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Thread: China’s mountain of debt, explained

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    China’s mountain of debt, explained

    Beijing may be even more indebted than Washington. But thanks to communism, don’t expect any Lehmans.

    David CaseJuly 8, 2011 07:10

    Debt is the economic scourge of our time.

    First it buried American banks and mortgage holders. Then we learned that euro zone governments such as Greece, Portugal and Ireland were in hock over their heads. Japan’s debt is twice the size of its annual economy. And in Washington this month, Republicans and Democrats are engaged in brinksmanship over the American taxpayer's $14 trillion hole.

    Through it all, China has been seen as the stalwart of financial prudence. But we now know that the country faces its own challenges.

    As GlobalPost has reported in the past, China's banks have been engaging in risky “off balance sheet” lending somewhat reminiscent of Enron’s shenanigans. Last week, Beijing released a national audit revealing that local governments owe an estimated $1.65 trillion in outstanding loans. This week, Moody’s has indicated that the problem is significantly worse, by as much as $540 billion. And that's only local government debt. It doesn’t include the central government’s huge obligations, or those of banks that are essentially guaranteed by Beijing.

    Even for a miracle economy like China's, that’s a lot of debt.

    To put this in perspective, GlobalPost interviewed Victor Shih, an expert in China’s economy, who has been following the debt situation closely. Shih, an assistant professor of political science at Northwestern University, holds a Ph.D. in government from Harvard. (The interview has been condensed and edited by GlobalPost.)

    GlobalPost: Put this in perspective for us: How much debt does China have?

    Victor Shih: That depends on what you include. Large sectors of the Chinese economy are owned by the government. The debt of these state-owned enterprises is what’s called a “contingent liability” — ultimately it’s the responsibility of the government. If you count all of these liabilities, then you get to an extremely high number, something like 150 percent of the Chinese gross domestic product, or more.

    A more restricted definition is debt that's owed by either the central or local governments. That is about 80 percent of China's GDP.

    If China's central and local governments are responsible for the companies’ debts, is that the more prudent number to use?

    It depends on the prevailing economic conditions. When the economy's strong, then there's no need to look at the wider contingent liabilities, because there's plenty of money to go around. If the business environment begins to deteriorate, state-run enterprises could go bankrupt. In those cases, you do need to look at the broader liabilities. If growth slows down substantially, people may find that the Chinese government in fact owes a lot more than 100 percent of GDP.

    How sound are the businesses that owe all this money in China? A lot of China’s outstanding loans were made in a rush after the crisis began in 2008, correct?

    Yes, loans under the crisis-era stimulus program were very rushed.

    In China, there are two different kinds of government-related investment projects: centrally directed ones and locally directed ones. The centrally directed projects are a little bit better, though in some cases, also very wasteful. They involve things like building a high-speed rail, or a major airport, or expanding Beijing. These projects tend to bring more benefits to the national economy, and so trillions [of yuan] in loans have been provided to the centrally directed projects.

    What about the local projects?

    The locally directed projects, in many cases, are extremely wasteful projects, such as building an Olympic-sized stadium in a city with 800,000 people, or building hugely expensive government buildings. The local governments have all of these cockamamie projects which got approved when the central government panicked in 2009.

    When you build an Olympic-size stadium in a city with 800,000 people, that stadium is not going to generate a lot of cash flow. The banks, so far, are rolling over a lot of this debt: rather than declaring it non-performing, they say “okay, we'll give you a new loan, and part of the new loan you'll use to repay the old loan.” This is why you see a relatively low non-performing loans ratio in China.

    Why does China's debt matter to its central government in Beijing, and why does it matter to Americans and others outside China's borders?

    Americans probably wouldn't be hurt that much. Some people worry that if there's a debt bubble that somehow bursts, then China will redeem its large holding of U.S. Treasuries to bail out Chinese banks. That is a possibility. I think that if that were the case, others would snap up those Treasuries. Interest rates may go up a little bit, but probably not by that much.

    As for the Chinese government, the current leadership steps down from power next year. They don't want to look bad by revealing that they got China into so much debt. On the other hand, the new leaders will want to do more to reveal the problem, because otherwise there's some risk that they will be blamed. So we do see this kind of conflicting tendency within the Chinese government to disclose how much local debt there is.

    How bad is the problem? What are the chances that China could suffer a debt crisis like the one the US faced in 2008 or certain euro zone countries are facing now?

