Satyajit Das: “All Feasts Must Come to an End” – China’s Debt & Investment Fueled Growth (Part 1)

By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

The re-emergence of China has dominated recent economic and political discourse. The Chinese economy is forecast to expand by around 60% in the period between 2007 and 2012, compared to around 3% for developed economies. While China’s rise is important, its drivers are frequently misunderstood and poorly analysed.

China’s economic structure is deeply flawed and fragile. The Chinese growth story may be ending. As an old Chinese proverb, probably apocryphal, holds: “There is no feast that does not come to an end.”

Good Times, Desperate times…

Prior to the global financial crisis, China’s impact was mostly in manufacturing, especially consumer goods, and demand for commodities. With its large, low cost labour force China became the world’s manufacturing centre of choice, exporting around 50% of its output. This helped reduce inflation, lowering living costs throughout the world.

China also emerged as a large purchaser of commodities. It is now the largest purchaser of iron ore and other nonferrous metals. It is also one of the biggest purchasers of cotton and soybeans.

Between 1990 and 2010, China’s share of world coal consumption increased from 24% to 50%, in part driving a doubling of coal prices. In the same period, China’s share of world oil consumption increased from 3% to 10%, contributing to a 233% increase in oil prices.

Chinese savings and foreign exchange reserves (totalling over $3.2 trillion) were a major source of capital for financing developed countries, especially governments. China exported savings of around $400 billion each year, helping reduce interest rates in the US by as much as 1.00% per annum. Its role as an exporter of capital flows is surprising given China’s average income per capita is around $4,000, well below that of the US and Europe.

Following the GFC, China’s role became even more important. China, together with some of the other BRIC countries such as India and Brazil, contributed a large portion of global growth in 2010 and 2011.

As Western governments ran up large budget deficits in an effort to maintain economic growth, the ability to borrow from China, especially its large foreign exchange reserves, became important. Most recently, the European Union (“EU”) and the International Monetary Fund (“IMF”) sought the financial support of China to resolve the European debt crisis.

The country’s increasing importance and foreign praise has led to Chinese hubris. The 30 July 2009 editorial in the English language People’s Daily, an official publication, boasted that China, under the leadership of the Chinese Communist Party (“CCP”), had coped successfully with the financial crisis, earning worldwide attention: “High-level figures from the western political and economic spheres … envy China’s superb performance … as well as “China’s spirit”– the kind of solid, unbreakable “Great Wall” at heart to ward off the financial crisis.”

Lock and Load….

In the first phase of the GFC, China was badly hit, with growth slowing and lay-offs of 20-25 million migrant workers in export based Guangdong province alone. Like governments throughout the world, China responded with massive monetary and fiscal stimulus.

In late 2008, China announced a fiscal stimulus package of Renminbi 4 trillion (about $600 billion) over 2 years. The fiscal measures were modest equating to a budget deficit around 2.2%. The major response was via the large policy banks, which are majority government owned and controlled.

The banks were directed to extend credit and finance infrastructure projects on a large scale. If additional credit growth over and above normal lending is taken into account, then the Chinese government’s stimulus totalled around 15% of gross domestic product (“GDP”), amongst the largest in the world.

New lending by Chinese banks in 2009 and 2010 was around 40% of GDP. New bank loans in 2009 and 2010 totalled around $1.1-1.4 trillion, an increase from $740 billion in 2008. Total outstanding loans in the economy have jumped by nearly 50 per cent over the past two years.

Around 90% of this lending was directed towards investment in building, plant, machinery and infrastructure by State Owned Enterprises (“SOE”). In 2010, China allocated over $2.6 trillion to investment expenditure – the highest proportion of GDP of any major economy in the world. According to the World Bank, almost all of China’s growth since 2008 has come from “government influenced expenditure”.

The Short of It…

China’s use of rapid growth in credit to restart growth has increased the volume of credit outstanding to 130-140% of GDP and as much as 160-170% when off balance sheet lending is included.

In the 1990s, a similar increase in the growth of lending resulted in sharp increase in bad debts. The biggest state-owned Chinese banks were insolvent, requiring government bailouts that cost around 40% of GDP, only ending in 2004.

