China’s Exploding Debt

By C.P. Chandrasekhar, Professor of Economics, School of Social Sciences, Jawaharlal Nehru University, New Delhi, India. Cross posted from Triple Crisis

If the international media are to be believed the world, still struggling with recession, is faced with a potential new threat emanating from China. Underlying that threat is a rapid rise in credit provided by a “shadow banking” sector to developers in an increasingly fragile property market. Efforts to address the property bubble or reduce fragility in the financial system can slow China’s growth substantially, aggravating global difficulties.

The difficulty here is that the evidence is patchy and not always reliable. According to one estimate, since the post-crisis stimulus of 2008, total public and private debt in China has risen to more than 200 per cent of GDP. Figures collated by the World Bank show that credit to the private sector rose from 104 per cent of GDP in 2008 to 130 per cent in 2010, before declining marginally in 2011. The evidence suggests that 2012 has seen a further sharp increase.

The problem is not merely the rapid rise in credit as a means to spurring investment and growth. More significant is the rapid growth of lending by the “shadow banking” system, at the forefront of which are off-balance sheet vehicles of banks to which deposits mobilised by offering relatively higher interest rates, through means such as wealth management products (WMPs), are diverted. Such loans are then provided to borrowers such as real estate developers to whom lending by the banks is being restricted. As of now WMPs are placed at around 10 per cent of total deposits in Chinese banks, but the rate of growth of this relatively new phenomenon is high. Further, banks are diverting these resources even to securities brokerages for management. Overall, central bank figures indicate that conventional bank loans have fallen from 95 per cent of total financing in 2002 to as low as 58 per cent in 2012.

Diversification away from bank lending as the main source of finance may be seen as a good thing. Further, “shadow banking” institutions are not completely unregulated. The trusts that manage the WMPs are regulated. The problem is that such regulation is light and much less than applicable to the banks, especially with regard to the areas to and rate at which lending occurs. And the original sources of funds are the WMPs issued by the banks. This does lead to a significant degree of maturity mismatch, with the deposits being mobilised of much shorter duration than the investments made. The expectation clearly is that there would be adequate inflows of these “deposits” to more than cover any withdrawals. That may be misplaced. Moreover, the investments to which these funds are being diverted are mostly opaque, though there are strong reasons to believe that the favoured destinations are the property or financial markets.

Recently, evidence has been emerging that customers investing in WMPs, enticed perhaps by their association with known institutions and promises of guaranteed returns have found themselves making losses. Examples quoted include products sold by leading banks and investment companies such as China Construction Bank, CITIC and Huaxia Bank. The net result is an effort on the part of the government to increase regulation of shadow banking by requiring greater disclosure. The fear is that this may reveal much and force a contraction in the activity of these institutions operating in the shadows.

But that only points to a larger issue that confronts the so-called “emerging markets” looking to sustain high rates of growth for long periods of time with the hope that they would experience the transition to developed country status as, for example, South Korea did. It is now increasingly clear that beyond a point debt-financed investment and consumption expenditure is crucial to delivering persistent high growth. Since that requires lax lending conditions to expand the universe of borrowers, it requires an environment of “confidence”—among lenders to lend and borrowers to borrow.

That confidence, as in China’s case, possibly comes from earlier rounds of robust real growth. The lending spree that it triggers only drives growth further and feeds that confidence leading to less caution in granting and accessing credit. This obviously requires intervention from outside in the form of strong regulation. China’s central bank governor Zhou Xiaochuan says regulation is indeed adequate. But even the recent demand for greater transparency seems inadequate if the pace of credit expansion is an indicator. One reason for complacence is that the commitment to relatively high growth among China’s policy makers discourages curbs on the credit growth that underlies GDP expansion. That ambivalence is felt in the context of a boom in China’s property market triggered by the successful post-crisis stimulus fashioned by the government in which credit played a crucial role. With a significant share of that stimulus increasing demand for real estate, price increases have been so large, that the spiral is now being identified as a bubble. This does seem to call for a stronger dose of regulation, even if at the expense of some growth.

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  1. jake chase

    I suppose the source of all these bank deposits is an army of Chinese workers slaving at coolie wages? Or perhaps a regiment of Chinese manufacturers turning out degraded dreck for the US market?

