China’s Mountain Of Debt Is About To Crumble

Yves here. I wasn’t aware that cross-company guarantees were common in China. This is alarming for two reasons. First, it is presumably explicitly to allow the borrower to take on more debt than warranted given his financial condition, so it allows for widespread high levels of leverage. Second, it is just about certain that guarantors don’t disclose how much in the way of guarantees they have made, which means any assessment of their credit-worthiness as a borrow or guarantor is likely to be too generous. Third, cross guarantees create contagion. When one company fails, its guarantors are expected to pay up. They may fail or delay payments to suppliers and other creditors, increasing stress.

By Alex Kimani, a veteran finance writer, investor, engineer and researcher for Divergente Research LLC and Originally published at SafeHaven

Hordes of China’s private firms are now going under after guaranteeing other’s loans.

China’s debt crisis has been christened many unflattering names, including a ‘mountain,’ ‘bomb,’ ‘horror movie,’ and ‘treadmill to hell.’ Well, the reality is that it’s probably a combination of all the above.

The unfolding collapse in the country’s complex web of debt guarantees clearly highlights the vulnerability of its financial system even as it opens up a hazardous front for an economy deep in the throes of the most dramatic slowdown in growth in three decades.

China has been trying to slam the brakes on unsustainable levels of debt that have powered the economy for decades. But the extent of just how much the country had come to rely on borrowed money is now beginning to unravel.

Financial Deleveraging

Financial deleveraging was a key goal of President Xi Jinping’s 2015 supply-side structural reform plan. The campaign was meant to curb growing risks in the country’s overheating financial markets mainly through tighter asset management and clamping down on shadow financing.

A couple of years down the line, hordes of private Chinese firms have been folding up as they struggle to raise new funds to repay old debts let alone survive. Corporate debt defaults tripled in 2018 after reaching a record 115.45 billion yuan and experts have warned to expect even more.

Yet, another unexpected problem has surfaced: many companies that guaranteed other ’s loans are unable to honor their obligations. This contagion risk in a web of cross-guarantee system is the last thing that the country needs even as the government calls on state banks to boost lending to the private sector. The warning bells have already sounded in the once-prosperous city of Dongying, a famous oil refinery and industrial hub

According to Reuters, no less than 28 firms in the city are now seeking to avoid bankruptcy by restructuring their debts as the loans they guaranteed for other firms turn soar. Among the 28 include iconic names such as Shandong Jinmao Textile Chemical Group and Shandong Dahai Group, both of which featured in the list of China’s top 500 best-run private enterprises for 2018.

Private firms in China, especially those that operate in traditional, capital-intensive industries, often require substantial collateral or guarantees by other companies before they can secure bank loans. But in a nation so heavily indebted, there’s a strong likelihood that the guarantors themselves have taken on loans guaranteed by other firms–ad infinitum. Unfortunately, the two companies mentioned here are simply the tip of the iceberg. Cross-guaranteeing is a common practice in China where defaults can quickly cascade across the system when a single loan goes bad and threaten to disrupt new lending and local financial systems.

You can hardly blame private firms for being overzealous when lending a helping hand to a friend in need. The Chinese system is incredibly skewed in favor of government enterprises with private firms only receiving 25 percent of loans disbursed despite contributing 50 percent of taxes; 60 percent of GDP and 90 percent of new hires. With funds hard to come by, the sector has to rely heavily on guarantees which add 2-3 percentage points to their financing costs.

Non-Performing Loans Surge

How bad is the cross-guarantee problem? Probably worse than you would imagine. Shandong Dahai Group has guaranteed debt for 14 companies adding up to 2.67 billion yuan ($394 million) or nearly half of its total assets. Of the 14, 6 have already run into financial or legal trouble while two have been blacklisted by the courts as ‘dishonest debtors’ due to their abysmal creditworthiness.

Meanwhile, the resource-rich Dongying area has seen two prominent banks– Guangrao Rural Commercial Bank and Dongying Bank – hit by a sudden surge of non-performing loans that threaten their very survival. More than 95 percent of Guangrao Rural’s bad loans were backed guarantors who themselves were heavily indebted.