The current loans have financed, in the main, property and infrastructure projects. Increased lending created asset bubbles in property and shares (both now unwinding). It is doubtful whether the cash flows from the investments will be sufficient to cover all the debt, increasing non-performing loans in the banking system. Governor of the central bank -People’s Bank of China (“PBOC”), Zhou Xiaochuan observed candidly that the large credit flows “pose bank lending quality risks”.

With characteristic hyperbole and an eye for media attention, James Chanos, a hedge-fund investor argues that China is “Dubai times 1,000 or worse”. Predictions of a financial and banking collapse are overstated. Property loans are conservatively structured and also the government has a variety of policy tools to manage problems.

Predictably, in February 2012, the Chinese government instructed its banks to roll-over $1.7 trillion of loans to local governments, to avoid the risk of default. It was tacit recognition that the loans were at risk and may not be able to be repaid on schedule. There was lip service to the fact that Chinese banking regulators would check to ensure that the loans were capable of being repaid. Having already borrowed from the playbook of Western governments to resuscitate the Chinese economy from the GFC, Beijing now adopted “extend and pretend” strategies, deferring the day of reckoning on the loans.

As China analysts, such as Michael Pettis, a professor of finance at Guanghua School of Management at Peking University, have observed the bad debts will absorb significant financial resources and restrict domestic consumption.

The government will recapitalise of the banking system by lowering deposit costs and ensuring a wide spread between their borrowing and lending rates.

The Chinese government and PBOC will continue to keep interest rates low, negative in real terms after adjustment for inflation. Low interest rates will make it easier for borrowers to meet repayments. Low or negative real returns entail writing down the loan principal in economic terms while maintaining its nominal value. The banks effectively pass this cost onto depositors in the form of low or negative returns on their savings. Given few alternative investment opportunities, savers have to accept this or take speculative positions in other assets like property.

The PBOC will ensure a wide spread between the bank’s deposit and lending rates, probably around 1.5-2.5% higher than normal. This increases bank profitability and helps build up the bank’s capital base.

Just like the Japanese after the collapse of the bubble, Chinese householders will be forced to pay for the restitutions of their insolvent banks. Savers will pay a disguised tax – low deposit interest rates and high borrowing rates. In effect, the bailout will entail a large transfer of wealth and income from households to other parts of the economy, amounting to several percentage points of GDP.

This will reduce wealth but also slow consumption growth, at a time when external demand for Chinese products and Chinese trade surpluses is decreasing.

The Long of It…

The long term effects of this debt fund investment boom are more complex. Revenues from many projects will be insufficient to cover the borrowing or generate adequate financial returns.
Over-investment in non-productive, low return projects will ultimately reduce growth.

The bulk of investment has been by SOEs in government-backed infrastructure projects – the tiegong­ji (meaning “iron rooster”), a homonym for the Chinese words for rail, roads and airports.

The Ministry for railways is planning investments of around $300 billion, adding 20,000 kilometres (“Kms”) of rail track to the existing network of 80,000 Kms. China’s rail network will become the second-longest in the world behind the US, overtaking India.

China is also having a love affair with super fast train. Undeterred by accidents and the high cost, further expansion of the high speed rail network is under way. A new service between the southern cities of Guangzhou and Shenzhen travels at 380 kilometres per hour (KPH) nearly halving the travel time to 35 minutes. CSR Corp, China’s biggest train maker, has plans for a super train capable of 500 KPH.

China is constructing around 12,000 Kms of new expressways at a cost of over $100 billion. China road network of over 60,000 Kms of high-speed roads is only slightly less than the 75,000 Kms in the US. China is planning to expand the high-speed road network to 180,000 Kms even though China has only around 40 million passenger vehicles compared to 230 million in the US.

There is a spate of new airports and expansions of capacity at existing facilities. Jiaxing in eastern Zhejiang province is converting a military landing strip into a commercial airport at a cost of around $50 million. The town is only one hour’s drive on brand new expressways from three of China’s busiest international airports in Shanghai and Hangzhou. There are also plans for a high-speed rail line connecting Shanghai and Hangzhou.