    I don’t see why this matters to Americans, apart from those foolish enough to ‘invest’ in Chinese equities, who will deserve whatever they get.

    1. Susan the other

      We are led to believe that China is in overdrive trying to create a consumer, domestic consumer, based economy. Maybe. Or maybe it’s just an economy in such confusion that it is a FIRE economy. Pun intended. The fact is this article is vacuous. Because growth and contraction aren’t hapless consequences of an economy of the blind – they are political decisions. An economy is a policy. China is currently a good example of how you have to control private and/or shadow banking if you are using functional finance to guide your economy. Two banking policies are one too many. Shadow banking will eat up the other half.

  2. David Lentini

    “This does lead to a significant degree of maturity mismatch, with the deposits being mobilised of much shorter duration than the investments made. The expectation clearly is that there would be adequate inflows of these “deposits” to more than cover any withdrawals.”

    Paging Mr. Ponzi ….

  3. from Mexico

    Thank you for this information.

    One of the points of misinformation frequently proselytized by the Chinese exceptionalists on these threads is that there is no credit boom in China driving the real estate boom, that when Chineese invest in real estate they pay cash, whereas profligate Westerners borrow.

    If credit to the private sector rose from 104 per cent of GDP in 2008 to 130 per cent in 2010, before declining marginally in 2011, and the evidence suggests that 2012 has seen a further sharp increase, then that seems to be some good evidence to the contrary.

    Thanks for setting the record straight.

    1. Synopticist

      A credit driven mal-investment boom is a credit driven mal-investment boom, whatever your accent.

      People are buying apartmants in Shanghai and Bejing for hundreds of thousands of dollars, when averge incomes in those cities are maybe a fortieth of that. What could possibly go wrong? Because house prices never go down, right.

      I can’t quite get my head round some of the decisions the Chinese have made in the last 5 years. If there’s a couple of lessons to be learnt since since 2007, mine would be…

      1. Dont encourage the shadow banking sector, and…
      2. Whatever you do, DON’T build too many houses.

      The 2 countries that made both of those mistakes are Spain and Ireland. Cajas and Anglo-Irish, 2 fat noughties era construction booms, both hailed as economic success stories, and now look at them.

      1. Synopticist

        Oh, and lesson number three would be… Don’t encourage a gombeen, grifter nexus of corrupt local politicians, property developers and dodgy financers, whose losses and thefts will have to be socialised.

    2. Chris

      Plenty of people have mortgages in China, but the maximum banks will lend is 70% of purchase price. A lot of property is bought by individuals outright with cash. The structural risks are loans from State Owned Trusts (funded through so-called Wealth Management Products sold to individuals through bank branches) to property developers. The chains of interests associated push interest rates up to 30%. No matter how profitable a development, those kind of interest rates are killers.

  4. Ignacio

    According to Michael Pettis, the majority of malinvestments made in China do not occur in real estate but in infraestructure spending by state owned, and there is were the losses migth break the confidence required to go on. Apparently those SOEs are beign increainsgly financed by shadow banking instruments.

    1. Chris

      SOEs have enormous investments in the real estate sector. The big central SOEs were ordered out of the property market in 2010 but none have withdrawn. At the local level, huge amounts of development are being conducted by local SOEs. Some of their funding is via low interest bank loans. Other finance is increasingly funded by so-called Local Financing Platforms which are drawing high interest funding from Wealth Management Products sold by banks at 10%+ interest.

  5. Clive

    What I don’t get about the China bulls (and there does seem to be an awful lot of them about so it’s nice to read this feature to get another perspective) is, why are they unable to look across the Sea of Japan and, erm, see Japan then think to themselves “hey… I’ve seen this movie before…”

    Oh, of course. This Time is Different. I guess..?

  6. TomDor

    Call me a dumb ass but, this looks like a propaganda piece issued by the shadow banking system. Empty cities in China…cities only filled with air….ya think their is a property bubble? Duh.

    Rolling over long term debt into short term alternate debt – looks like an escape plan to me!!!
    How on earth are the loans to the speculators (property developers) going to be paid back when no can put up enough money to carry the property already developed? – Well, my guess is, it will be the international suckers who believe the propaganda issued by the shadow bankers to buy their ponzi financial products – Bernie would be proud.

  7. Bam_Man

    Well…China has a Central Bank that can eventually buy up all these bad debts with freshly printed money, right? So what’s the problem?