    I’d say zero, because the Chinese banking system is different from in the U.S.

    The Central Bank of China has already explicitly said that it would bail out all the distressed financial institutions, so there's no Lehman Brothers problem, where a big financial institution could get wiped out. But this creates a problem of moral hazard: You're telling the banks that they'll always get bailed out, so they never need to improve their performance.

    The problem is inflation. Every time you bail out a bank, the Central Bank essentially prints new money and gives it to the banks, so everything remains liquid. If you do this year after year, you drive up prices, by flooding the economy with new money.

    Over the next two to three years, there's unlikely to be any kind of credit crunch causing a financial crisis in China, but you will see fairly significant inflation. If inflation persists, you erode people’s savings because their money will buy less. So consumption (in real terms) will never be a main engine of growth in China if this continues. That would be a problem when their exports slow down.

    Is slow consumption growth a problem for the U.S.? During the crisis the U.S. government wanted China to consume more rather than depending on exports for growth?

    Definitely. China can now only grow either through investment, which drives up commodities prices, or through exports, which competes directly with the U.S., Europe, and other countries. That is a problem of the Chinese growth strategy for countries that are not China.

    China blames the Federal Reserve for the quantitative easing program that it has used to stimulate the economy. They say that exports inflation to the rest of the world. That may be true, but China also exports inflation.

    The Central Bank of China prints 15 percent to 25 percent in new money supply every year, and that drives up commodities prices around the world. The U.S., being a commodities rich country, is relatively immune to that inflation. But in other countries, where people mainly consume commodities like corn and soy beans, prices have gone up tremendously. People in those countries suffer in part because of Chinese printing of money.

    The downside of all this debt, it seems, is that the government's legitimacy depends on its ability to continually improve the standard of living of its people. Could inflation and debt provoke instability in China?

    There is already a huge amount of instability in China. There have been 80,000 mass incidents, some of them are very peaceful sit-ins, but there are thousands of riots in China. But all of these incidents have been very isolated to one or two places, there has not been any sort of inter-regional unrest.

    When you have such a powerful apparatus to maintain control, why do you need legitimacy?

    Some Arab governments these days may have a tough time with that question.

    The Chinese government would say that that's because they allowed social media to operate freely, which is not the case in China.

    Do we know which local governments face the biggest debt burdens? Who's the Greece of China?

    The biggest problems lie in middle income provinces, which aspire to be the next Beijing, Shanghai, or Guangdong. These places, like Tianjin, Wuhan, Chongqing and Chengdu have borrowed an enormous amount of money to finance infrastructure construction, but at most, there will be one, maybe two new Shanghais. These middle income places with high aspirations will ultimately run into some serious issues, which they’ll have to work out with the central government.

    How could China, the world's second biggest economy, make so many inefficient decisions, without suffering serious repercussions?

    The magic is that the government controls all the banks, and capital controls prevent people from moving money out. The Chinese people don't have any choice — they put their money in the bank, then the bank uses the money to lend to state-owned enterprises. Or you invest in the stock market, but most of the companies listed in the stock market are state-owned enterprises. You buy real estate, and the proceeds from real estate largely go to state-owned companies. The money always ends up in some entity controlled by the government. This is why it's been very sustainable.

    So essentially the debt is owed to Chinese families who have put money in the bank, and they're likely to get bailed out. Nobody's going to lose the way we saw people lose in recent years in the U.S.

    They're not going to lose their deposits, but there's an inflation tax every year. Right now, there's what's called negative real interest rates in China. Inflation rates are nearly 6 percent, but deposit interest rates are only 3.5 percent, so every year that you leave your money in the bank, you lose almost 3 percent, in real purchasing power. So that's basically a tax.

    So the Chinese consumer is taking the brunt of this.

    Yes. Households are being taxed left and right, in many different [hidden] ways. This creates a lot of insecurity in your average household, which means that they're not going to spend a lot of money. A lot of services — even though they're supposed to be free — actually cost a lot of money. So people with children, people with sick relatives, have to pay a lot of money to send their kids to school, or to send their relatives to the hospital.

    There's also an explicit government tax, and high prices that Chinese consumers have to pay to state-owned monopolies and oligopolies, so certain sectors are highly uncompetitive. Prices are set by the planning authorities in many cases, so that also constitutes a kind of a tax on households.

