Jim Chanos on China’s Contingent Liabilities

Edward here. The overall gist of Jim Chanos’ comments on Bloomberg the other day were that China has off-balance sheet contingent liabilities due to its implicit commitment to state-owned enterprises which are knee-deep in land and property speculation. This speculative excess will lead to credit writedowns. Chanos repeated his contention from CNBC last week that he is net short China as a result, a bet Hugh Hendry has also been making – with spectacular results recently. See Michael Pettis piece on The debt-financed investments of Chinese state-owned enterprises for a comprehensive analysis of this problem.

I should also add that these are the same arguments that are used regarding why Spain and its sick banking sector are having problems in Europe’s sovereign debt crisis. It is also one reason Claus Vistesen has given for being cautious in Denmark. And it is the reason Fannie and Freddie’s nationalisation in the US should have been expected. The point is one needs to consider not just the sovereign, but quasi-sovereign debt that creates contingent liabilities which the sovereign could be reasonably expected to cover in the event of crisis. In France, we may well see this problem crystallized next due to the liquidity crisis affecting French banks.

Bottom line: expect a slow down in China – how much of one is still up for debate. Anything above 7% y-o-y GDP growth should be considered a soft landing though. Below that 7% number, analysts would consider that a hard landing. That is lower, but not necessarily dire. The west would love numbers like that.

P.S. – this is the kinds of excess we’re talking about right here.

Bloomberg Television sent me the following partial transcript:

On the Chinese government’s balance sheet:

"The Chinese government’s balance sheet directly does not have a lot of debt. The state-owned enterprises of the local governments and all the other ancillary borrowing vehicles have lots of debt and its growing at a very fast rate. The assumption is that the state stands behind all this debt. We see that the debt in China, implicitly backed by the Chinese government, probably has gone from about 100% of GDP to about 200% of GDP recently. Those are numbers that are staggering. Those are European kind of numbers if not worse."

On how a Chinese property bubble will play out:

"I think that will be the surprise going into this year, and into 2012 – that it is not so strong. The property market is hitting the wall right now and things are decelerating. The CEO of Komatsu said last week that he is having trouble getting paid for his excavator sales in China. Developers are being squeezed. They’re turning to the black market for lending, this shadow banking system that is growing by leaps and bounds like everything in China.

"Regulators over there are really trying to get their hands around the problem. In the meantime, local governments have every incentive to just keep the game going. So they will continue with these projects, continuing to borrow as the central government tries to rein it in."

Chanos on his long and short positions:

"We are short Chinese banks, the property developers, commodity companies that sell into China, anything related to property there is still a short."

"We are long the Macau casinos. It’s our long corruption, short property play. We feel that there’s American management and American accounting. They are growing at a faster rate even than the property developers."

On the IMF lowering growth estimates for China:

"A lot of people are assuming that half of all new loans in China are going to go bad. In fact, the Chinese government even said that last year relating to the local governments. If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%.  Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero."

Source: Bloomberg Televison

video below (click here if you are using Google Chrome)

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward http://www.creditwritedowns.com


  1. MyLessThanPrimeBeef

    By trying to avoid pain the first time, it will only be worse for China when the second one hits.

    It’s less about where you stand and more about where you stand RELATIVE to your fellow countrymen.

  2. Mark P.

    Some of you may not have followed the link in Edward’s ‘P.S. – this is the kinds of excess we’re talking about right here.’

    It’s staggering stuff, taking you to a presentation showing the new headquarters of the Chinese corporation Harbin Pharmaceuticals — not Super-Versailles as it might appear.

    Après Nous, Le Déluge

    This second link gives some idea of the scale of China’s newly-built but empty cities. When the bubble bursts, at least these will be still standing and Chinese people may be able to move into them.

    The City as the Ultimate Bubble

    1. Mike M

      John Thain just saw that and is wondering if the Chinese need an experienced CEO with a penchant for elaborate interior decorating around the headquarters.

  3. jaymaster

    Excellent point and a good explanation.

    Your mention of French bank debt as an example of quasi-sovereign debt is spot on.

    Even beyond the banks, almost the entire French industrial base is practically nationalized to some extent. And thus, ultimately subject to sovereign coverage of debt.