While some of the investment is productive, the need for rapid ramp up has meant that an unknown amount is unproductive.

In Hunan, local authorities tore down portions of a modern flyway and used the stimulus funding to rebuild it. Stories of ghost cities, such as the empty newly-built city of Ordos, Zhengzhou New District, Dantu and the orange area to the north-east of the Xinyang, abound. There are ghost shopping malls in many cities.

Based on estimates from electricity meter readings, there are more than 60 million empty apartments and houses in urban areas of China. Many of the properties were purchased by people speculating on rising property prices.

Crowing Roosters or Eating Crow….

Analysts, such as Pivot Capital Management, argue that the efficiency of Chinese investment has fallen. One measure is the incremental capital-output ratio (“ICOR”), calculated as annual investment divided by the annual increase in GDP. China’s ICOR has more than doubled since the 1980s and 1990s, reflecting the marginal nature of new investment. Harvard University’s Dwight Perkins of Harvard argues that China’s ICOR rose from 3.7 in the 1990s to 4.25 in the 2000s. Other researchers suggest that it now takes around $6-8 of debt to create $1 of Chinese GDP, up from around $1-2 around 20 years ago. In the US, it took $4-5 of debt to create $1 of GDP just before the GFC. This is consistent with declining investment returns.

Sino-philes dismiss the lack of efficiency arguing that the decline was because of falls in the growth rate due to the collapse of global demand. This assumes that global demand will rebound strongly increasing the returns from these investments.

Sino-philes also argue that the investments in infrastructure will produce long term economic benefits and returns from increased productivity. They point to the fact that few investment programs of social infrastructure are profitable. They point to the mid-19th century boom in investment in railways in Western countries, which generated economic benefits, but few made an adequate financial return with many going bankrupt. They also argue that China lacks necessary infrastructure.

China has six of the world’s ten longest bridges and the world’s fastest train. But 40% of villages lack paved road providing access to the nearest market town. The real issue is whether the specific projects are appropriate.

High-speed rail lines in China may increase social return, improving the quality of life for the average Chinese if they are wealthy enough to afford to use them. But the financial return on capital invested in these projects will be low.

While super-fast trains are appealing to politicians and demagogues proclaiming superiority of Chinese technical proficiency, investment in improving ordinary train lines, rural roads, safety and more flexible pricing structures may yield higher economic benefits.

Ironically, given the motivation of the plan to increase employment opportunities, this capital-intensive state investment has created relatively few jobs. Instead, the programs, which are overseen by the Chinese Communist Party (“CCP”), have been used to achieve political objectives.

Over Building…

China’s investment boom may also be exacerbating industrial overcapacity. The greater portion of investment has been in infrastructure, rather than manufacturing.

A 2009 report prepared for the European Chamber of Commerce outlines the over-capacity. In its analysis of six major sectors, the report identified the following capacity utilisation rates: steel 72%; aluminium 67%; cement 78%; chemicals 80%; refining 85%; and, wind power 70%.

In 2008, China’s steel capacity was 660 million tons against demand of 470m tons but the difference is similar to the European Union’s total steel output or the combined output of Japan and Korea. China’s excess in cement is larger than the total consumption of the US, Japan & India. Yet China continues to add capacity.

If China be unable to absorb this new capacity domestically, then it might seek to increase exports, in order to maintain production and growth. This would increase a global supply glut. To the extent that Chinese growth is driven by such spending on unproductive investments, it is both wasteful and ultimately economically destructive.

The government’s response highlights the severity of China’s problems of late 2008 and early 2009. China’s economy, especially its export sectors, experienced a large external demand shock, stemming from rare synchronous recessions in the developed world. Beijing deployed massive resources to restore growth to counter the economic and social impact of the slowdown.

The unsound foundations of Chinese economic and financial strength have been largely ignored. But then all food tastes good to the starving man.

NOTE Part II is here.

Print Friendly, PDF & Email


  1. Min

    “The banks were directed to extend credit and finance infrastructure projects on a large scale.”

    Now, why didn’t we think of that?