    With all of these different kinds of implicit and explicit taxes, it will be extremely hard for the Chinese consumer to really pick up the slack and that's where China’s growth will run into some serious issues in the coming few years.

    Meaning that when China exhausts its export potential, consumer spending won't be able to pick up the slack because of these many hidden taxes that the people face?

    Yes, exactly.

    What’s the near-term effect of all this?

    The biggest potential problem comes from the elite. There are some very wealthy people in China. They're not going to sit there while their savings are eroded away at a rate of 3 percent or 4 percent a year. They're going to do their best to find a high return, as rich people around the world do. Even China's capital controls are not going to stop them. So I think, in the future it may become more apparent that China is experiencing net capital outflows.

    But moving your money abroad is not legal in China.

    It's not legal, but it happens all of the time. There are hundreds of underground money changers who help people move money out. You just give them a million dollars worth of Chinese Yuan, and in Hong Kong you can take out a million U.S. dollars. They just charge a small fee.

    Another concern in China is the real estate debt, given how quickly property prices have risen. In your view, is the real estate market in a bubble, and if it bursts, what would the effect be on government debt?

    It's not such a serious problem yet. If real estate sales slow temporarily, developers may still keep on buying land, because land prices have gotten cheaper, and some of the larger, well-financed developers see it as a good chance to buy land. If the slow down in real estate persists for half a year, you may begin to see even the well-financed developers slow down their buying. The local governments will not be able to sell land, which is the main source of cash that they use to repay the banks. If there's another half a year after that, then these loans may become non-performing. The chances of that is relatively low over the next few years.

    At 150 percent of GDP, that’s a debt rate similar to Greece’s. Obviously Greece's growth rate is much lower than China's. But it’s surprising to hear that things seem as sustainable as they are.

    Well, Greece has German bankers, and China has Chinese bankers, that's the difference. Japan has a debt-to-GDP ratio of 200 percent, but they owe it all to Japanese households.

    That makes it sound like capital controls aren't such a bad idea after all.

    Well, if they're used to finance all these state monopolies and oligopolies, then it's extremely bad for the economy in the medium term.


    Visit Victor Shih's blog, or follow him on Twitter @vshih2.

    Follow David Case on Twitter @DavidCaseReport.
    No such thing as a good tax - Churchill

    To make mistakes is human. To blame someone else for your mistake, is strategic.

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    Normally I don't wast time with fan boy write up like this, but it is Sunday, what they hack.

    The entire article never spells out how much China's debt is. The only hard number that was given was the debt is at @150% of GDP. But, which debt?

    In America, the government debt of 14 T but it does not include personal debt nor local government debt. Thus the base for his entire argument is false, how can one adds (which the real numbers were never provided) all the debt in China and claims it is worst them then the US Federal debt.

    Back to the other point of his article, that because China is Communism, thus all debt must be government owe. Anyone with access to google can find out what percentage of Chinese companies are SOE. or, 60% of all Chinese exports are done vis foreign companies or JVs , not SOE.


    I'd agree that the Chinese growth for the last few years has been based on heavy investment, but if it can provide jobs, hey, let them dig holes. Blaming China's "printing money" as the cause inflation elsewhere is silly at best.



    The Central Bank of China prints 15 percent to 25 percent in new money supply every year, and that drives up commodities prices around the world. The U.S., being a commodities rich country, is relatively immune to that inflation. But in other countries, where people mainly consume commodities like corn and soy beans, prices have gone up tremendously. People in those countries suffer in part because of Chinese printing of money.
    Someone needs to go back to school and read Econ 101 again.
    “the misery of being exploited by capitalists is nothing compared to the misery of not being exploited at all” -- Joan Robinson

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    What I thought about Chinese printing money is the constant preassure Chinese face to the value of the yuan.

    However, this is one of the articles on the net saying China has serious problems with the debt. In another article I ran to, it says the local governments owe around 30% of China's GDP ($1.7 - 2,2 tn), while the IMF projects the total public debt @ ~20% of the GDP.

    Something is wrong with the numbers.
    No such thing as a good tax - Churchill

    To make mistakes is human. To blame someone else for your mistake, is strategic.

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    That is the problem, the article lack seriously analyses for me to consider worthwhile.
    Public debt is not the same as Federal debt nor it is the same as local government debt. Using commie-ism to link them all together is not only lazy but also misleading.