China’s top banking regulator, Guo Shuqing, has been calling for banks to double their funding allocations to private companies to 50 percent. But even with the country having cut down reserve requirements five times in 2018, banks are preferring to use the freed up liquidity to buy expensive bonds than lend to local businesses. This clearly illustrates just another reason why the country is now facing the worst slowdown in economic growth in decades.

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  1. Code Name D

    At this point, we have basically watched the fuse burn its way into the bomb. We know the fuse is still burning, making its way to the powered, despite the fact we can no longer see nor hear the flames. At this point, there is nothing to do but close your eyes, put your fingers in your ears, and kiss your ass good-buy.

    But this all still leave a question. How will this impact the US economy under the dollar, or the Euro for that matter? Did the collapse of 2008 manage to transmit across currencies? Or was the collapse contained to just US dollar-based economies with minimal or reduced impact to other currencies? Is the yuan to be sufficiently isolated to replicate the effect, or is the US or other currencies too tied to Chinese debt? How will this impact US manufacturing, given how dependent we are on Chinese manufactured goods for just about everything we use and consume here.

    1. Carlito Riego

      First of all, China’s massive debt build up has been documented for over a decade. Alarm bells have rung so many times its difficult not to dismiss them as background noise (until the fire starts warming your side and then engulfs you).

      I’m no expert and I’m not sure how it will impact Western economies, but in the wake of the 2008 crisis up until recently, China has been a growth driver for a number of companies, especially consumer goods companies who rode on the ’emerging middle class’. There has been ups and downs (corruption crackdown, mini trade wars…) and the companies the most exposed have been bruised -but then continued to expose themselves to China as there are not too many countries left were you can grow at double digit on such a big scale (market size).

      So here are my 2 cents: companies that are struggling in Europe because of no-growth and fighting for precious markets shares in US and until then relied on China to boost top line will experience a crunch that could trigger a downward spiral. Not saying the world will collapse, just that these companies will have to readjust (read: fire people), which could trigger a recession.

      I’m not even talking about the trade war with the US as this topic is way above my head. But can China maintain its expensive fixed peg to the USD (yes, I know, it trades between boundaries… cf 2015) amidst a balance sheet recession ?

      I would turn to Mr Pettis for more insights.

      1. Yves Smith Post author

        First, it hasn’t been “documented” because there is no good data. Did you ever hear of the term “shadow banking”? That means lending by parties that don’t report to regulators, hence it can’t be tracked. And no one anywhere in the world has good numbers on loan guarantees.

        Second, as Pettis explained, Chinese GDP isn’t a growth measure. It’s a planning target. So invoking GDP tells you squat. And Chinese growth has fallen, to the degree that it is creating domestic stress and the IMF is sounding big time alarms. And Pettis is for the first time evah saying things are bad everywhere. So nice try.

        Third, the fact is that China has had a lot of mini-crashes but then decided to keep reflating its various bubbles, including some bail-outs of its wealth management products (a shadow banking vehicle).

        Fourth, bubbles go on way longer than people expect, so the bears can look like idiots until they are vindicated. There were people who were concerned about the Japanese real estate bubbles in 1985. The BIS first started sounding warnings about loosely synchronized housing bubbles in 2003.

        1. whine country

          Yesterday there was a post about reforming the accounting profession in the West. I guess we need to add China to the list. I wonder sometimes if the in-accountability of accountants isn’t by design. Laws are like sausages, it is better not to see them being made – Otto von Bismark. To paraphrase – Looting will continue until morale improves.

          1. cnchal

            > Yesterday there was a post about reforming the accounting profession in the West.

            My understanding from reading that, is that reform isn’t possible, until the top 10% of management of those accounting firms is swinging from the lamp posts with their neckties as nooses.

            1. whine country

              Like I said, Looting will continue until morale improves – or we have a crisis. Remember Winston Churchill – You can trust Americans to always do the right thing. But only after they have tried everything else.

          2. LB

            The biggy in the west is Pension Ponzis. Hidden off the books, its clear fraud. If we take the UK the WGA [Whole of Government Accounts] are made with the claim they conform to IFRS rules. They don’t Pensions are omitted. They are reported in quite a few cases when you look at the sub entity reports.