    “Predictably, in February 2012, the Chinese government instructed its banks to roll-over $1.7 trillion of loans to local governments, to avoid the risk of default.”

    Now, why didn’t we think of that?

  2. different clue

    What happens to the Chinaconomy when China has finished substantially destroying its own surface and subsurface water resources, soil resources, etc.?
    How bad a neighbor is China prepared to be to all the downstream Asian neighbors whose principal rivers all rise in China? If China decides to reroute all these rivers and turn the Irawady, Brahmaputra, Mekong, etc. rivers into semi-dry gulches, how will the neighbors respond? Will China’s military be used to make sure they all bow and say:
    thank you Sirs, may we have another?

  3. j.grmwd

    Are the foundations of any countries economic and financial strength solid by this kind of metric. If total credit outstanding is 160-170% of GDP, I doubt there’s a Western country with less.
    As for the wisdom of their infrastructure spending, I can’t help compare traveling in India where, despite being an up-and-coming economy, everything seems to be falling apart (especially in the neoliberal northern states, southern India is often quite different) and China where every time you make a trip somewhere, you find it quicker, faster, and easier than the last time (and that includes tiny villages). That being said the pollution really is a nightmare. If China falls, it’s going to be environmental degradation and demographics that do it not their finances.

    1. Jessica

      China’s economy could be put on solid footing by shifting funds into an improved standard of living for ordinary people. But politically that is out of the question.
      Then again, the same could be said of the West.

  4. Max424

    China, doing terrible, facing implosion, staring doom in the face.

    China, doing much, much better than anyone else. Easily the richest nation on the planet –no one even close.

    Hmm … what does this mean?

  5. jake chase

    An excellent job of analyzing the Chinese economy in the meaningless metrics of Western economics. Chinese banks are state controlled, Chinese big business is state owned. Chinese debts to Chinese banks are largely imaginary. Chinese currency is electronic wallpaper. What matters about China is its steadily increasing economic power, which is predicated on nothing more or less than the bankruptcy of American and European economic model. In the West, debts of individuals are real and largely non dischargeable, which means deflation. In China, debts mean whatever the government decides they mean, which probably means nothing. Meanwhile, America’s debt to China, which is real, grows and grows and grows and grows. Nothing good will come out of this, except perhaps for China, which is playing technological leap frog at Western expense. The deal is our advanced technology for their consumer drek which falls apart before you reach the checkout counter.

  6. Max424

    Richard Heinberg asks:

    “At seven percent annual growth, China’s coal output would double every 10 years; is even one more doubling even remotely possible?”

    China’s oil consumption is double-doubling. Forget about remotely; I ask, is even one more double-double theoretically possible?

    The answer is yes. But to do it, China will need to dominate the Alberta tar sands, and it therefore, must crush all the weepy enviros that stand before it in opposition –like this Canadian, Garth Lenz:

    If you believe in pointless exponential economic growth (which just about everybody does), and you are sane, then you also accept it will be necessary to poison the earth to such an extent, that much it, or possibly all of it, will prove uninhabitable to humans within the time frame of this century.

    That does not mean you are a doomer. It just means, you are person who couldn’t give two shits about your kids, your grandkids, your fellow creatures and beings, or the future of our small blue orb beyond your own selfish life path.*

    If you believe that global warming and global poisoning are both riding exponential doom curves, and you are sane, then you also know that nothing can stop what’s coming. It is likely the reality of all this bothers you immensely. It might even make you cry while giving a TED/talk about the tar sands.

    It also means you a doomer. There is nothing wrong with this, in my opinion. It just means, at this final denouement stage for our species, you care for something much greater your own puny existence.

    *It is possible, even quite probable, that you believe most fervently in an all-forgiving God. As an smart investment hedge … of course.