    Debt is bad -- as the recent US debt debate reminds us – it is not as bad if there is incoming to match it. In the real works, line-of-credit is calculated not by debt alone but also one’s ability to play back
    “the misery of being exploited by capitalists is nothing compared to the misery of not being exploited at all” -- Joan Robinson

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    What I thought about Chinese printing money is the constant preassure Chinese face to the value of the yuan.
    One can't not match the growth the economy without increasing the M2 Money supply. A greater economy requires a greater amount of money
    Last edited by xinhui; 08 Aug 11, at 06:11.
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    Quote Originally Posted by xinhui View Post
    One can't not match the growth the economy without increasing the M2 Money supply. A greater economy requires a greater among of money.
    My thoughts were in regards to the Victor Shih's claims that whenever China prints money other nations pay more expensive soybeans. Was thinking (even if that is true, not seeing how, but still) how expensive would the soy be if China goes for a stronger yuan
    No such thing as a good tax - Churchill

    To make mistakes is human. To blame someone else for your mistake, is strategic.

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    people pay more for soybeans because more of Corn and soy are being used in ethanol production, drop in yield and a lot of speculation.

    With all those investors leaving the stock market, where do you think they are headed to? The commodity market.


    World supply and carryover

    Penton Media - Corn & Soybean Digest, Click Here!
    Turning to the forecast of worldwide corn supplies, measured as days of use on hand, he says the 2010-2011 marketing year is about 60 days. The 20-year average would be about 90 days. Sixty days, he says, could be the new normal.

    “The U.S. situation has tightened up considerably since earlier estimates from this summer. For the last two crop years, we have seen record production, but we have increased our usage in excess of what we’ve been able to produce.”

    According to USDA demand categories, there has been a slight dip in feed and residual use for 2010, exports are up some, but ethanol is still the driving force, says Welch.

    Much of the price response seen recently in the corn market is due to lowered expectations on yield prospects for the 2010 crop, he says. “Last year, we were coming off a record crop of 164.7 bu./acre. USDA’s most recent estimate is 162.5. Even though the market has risen in response to a yield shortage, we may not have accounted for all of the acres out there. Until we know for sure, there’s a lot of speculation.”

    It has been a while, says Welch, since the corn crop yield average was below the trend line. “With the advances in technology and modified seed, we hear remarks that there will be no more crop failures. I’m not quite on that bandwagon, but the productivity we’ve built into this corn market is amazing. If we do have a crop shortage, given our carry-over stocks, things will get serious in a hurry.”

    The supply and demand numbers tell an interesting story, says Welch. “With the reduction in yield expectations, we’ve seen a drop in production estimates. And with higher prices, we’ve dropped domestic use somewhat. With what’s happening around the world, we’ve responded to that with higher expectations for exports.”

    Ending corn stocks are well below last year, he says, and well below the five-year average, demand has increased, and last year’s crop is being used at a faster rate than was thought. All of these factors have created the current supply situation.

    Ethanol prices, says Welch, have increased dramatically over the last several months, from about $1.50 to about $2/gal. “As we’ve seen prices going up late this summer, higher ethanol prices have compensated for that.”

    At $2/gal. ethanol, the ethanol plant can afford to pay about $4.40/bu. for corn and stay in the black, he says. Lower ethanol prices or higher corn prices will push the plants back in the red.

    Looking at U.S. plantings for 2011, Welch doesn’t think an anticipated increase in anhydrous ammonia will affect growers’ decisions to plant corn. “I don’t see that as a factor in terms of farmers not planting corn. There is enough incentive in the market to attract the acres we need today. We’re not going to lose acres to soybeans at these prices. We’ll see more corn acres in 2011.

    Corn Market Driven By Ethanol | Energy content from Corn and Soybean Digest
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    Victor Shih forgets to mention that the Chinese money supply has been growing at the constant double digit rate for over two decades.

    Addition to what Xinhui has mentioned, the price of soybean is determined by the supply and demand of the market. The rise of the income in China increases the demand of livestocks. Subsequently, the demand of soybean increases. The rise of the Chinese currency make the import of the US and Brazil soybean cheaper. The increase in importaton of cheap soybean depresses the price of the domestic soybean. The Chinese farmers allocate more lands for wheat and rice and less on soybean. The price of soybean continues to rise, and American, the Chinese and Brazilian farmers have increased their planting of the soybean. Eventually, the market will reach a new temporarily equilibrium as the expectation of higher yield. This is what Econ 101 taught me.