            Why? People would work out the consequences of the debts. Namely they won’t be paid.

        2. Wimal

          Though you say ” lending by parties that don’t report to regulators, hence it can’t be tracked” here are all the details on China’s Shadow banking of Moody’s updated to Dec/2018;
          As you will see on page/4; “Assets funded by
          banks’ off-balance sheet wealth management products (WMPs) and non-bank financial institutions’ (NBFIs) asset management products also
          declined a further RMB1.6 trillion during the same period.”

          1. Yves Smith Post author

            Help me. Those are estimates. When McKinsey makes estimates for products where there is no central registry (like data from exchanges or reports provided by bank regulators), the estimates are usually shown as ranges and they generally are X to 3x. This estimate is further (obviously) an estimate by referring to market value. Many assets funding WMP are illiquid (meaning there is no traded market value) and unless they are legally required to provide periodic values of the underlying assets, there won’t be any formal effort to revalue the assets. There have been numerous cases of asset management holdings not being valued accurately on a current basis, from CLOs during the crisis, CDOs, SIVs and credit card receivables in the early stages of the crisis, and private equity when public equities are doing badly.

            Moodys was also providing estimates of subprime mortgages back in the day, and those were arguably easier to find given that mortgages have to be recorded, and similarly didn’t label it as an estimate. Estimates of the size of the subprime market by different experts ranged from $1.1 trillion to a bit over $2 trillion. You can’t even get an accurate figure as to how many mortgages there are in the US despite them all being required to be recorded.

            The only country I have seen where you can get extremely accurate market size data (and this is across all sorts of products) is Japan because the authorities require extensive reporting from even very very small companies.

            Better trolls, please.

      2. PlutoniumKun

        Another shout-out to Michael Pettis – his analyses are always profoundly interesting – although I would note that he looks at the ‘big picture’ of balance sheet analysis and may not really know just how much is going on under the surface.

        I think the conventional view is that the Chinese financial system is simply not intertwined sufficiently with the global system to trigger major problems. But a major Chinese reversal would have significant regional impacts. Countries like Australia and Brazil would suffer a major blow to their commodity exports, and Australia’s hugely inflated housing market might find it a terminal blow. Germany I think would be most vulnerable as China is a major market for their machine tooling and cars. I doubt if the US would suffer much direct loss, although there would be an obvious impact on regional housing markets.

        1. OpenThePodBayDoorsHAL

          Communist China’s “banking” is really quite different from the Western versions, generally in the West we start with a demand for loans, for example a business that wants to borrow in order to expand, and banks are supposed to underwrite (say yes or no) based on general economic conditions and the borrower’s capacity to repay.

          In China by contrast they start from the supply end: banks are simply instructed by the central bank how much credit they will extend, with consequences if they do not meet their lending targets for that quarter. It’s command and control. Since banks create money (in both systems) the amount of money in each system is simply based on the flow of credit…so China literally can turn on the economic growth rate like a spigot. Last week for example they manufactured a marginal additional 1 *trillion* yuan.

          It’s all fun and games until somebody puts an eye out. The Chinese do have an advantage in that they have a sovereign currency (emitted by the state) unlike Western countries that have currencies emitted by corporations (banks), which means Western central banks must resort to parlour tricks like “QE” when those banks lose the appetite to lend.

          (Ed. opinion: we’ll soon be seeing QE 4,5,6, etc. since economic conditions are softening so as banks lend less the only way to materialize more money into existence will be to continue pretending that the banks’ prior lending never happened).

        2. jsn

          Because of its capital controls and willful financial disconnect from the globalizing capitalist system, the effects of a crash in China will show up, ironically, in the real economy: reduced import & exports flows etc., as you note, and either flight population following the flight capital, where it can, or the withdrawing flight capital, where people cannot follow, by those now needing it in China.

          The scale of the change in all of these flows will likely be noticable.