    Multiply that by a factor of maybe 200 for the situation in China. Then add in a layer of debt from local governments (who, BTW are apparently becoming increasingly belligerent to the central planners.) Not a pleasant situation.

  4. monday1929

    “Long Macau casinos-Long corruption, short property play”.
    That was my Citi play back in 2008- long fascism (at a buck), short the rest of the economy.
    DBB, the base metals, finally broke this week. Hundreds of DBB PUTS will help fund the Bankers Bounty Fund- rewards for whistle blowers who can Jail Jamie Dimon and his ilk.

    The Chinese probably took the advice of the most criminal of Wall Street’s exiles and condensed 20 years of a credit bubble into 3 years. At that rate, their Great Depression should last 3 months. Or, maybe not. They have much Copper to dump on the Market when creditors call.

  5. monday1929

    What could be more disgusting than a Short based on the fact that China is using “American management and American Accounting”.
    This is an indictment of an entire generation. Harvard should hang its head in shame. Your graduates have raped the legacy of those who died in WWII, and soiled the idealism of the young men and women who die daily thinking they are defending an American exceptionalism that your alums have smothered. Elite my ass.

  6. scraping_by

    Well, maybe…

    If Mr. Chanos were speaking of a Euro country or an American city, probably. For China, some questions to be answered.

    Who holds the debt? That is, who’s poorer for a default? If it’s individual Chinese or Chinese companies, trouble with GDP. If it’s the Chinese government printing up money to buy local bonds, no big deal. Even if it’s the banks, they’ll just remain middlemen for the printed money and go whistling on.

    Foreigners? They’ll just go back to “making faces for the barbarians” like they have in the past. Every deal with American and European companies and countries I’ve read about is structured win/lose, even thought the non-Chinese party thinks it’s win/win. Komatsu might have just needed a reminder.

    Chinese success has come because its lending is resource and infrastructure driven, rather than cash return driven. They’ve used money to create real world wealth rather than rack up numbers in a bank account. Now, how well that’s going to hold up over the years, given the piss poor quality of Chinese engineering products and the long term prospects for resource demand is anybody’s guess.

    The Chinese government has used money to create infrastructure. Their interest is the infrastructure, which is wealth, and not the money, which is a counting device. Kucinich has introduced a bill to create government lending to create wealth, not to wring money out of the rubes. An odd concept to those of us propagandized by the financialization gangstas, but it’s reality.


    1. Glen

      Interesting post.

      And leads to some questions, why would China follow the leads of the US and EU and bailed out their failed “private” banks? These banks have absolutely no sway over the central government unlike in the US and the EU. They would be the one country to benefit by winding down broke “private” banks with BK and telling all the foreign investors to go sue the banks (i.e. your money is GONE).

    2. Fiver

      Neither infrastructure nor anything else is wealth if you cannot effectively utilize and/or sustain it, and China faces both aspects of mad levels of over-capacity in spades. China cannot, repeat, can not, broadly attain a standard of living comparable to what the US now provides the average American. Nor can the US for very much longer, for that matter, as has been evident for some time, even with a MAJOR re-distribution of wealth, the likelihood of which is roughly Zero in any event.

      China’s central government has lost control over the bulk of the economy. Those that think China’s leaders can just snap their fingers and whatever edict is realized are stuck in the ’80’s, even ’90’s. It is virtually certain that they know how far out on the limb they and their country are – but they have no idea how to get back to a safer perch without blowing this gargantuan bubble to bits. If they don’t formally target 5% or less growth, they are utterly fu**ed. It may already be impossible for them to pull off without a multi-faceted implosion.

  7. Glen

    Like the EU, you’ll know China’s in bad shape when Geithner is over there arranging for a Chinese bank bailout with US taxpayer dollars.

    Some how I cannot even imagining that happening, but I’ve continually under estimated Timmy’s ability to hand out taxpayer bucks to zombie banks.

  8. MyLessThanPrimeBeef

    Now, how well that’s going to hold up over the years, given the piss poor quality of Chinese engineering products and the long term prospects for resource demand is anybody’s guess.


    It would also depend on how fast we can ‘innovate’ to make all those Chinese infrastructure projects obsolete.

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