The unfolding scandal surrounding the Chinese brokerage Sealand Securities, reported here at Financial Times and widely underreported here in the States, is refocusing attention on the sheer unfathomably massive scale of China’s debt. The editors of the Wall Street Journal remark:
Government interference had pushed China’s bond market into bubble territory over the past two years. Beijing encouraged companies to issue bonds to reduce their reliance on bank lending, while prodding others to buy them. The authorities also rescued troubled companies to prevent them from defaulting, which has led to a fundamental mispricing of risk that will make the correction all the more painful.
As always, the bursting of a bubble reveals who was swimming naked. Last week, brokerage Sealand Securities defaulted on a bond-financing transaction allegedly made by a rogue employee. Rumors are also circulating that investors are pulling their money out of funds holding bonds. Firms that used high leverage to deliver promised returns now face margin calls.
The larger question is whether China’s real economy is itself a bubble. According to official figures, bank lending and social financing are growing at roughly double the rate of GDP. Total debt now stands at 260% of gross domestic product, up from 154% in 2008. That doesn’t count the trillions of dollars in loans that banks have classified as “investment receivables†and other such dodges.
I’ve seen estimates that China is borrowing $6 to get each additional $1 of GDP. It’s hard to see how that could continue indefinitely.
When you divvy Chinese debt into its component parts there’s individual debt, corporate debt, and government debt including the debt of local governments. Nominally, the preponderance of the debt is corporate debt. However, to an extent that is illusory. Many of China’s largest companies are state-owned enterprises and, unsurprisingly, they’re the largest borrowers, too. Since China’s banks are state-owned, that means that most of that debt is the government borrowing from the government. Some of that debt is resurfacing in California in the form of cash-only purchases of multi-million dollar homes but that’s a subject for another post.
So the Chinese government is borrowing from the Chinese government and an increasingly large proportion of the borrowing is going to service past loans owned to the government by the government. The PBoC then releases more money to provide liquidity. Welcome to the wonderful world of fiat currencies.
Can it go on forever? The Chinese are in the midst of a fascinating experiment. We’ll know the results soon.
If they take a major hit economically, look out. Authoritarians tend to double down on nationalism when things get hairy with the populace. Fortunately we’ve hired an illiterate man-baby to manage things, so I’m sure it will all be fine.
Internally, China can do what it wants – strongly encourage wealth bequeathed to the state upon death, forgive loans, adjust the books, print money, destroy money, etc. Externally, they can only do what the market will bear.
This should be no surprise, and for anybody who is surprised, Europe is bad also. European banks are a house of cards, and the reason for the Greek bailouts was not to save the Greeks. It was to prevent a cascading implosion of credit support.
The US will be affected because all the countries with credit backed currencies have integrated balance sheets. This is what allows the free flow of money. For the US, there are also trade deficit dollars floating in the inter-national financial ether, and they do return to the US as credit instruments.