        3. L

          Some of this is already visible. Home prices in Melbourne and elsewhere have fallen on the order of 10% in recent months according to Wolf Street. As has been documented there and elsewhere there have been impacts on Chinese demand too that will affect growth. Ford, and Apple, for example, both owe most if not all of their recent success to Chinese demand for their products. While those products are not manufactured in the US a drop in demand will still affect the US based designers and executives who manage them. Not to mention the funds that have invested in them. And further as The Diplomat has noted a number of Chinese firms have already reduced hiring or started layoffs. Some of these (e.g. all the bitcoin companies) clearly were externally driven but others are more about domestic issues.

      3. Jeff

        China has been a growth driver for a number of companies, especially consumer goods companies who rode on the ’emerging middle class’

        Can someone give an example or citation for this statement?
        IIRC, the Chinese had (have?) a law in place forbidding you to repatriate any earnings from Chinese customers. You have to reinvest that money in China again.
        So selling to Chines might grow you China-based business, but not elsewhere.

        1. Yves Smith Post author

          This is from memory, but (and this is not company-specific) but the IMF report I referenced above said China had contributed ~30% to global growth, but I cannot recall over what time frame, and desperately need to turn in, so please forgive me for not finding the report and firming up the details.

        2. animalogic

          Australian home buyers may see a silver lining to a Chinese down turn. It might slow the rate of Chinese buyers lobbing into Melbourne or Sydney with suitcases (literally) stuffed with cash.

      4. Mael Colium

        We don’t really know the truth of China’s financial crisis because so much data is cooked up and cross financed to an extent that it is difficult or almost impossible to connect the dots. The only real guide the world has is their import focus which they ramp up and down to balance their economy. What they haven’t experienced before is trying to negotiate their shenanigans while attempting to deal with the trade war that Trump has dumped on their plans. Don’t forget their vast holdings of US treasuries which supports their world trade and if the US so chooses, could be tied up in a blink with capital controls.They have rigged their exchange rates, stolen or demanded technology transfers from the west without recompense, exercised financial terror on emerging nations (learned that from the IMF) and held to ransom countries dependent on their imports. Well, the game has changed. How this all plays out is in the lap of the Gods, but don’t expect the west to be too sympathetic considering the advantages squandered by China over the decades. Their totalitarian elite are starting to show their true world intentions so I doubt they can look to Europe for bilateral support or other parts of the globe with the exception of Russia and a few rogue states.

        So yes. we’ve heard it before, but in essence this time it’s different. Keep your powder dry.

        1. animalogic

          Gee, Mael, you’d think the West hadn’t given as good as it got – how dare those Chinese assert their sovereignty !.
          And as for Russia, & others being “rogue nations” — well, truly, that’s rich.

    2. oliverks

      The west coast of the North America has seen a large influx of cash buyers from China in the real estate markets. This include LA, SF, Seattle, and Vancouver.

      I have always wondered if these were all cash buyers. I suspect many borrowed the money informally inside China. Perhaps it won’t make a difference as people would prefer to own real estate here. Or perhaps people will be forced to sell, and cause a mighty unwind.

      1. Lila

        Dare I speculate on the Chinese woman currently held in custody in Canada? Does she really have any intention of returning to China or will she decide, given the financial situation in China, that Canada is a safer bet?

    3. John k

      In 2009 China boosted spending to counter the slowdown in the west, in turn boosting their imports and helping the west recover from GR.
      China imports look to be falling now, will affect the west. Plus China will reduce prices as their exporters become desperate… yuan will fall, exporting deflation and annoying trump.
      Reduced commodity imports affect several, Au, Ca, Br.
      And house bubbles in Ca, US, Au…
      Not so much a problem if the west is growing with great vigor…
      Europe turning down now, and brexit on deck…
      Not to worry, pipartisan brits will work together and spend like drunken sailor on infra… just like our own congress…

  2. Clive

    This kind of almost pay-to-play arrangement was one of the not very well documented causes of the financial crunch in Japan. Big companies would place contracts — and sometimes there wasn’t even so much as a formal contract, there was quite a lot done on verbal agreements, understandings and long-standing relationships — but would be, ah-hem, flexible in paying and expect, double-ah-hem flexibility in having the small suppliers extend them credit.