    1. Synopticist

      Yeah, but they may have to spend lots of their FX reserves to do it.
      But what can’t they do?
      They can’t give the middle class their savings back, based on insane property speculation in houses no-one will likelly ever live in, and they can’t replace tens of millions of decently paid construction jobs.

  8. Joseppi

    Yes, China does have a Central Bank that can paper over all Yuan debt problems just like the US Fed does. This feat is possible because of the linkage of China’s large FOREX reserve of US dollars. It’s mutally assured insurance. As long as they hold dollars as a counter balance – they can do anything necessary to keep the Chinese ponzi going.

    1. Really?

      Ponzi see, Ponzi do. All the world’s a Ponzi these days it seems.

      But will it go ’round in circles?
      Will it fly high like a bird up in the sky?
      Will it go ’round in circles?
      Will it fly high like a bird up in the sky?

      1. Really?

        Answer: the Chinese Ponzi will end the same way and more than likely at nearly the same time as the American version does. Fraud, in the end and after the fact, is not complicated. Detecting it in the heat of the moment and before it happens? Now, that’s the rub. Accountants have yet to develop a column and method to accurately account for human foolishness. Rest assured, it will no doubt be corrupted as soon as they do.

  9. Reader2010

    Karl Marx famously argued the accumulation of capital, which is defined as the relationship between labor and means of production, can only be accomplished via accumulation of debt.

    1. Hugh

      Historically, I would say that the accumulation of capital is almost always the result of theft of the gains from labor and as this process continues, debt becomes an increasingly important part of it.

      1. Really?

        And thus Marx, ever the capitalist pariah, rears his ugly head once again. Basic truths have a way of doing that.

  10. Hugh

    All the major economic players, the US, Europe, China, and Japan are suffering from the effects of kleptocracies. We tend to concentrate primarily on the US and Europe, but China has multiple bubbles going, credit, capacity, and real estate. I don’t know that much about the ins and outs of the Japanese economy beyond Japanification, but I have to say that Fukushima really blew the lid off the myth of Japanese technical competence. Just yesterday I heard that 300,000 were still displaced from it. I can’t help drawing parallels between their incompetence there and Katrina and BP here. Known disasters waiting to happen, nothing is done, the worst occurs, and the aftermath is a nightmare. This seems the new normal. Why should we expect better of China?

    I would also point out that in general downturns like depressions, it is the creditor countries that get burned the most. This is what happened to the US in the Great Depression and this is what China is looking at now.

    Long story short, kleptocracy dominates everywhere. There are no happy exceptions and unless or until they are overthrown, there will be no happy endings.

    1. different clue

      “Katrina” was not incompetence. “Katrina” was deliberate.
      Canadian journalist Jeff Wells wrote a bunch of articles about that under the topic-heading “Katrina” over at his blog called Rigorous Intuition 2.0
      The Macondo Blowout was perhaps incompetence or corner cutting or basic-protocol violating. But the coverup and the Corexit and etc. were not incompetence. They were collusion between BP and the Obamastration.

    2. Really?

      Long story short, kleptocracy dominates everywhere. There are no happy exceptions and unless or until they are overthrown, there will be no happy endings.

      Wow! If only today’s whole MMT thread could have been summarized thus!

  11. Ian

    A good article. Just what I have been thinking for quite a while, the Chinese have NEVER encountered a massive stockmarket crash or a housing collapse so when it does it really won’t be pretty. Many ordinary people have invested their life savings into the stockmarket in China… you can see our past repeating itself. I just hope when it happens China won’t be ripped apart by the people… they’ve been slaving for years saving for a better world for themselves.

  12. Sanctuary

    The problem in China is far, far worse than any Western analyst would seem to want to believe. Beyond the oceans of malinvestment taking place in ghost cities, the Chinese economy is not growing anywhere near 7.8%. The electricity usage numbers, freight shipments, construction do not back it up. It’s at least a half a percentage point lower if not more. And that’s not taking into account the severe effects of their environmental degradation. That lops it down to 4%. Then, when you factor in the much higher inflation rate, China’s not really growing at all.

  13. American Slave

    The difference between China and Japan and the west is that they have state owned enterprises and therefore unlimited leverage if they want to use it, especially if there money truly is undervalued than they have room to print money.

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