    Money and
    Year Quasi-Money Money Quasi-Money
    (M2) (M1) Currency in Demand Time Saving Other
    Circulation (M0) Deposits Deposits Deposits Deposits

    1991 26.5 24.2 20.2 26.7 28.5
    1992 31.3 35.9 36.4 35.6 27.6
    1993
    1994 34.5 26.2 24.3 27.2 41.8 55.7 41.5 36.0
    1995 29.5 16.8 8.2 21.5 39.3 71.1 37.9 29.3
    1996 25.3 18.9 11.6 22.4 29.4 51.7 29.9 6.4
    1997 19.6 22.1 15.6 25.0 18.1 33.7 20.1 -21.6
    1998 14.8 11.9 10.1 12.6 16.7 23.2 15.4 21.7
    1999 14.7 17.7 20.1 16.7 13.0 14.2 11.6 29.4
    2000 12.3 16.0 8.9 18.9 10.0 18.8 7.9 18.3
    2001 17.6 12.6 7.1 14.8 15.5 25.9 14.7 9.1
    2002 16.8 16.8 10.1 19.2 16.8 21.8 17.8 2.8
    2003 19.6 18.7 14.3 20.1 20.1 27.4 19.2 16.4
    2004 14.6 13.6 8.7 15.1 15.3 21.2 15.4 5.2
    Attached Images Attached Images  
    Last edited by kyli; 08 Aug 11, at 06:10.

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    There's some legitimate points in there but it's not really something that nobody's known for ages. that you can not supply a true number means that it really doesn't shed any new light on the issue.

    There are legitimate concerns with runaway projects in China , and yes it's true that Inflation outpaces interest rates pretty badly there which is a problem. That and there are a lot of dubious loans made by their banks (then again, as we've seen the last few years western banks are not actually better in this regard like... at all)

    At the end of the day, capital's value is often maintained due to perception more than real basis, as long as China can control that aspect of it, they should do well enough.

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    Eventually, the central government might need to absorb some of the local government debts. For the last few months, it has already fully evaluated the situation and the costs of sour debts. I think it has some understandings of the scope of the problems, but I don't know if it has the will to stop the continued accumulation of the local debts.

    However, the Chinese banks have been making 100billions a year. They could take a hit if it is spread out over a few years. The Chinese government has injected hundred billions in the 90s to early 00s to make them solvent. I don't think the chinese government would be too please to do it again a decade later.

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    So how accurate is the claim that only 35% of China's GDP is tied to personal consumption?

    I have the feeling that Beijing's statistics on that are less comprehensive compared to data about investment and infrastructure?

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    All Chinese statistics are subject to (according to that great authority, me) a 20% margin of error.
    Which means, for example, that the June money supply (M2) was either 36% larger or 9.3% smaller than a year earlier. Or, that Q-2's 9.5% real GDP growth was in the 7.6% to 11.4% ballpark.

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    Quote Originally Posted by xinhui View Post
    That is the problem, the article lack seriously analyses for me to consider worthwhile.
    Public debt is not the same as Federal debt nor it is the same as local government debt. Using commie-ism to link them all together is not only lazy but also misleading.


    Debt is bad -- as the recent US debt debate reminds us – it is not as bad if there is incoming to match it. In the real works, line-of-credit is calculated not by debt alone but also one’s ability to play back
    These days the mass media does not rely too much on scholarly analysis to inform their articles ;_; Looks more like a kind of controlled "soft" propaganda than anything like sterling journalism. (I guess these are all spun-up accounts to keep the masses from panicking.)Reading financial newspapers is a better way to find info on the topic under discussion, IMHO.

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    They're not going to lose their deposits, but there's an inflation tax every year. Right now, there's what's called negative real interest rates in China. Inflation rates are nearly 6 percent, but deposit interest rates are only 3.5 percent, so every year that you leave your money in the bank, you lose almost 3 percent, in real purchasing power. So that's basically a tax.

    So the Chinese consumer is taking the brunt of this.
    Sounds all too familiar to what's happening to us here, too.

    We're getting fractions of a percent interest on savings even while the REAL rate of inflation of the cost of living is about 5 or 6% AT LEAST.

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