    Of course, most of the time it all worked just fine. It wasn’t that the big companies and conglomerates didn’t pay. Quite the opposite, they never failed to pay. But lax accounting standards meant what the current outstanding invoice totals were were not easily determinable. And the banks played along too — if a mom-and-pop subcontractor was doing work for one of the bigger players, the bank would never put the thumbscrews on the small supplier because they knew it would create, another ah-hem, disharmony between the two parties. The banks were happy to carry the minnow-like suppliers.

    It all worked quite nicely. Until it didn’t.

    1. PlutoniumKun

      This is exactly the sort of informal arrangement which always seems to be ignored by conventional debt analysis. Of course, its not confined to Japan or China – I used to work in a small consultancy in London and this sort of informal deal was very common (we really had no choice as many of our smaller clients couldn’t afford our services, so it was all done on a verbal ‘no foal no fee’ basis). The difference of course is that banks would never provide funding on the basis of this type of work – it had to be more complementary to the more ‘conventional’ work we had with bigger more established clients.

      Its of course much more common in Asia where business always seems to work more on overlapping sets of personal contacts and informal agreements. What I find curious (and concerning) is that from my far-away vantage point, China seems to have a very similar type of structure to Japan in its golden age, but without the very strong societal bonds. In Japan it is genuinely profoundly shocking if someone breaks their word (assuming it was all done according to custom). In China, its done all the time – I know several Chinese friends who have lost lots of money when supposedly trusted business people just walked away with their cash. It makes me really wonder just what will happen if China hits the sort of wall Japan hit in the late 1980’s. I think that the reaction will be much nastier and much more dangerous.

  3. PlutoniumKun

    This is something I’ve been watching for years and yet I’ve seen so little mention of it anywhere in the discussions of private debt in China. Anyone with contact with China knows that beneath the ‘official’ banking system and the ‘shadow’ banking system, there is another system – you might call it the shadow-shadow banking system – one of a vast range of personal loans and guarantees that never appears in official statistics. As one Chinese friend put it to me ‘in my village, everyone owes money to everyone else’.

    And so far as I can see, the nature of Chinese society is that the exact same dynamic occurs from the local barber borrowing for a new shop to muli-billion yuan industries. Its simply how things are done in China and its how so many Chinese have funded their own businesses and small investments (including those properties around the world). A lot of those empty properties everyone has heard about around China are actually collateral for this type of loan, and who knows how often they’ve been used to generate more leverage. And this issue of cross-business guarantee is a natural extension of the Chinese tendency to see family/business linkages as a sort of continuum, not a set of discreet units.

    I’ve no idea what happens if it all unravels, but it certainly will not be pretty.

    1. Abi

      It’s interesting, thank you for pointing out

      Just thinking out loud here, I’ve learnt from complexity science to be patient for outcomes. I don’t believe Westerners have a good understanding of how informal networks/structures work within Chinese society, so I won’t be too hasty to predict shifts in a system you don’t really understand.

      Over time, I’ve just sort of come to understand that it’s the unseen informal interactions and networks that are the real drivers of the society and it’s economy.

  4. Rajesh K

    Isn’t this simple to fix? Just null out the guarantees? Yes, some companies will still go bankrupt, but at least it won’t pull down the guarantors like a domino.

    Banks will need to be recapitalized for sure, but we all know the Chinese NPL number is a big joke. It’s probably 10 times the official number.

    1. Yves Smith Post author

      You don’t “null out guarantees.” That’s a breach of a legal agreement, no different than taking someone’s money as part of a sale process and not delivering a product. You can’t have commerce if people can renege on their commitments when it becomes inconvenient to deliver.

      1. I.A.

        The “Communist Party of China” certainly has the political and legal authority to forgive wide categories of corporate debt, if they think it’s endangering growth or stability.

        The Communist Party of China controls not just the media, the legal system and the central bank, but much of the banking sector is state owned as well.

        There’s pretty much just two ways China could get into serious economic trouble: via external debt created by weak exports, or by not keeping their workers employed and happy.

        They have no external debt (in fact they are net creditors and asset owners), and they have all the policy tools to keep their citizens happy.

        So what would be the channel for economic crisis in China? Internal debt certainly not.

