-financial sector debt over the past decade.

As noted earlier by Houses & Holes, China will hold a long-delayed key financial work conference later this month, which will focus on financial security in the run-up to an expected changing of the top Communist Party guard later this year. The big issues up for debate are expected to include an overhaul of the financial regulatory regime, financial security and opening up of the financial markets.

If Xi Jinping’s poliburo takes another crack at reform then Chinese growth could really slow and the bad loans could turn unruly.

The Chinese debt time bomb continues to tick.

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  1. Perhaps it is a time-bomb, perhaps it is a damp squib.

    Japan in the 1980’s is very similar to China in the last 10 years. The closeness of business and government in both places means that no-one will call in the bad debts.
    China might just undergo 10-20 years of very low growth, like Japan, which won’t be good for Australia, either.

    Chinese nationals in Australia I’ve spoken to are more pessimistic – they are desperate to get their money out of China, and into safe assets like real estate. Ironically, this might be a reason local property prices are booming, Australian housing being a Mainland Chinese pessimism index.

    • sydboy007MEMBER

      Comparing China of today to Japan of the late 80s isn’t a fair comparison. Japan of the 80s had a very high income, while China is still predominately a low income country. Many of the demographics that Japan has faced since it’s crash are rapidly becoming an issue within China too.

      It takes $4 of debt for $1 of GDP growth in China. Probably even more debt to get the same growth in straya.

    • hahahahahhahaha yeah right. What happens when infighting of the elite starts? I don’t know too many billionaires willing to see their wealth paying for the upkeep/bailout of another billionaire just to save face.
      There’s a problem narrowing in on cultural norm/rule and applying it in all circumstances bad and good.

  2. “China might just undergo 10-20 years of very low growth, like Japan, which won’t be good for Australia, either.”
    According to the experts such as Professor Michael Pettis this is the most likely outcome. He says rather than a soft or hard landing, expect a looonngggg landing which is what Japan had.

    Sure Japan’s stock market and property market melted down and so did their global investment but unemployment never went over 6.6% and they remain one of the highest income per capita countries in the world.

    If China does the reforms and cuts the credit, their stock market has already tumbled, their property market will tumble, banks will shuffle around the debt and become zombie banks, reforms to privatize etc will take money from the government /SOEs and give to the people and give the citizens a bigger share of GDP. GDP will fall to 0-2% for 10-15 years.

    I don’t expect a 1930s style depression in China. I expect a Japan style slow down where the building and global investment gets cut by 2/3s and Australia will feel this.

    • For what my opinion is worth I totally agree with Andrew. It depends a bit on how much distortion you consider this debt has financed.
      I’m amused by Western economists waxing lyrical about China’s debt when they themselves are actually sitting on much larger debt problems and have advocated for that. The main difference is that, like Japan, China owes its debt to itself. It is a very productive economy with a generally prudent populace. So it has choices. Again this is not to say there is no distortion but there is a whole lot less distortion than, say, Australia has!

    • I’m not even really sure that Debt can even exist for a country with strong Current Account Surplus.
      You owe who and for what?
      Sure a slow down is possible but a self reinforcing debt spiral seems very unlikely, the good news wrt such a default is that it impacts China’s wealthy more so than it’s poor. The opposite tends to be true when a CAD country enters a debt spiral, the poor and working class get absolutely hammered as liquidity suddenly dries up and interest rates spike in response to the ensuing shortage of capital.
      Makes it all a bit like borrowing from loan sharks, in the end it matters more who you owe money too, than how much you owe.

      • Yup! You might be right. However mispriced money does create distortions as can government activity. When I think about China it is a bit hard to see the severe distortions but it’s a big place to get a picture of!

      • Coming
        I would like to discuss that with you some time. I think that it might be literally true but not actually true (think the conflation of CB and govt which in macro terms is a simple fact.) Also it is another one of those popular trite statements pedalled at the moment as a universal truth whereas it really depends on the situation and the particular dynamic in the country we are talking about.Anyway it might make another interesting day.

    • For me one thing that makes me think a long stagnant/low growth period like Japans is unlikely is that China will not have a “China” to sell too or debt fuelled Western countries either. Japan had the luxury of a booming world economy, China won’t have that. So it could go very bad. That’s why I wouldn’t be surprised if a new revolution took hold suddenly, though it depends on what to average Chinese ends up blaming.

  3. reusachtigeMEMBER

    There is no time bomb in China! The Chinamen have a far more superior economic system that does not allow for any serious issues to occur.

  4. michael francis

    Japan manufactures quality. China manufactures crap. Remember when the Chinese built boats, they didn’t call them Junks for nothing.

      • Simon
        The statement was made that they only produce crap.
        That aside. I agree Japanese quality is quite superb generally speaking.
        So a variety of goods that we bring out of China are the best in the world…no question. Now these are not high tech but do involve some detailed manufacturing.
        We also cooperate with a lab in China manufacfturing and selling medical related devices around the world. Again this work is as good as it gets without being the most complex high tech stuff.
        Most of the phones people carry around were made in China. I don’t know how we determine whether they are world class?
        Now it is true that if you want something made more cheaply for you you can get it. They’ll just down spec it in ways you and the public can’t see – it just doesn’t last as well or stand up to stress. Hence the ”relationship” is essential.

        So just some thoughts. There are a lot of people in here who mouth off about China who know nothing about it. There are some who appear from time to time who know a lot!

  5. I recently came across the following article which describes how the China govt *may be* positioning itself to avoid some of the consequences of it’s debt pile:

    I think the reasoning of the above article is worthy of consideration. The biggest problem I have with the author’s theory is that it supposes that a government is conducting deep thinking and working on a long term strategic process – a real stretch for almost any government, but perhaps (at least regards the ability to implement long term strategies China is better placed than most with their permanent government of sorts).

    It strikes me as highly plausible that, as this article suggests, China’s core reason for it’s One Belt One Road project is to “shift” it’s debt (to put it crudely) into geographically and politically strategic foreign fields, increasing it’s influence in those regions and also boosting demand for Chinese goods and services in the process. All this would make the downward “glide slope” shallower and reap a bunch of less tangible geopolitical benefits to boot.

    Worth some thought, IMO.