  7. Frontalcortexes

    What a silly article. “Day of reckoning” indeed! Doesn’t this author understand that like Hitler’s Germany the Chinese Communist Party uses MMT and it has taken steps to deflate its house price bubble that Western Neo-Liberal governments failed to do? Does the author not realize the senior Chinese Communist Party leadership laugh up their sleeves at the Western economies continually weakening their economies with Weimar/Zimbabwe style inflated money crashes inflicted by their private sector banks including shadow banks? Further laughter is then forthcoming as they witness these Western Neo-Liberal governments inflict further deflationary damage through austerity programs. Time the West woke up and started to use MMT before the Chinese Renminbi takes over as the reserve currency, is militarily supreme and imposes the kind of authoritarianism the West dreads.

    1. F. Beard

      Time the West woke up and started to use MMT before the Chinese Renminbi takes over as the reserve currency, Frontalcortexes

      The problem is that the West imagines it has a free market money system but doesn’t. The Chinese do not suffer from that delusion, it seems.

  8. F. Beard

    “All Feasts Must Come to an End” Satyajit Das

    Not if money was spent, not lent into circulation and not if private money creation was decentralized.

  9. Ignacio

    Congrats for this greatt piece. I just want to point out that I don’t like the “sino-phile” or “sino-phobe” terminology, which I find misleading. I’d rather use “sino-permabulls” or “sino-optimists”.

    1. F. Beard

      Our “credit” system is not private money creation. Instead it is fascist money creation and depends on quite a few government privileges such as a lender of last resort, government deposit insurance, government sanctioned rating agencies, legal tender laws for private debts and the capital gains tax on non-usury based money forms such as common stock.

  10. charles sereno

    I hesitate to offer anything but an uninformed conjecture. I worked as a civil engineer when the US Interstate project was conceived. As a witness to the bureaucracy and accompanying waste in executing the project, I was torn between its dream and its reality. To this day, I’m not sure where we (and the world) would be had it not happened.

  11. Jim

    Great Value-Added, Satyajit,


    The PBOC will ensure a wide spread between the bank’s deposit and lending rates, probably around 1.5-2.5% higher than normal. This increases bank profitability and helps build up the bank’s capital base.

    Just like the Japanese after the collapse of the bubble, Chinese householders will be forced to pay for the restitutions of their insolvent banks. Savers will pay a disguised tax – low deposit interest rates and high borrowing rates. In effect, the bailout will entail a large transfer of wealth and income from households to other parts of the economy, amounting to several percentage points of GDP.

    This will reduce wealth but also slow consumption growth, at a time when external demand for Chinese products and Chinese trade surpluses is decreasing.

  12. Fiver

    This was a good presentation of both views, though I frankly see no possibility whatever that China can maintain even this “slower” pace of “growth” for even another 5 years, and their leadership is as insane as ours if they attempt it.

    The real take away with respect to Chinese policy moves since 2008 is not that the Chinese have deftly dodged a bullet, but rather that they are hopelessly caught in mal-investment overdrive. They have built, and continue to expand, the urban and connecting shells for an economy and those sectors required to build more shells, but the time lapse before these post-2008 (even post-2005 in some cases) investments even begin to make sense keeps getting longer (the highway to car ratio being representative).

    China’s over-arching need now is to SLOW DOWN. They feared social “unrest” in late 2008/early 2009, and tossed roughly 50% of annual GDP at it in a very short time frame. For much of the public, the anticipated degree of fear/anger, wasn’t nearly as bad as that witnessed in many places elsewhere, yet the cities were essentially hosed down with money – at enormous cost. When all that negative inteest rate lending very predictably seeded bubbles of varying size throughout the economy, the Government embarked on an effort to “tighten” lending policy. Much noise in the Western business press was made over several very modest steps taken by Chinese financial authorities to tamp down those Chinese “spirits”, but it became evident earlier this year (2012, late 2011) that the Chinese leadership was in a panic with only a prospective 1% to 1.5% slowing of growth. That a leadership apparently believes its society, people, and economy cannot absorb a 1% (or make it 3%, or 5%) fall in the level of growth says they’ve actually lost control. They no longer know what to do when confronted with other powerful interests. And of course, they are so far a million miles from the truth awaiting all of us – we ALL have to slow down our total and individual consumption of resources. Either in a fair manner or foul – it’s coming, and when it does China will first, but we all follow down the consumption ladder.

Comments are closed.