        1. Yves Smith Post author

          China is now undergoing protest by young Marxist because they recognize the system is capitalist, not communist, despite the ideology. China has never engaged in debt forgiveness in any of its past mini-crises. It would amount, among other things, favoring certain parties over other in a manner they could not readily map out in advance, having no knowledge of the cross guarantees, and would be politically destabilizing. And China takes meeting obligations if anything more seriously than the US does, with its development of a social credit system. The social scoring system is hostile to debtors and even more to deadbeats, so your idea runs counter to a major Chinese policy push.

          In 2020, China will fully roll out its controversial social credit score. Under the system, both financial behaviors like “frivolous spending” and bad behaviors like lighting up in smoke-free zones can result in stiff consequences. Penalties include loss of employment and educational opportunities, as well as transportation restrictions. Those with high scores get perks, like discounts on utility bills and faster application processes to travel abroad….

          China first announced that it would be devising a “social credit score” in 2014. The government said then that the system would help ensure a model society in which “sincerity and trustworthiness become conscious norms of action among all the people.”….

          For those declared “untrustworthy,” the ability to buy business-class train tickets or to lodge at certain hotels can be rescinded. In some cases, the opportunity for their children to attend their preferred high school or college may be taken away, as may employment opportunities. (The government encourages employers to consult the blacklist before making hiring decisions.) Citizens who behave inconsiderately in public, like walking their dogs off-leash, can have their dogs confiscated and be required to take an exam to get the pets back.

          Although “untrustworthy” people are punished for bad scores, citizens who rank the highest in the new system can take advantage of perks like business discounts or booking hotel rooms without deposits.

          And an explicit objective is encouraging “responsible” behavior with debt:

          The system started from a goal of helping citizens build creditworthiness, as China’s economy exploded and economic reforms required banks to be able to evaluate individuals looking to borrow money to buy houses or start new businesses. Fraud and excess borrowing were rampant because most people didn’t really have much of a credit history. To measure its citizens’ trustworthiness, in 2014, The State Council laid out a plan that aims to build a centralized database to evaluate individuals and organizations based on their financial and social behaviors.

          1. MyLessThanPrimeBeef

            Social credit score.

            It seems like he concept can be easily applied to a person’s environmental behaviors for a Green Credit Score.

            One’s energy-consumption (including airline miles, car miles, public transport miles, etc) per day can be tracked.

      2. Rajesh K

        Agreed, but this is China and the players are all local. I am sure they can dress it up with some “legal sounding term” that amounts to the same thing. Heck, perhaps the “bad assets” can be bought by another Asset Management Company or something like that. After all the banks were also insolvent at one point in time.

        Also “Is About To Crumble” would sound more legit if the author has …. skin in the game, perhaps some trade?

        Disclosure: I am short the Yuan. I do think the currency is overvalued, but if tomorrow the Yuan goes to 10 bucks, I might just be able to retire pronto.

        1. furiouscalves

          Well, I guess you could look at it as an opportunity for the state to take whatever private business they want total control of for themselves and let the others blow up. I have a feeling the state will do just that, and we will see an even less productive china with even more state run companies made from these private companies that may have formerly been an important driver of growth. The currency will then probably be worth less yeah.

  5. skippy

    Its interesting to view China from the perspective of say pre WWII Japan and how they reconciled Japans failures to stave off the encroaching lusty desires of anglophone corporations and their investors expectations of yield and their political hand maidens facility.

    File under when culture and the market collide …

    1. skippy

      Colonel Smithers ….

      England was going down the gurgler since that battle ship conversation brokered from a safe place considering the geopolitical enviroment at the time, yet as it had established VoM during the proceeding epoch found inventive ways to facilitate a transition. Then neoliberalism got its hooks in everything and FIRE was the name of the game.

      China saw the writing on the wall and changed its game, albeit with cultural application, for better or worse.

      So now its similar to say coming to Oz a few decades earlier from the U.S. and experiencing the event horizon from an earlier observer point. I would only add that observation is being compressed or accelerated due to friction-less capitalism where stock plays a diminished role in historical comparison.

      75% of Australian GDP is services …..

  6. Ignacio

    Yesterday my wife went to an investment forum organized by Morgan Stanley. They seem to be very bullish on China stocks because a formal agreement between the US and China is seen to be signed soon. So they were recommending chinese stocks enthusiastically. I told my wife, yes, that can be an opportunity but think of it as short term, very short term.

    1. cnchal

      > They seem to be very bullish on China stocks because . . .

      Imagine how much money they would make if they said “stay away from that dog crap”.

    2. PlutoniumKun

      Wow, bullish on Chinese stocks? That is, shall we say, a refreshing unusual take.

      It is of course possible to make a lot of money on Chinese stocks – the market is notoriously volatile, so if you have strong nerves and time it right and are lucky, then I’m sure you could do well. Otherwise….

      1. Ignacio

        Imagine, they are talking to an audience of totally inept fund&pension managers, or at least that’s what they must think. In some cases they are quite rigth.

  7. johnnygl

    These cross-guarantees sound like they could possibly act like CDS did in the US in the 2007-8 episode.

    Yves has pointed out that a big part of the problem during the crisis is that no one knew where the unexploded bombs were buried so they stuffed all their money in treasuries and money market funds (until LEH happened and it turned out mm funds weren’t safe, either).

    A big lesson from 2007-8 was that all players in finance trust and rely on each other….until some of them start blowing up, unexpectedly. Then, no one trusts anyone!

    1. Jason

      Possibly, but that would require more data to conclude than provided in this article. Anecdotes about one city and a few companies don’t quite do the job.

  8. Susan the Other

    We, the planet, will manage to reduce CO2 by cutting China’s manufacturing by 30%. The Yuan will devalue accordingly. The dollar will get stronger in spite of our own predicaments. There will be less plastic pollution. We might run out of toilet paper, so best to stock up. Consumerism is probably over. Looks like retail even jumped the gun by already fizzling out here. Bad Christmas omen. We might not get into a serious fight over South China Sea oil now. China will not want to default on any foreign debt so they will nationalize everything that is in trouble to keep things from collapsing. Which will be everything because that’s what a 30% cut does. China’s banks are buying bonds, but they are not speculating in derivatives, hopefully. And because China can’t sleep at night when the crowd gets angry, it will make sure that there is sufficient employment to keep society peaceful. Maybe green jobs? So all this co-signed credit will merge in one big gob of nationalized rehypothecations and everybody will get a bowl of rice. And I’d guess very few if any will have their mortgage foreclosed and be unceremoniously – immorally but not illegally – dumped at the curb. We have been, easily, as disgraceful as China could ever be.

  9. stevelaudig

    So what is the metaphor? Corporations handcuff themselves to other corporations which are soon-to-be suicides? Handcuffed to a corporation the path of which takes it off a cliff? Impression, any ‘important’ corporation as in technology, number of people employed, centrality to national defense, power generation, infrastructure, etc, has one or more PRC members on the board or occupying a high-pay, low-work job in uppermost management and will have been instrumental in, or knowledgeable of, this “chain gang” of loan guarantees creating a purge opportunity.

  10. Steven Greenberg

    I think it might have been Steve Keen that has been talking about the Chinese debt crisis for a long time. Since I knew Keen was a firm believer in MMT, I couldn’t understand why he was so concerned about debt in China. Someone finally woke me up to the fact the problem was private sector debt, not government sector debt. Lately, I have been reading what Michael Hudson has to say about private debt to the rentiers in the FIRE sector in the USA – similar results will ensue.

    Perhaps the solution is for the Chinese Central Bank to go into the retail banking business of lending to the under-served parts of the private sector. As we have known since Keynes explained this in the 1930s, just pushing money out to institutions does not make them spend it the way the government wants them to. At some point the government has to spend the money directly to the recipients it wants the money to go to.

  11. Aloha

    I am fascinated about banking and countries, power plays between countries around the world, etc. About a year ago I came across this private blogger who loves to go into great detail about China’s investing strategies and it’s impact on the world with the added bonus of a sense of humor!

    An article done on January 1, 2019:
    “Keeping it Simple, Short and to the Point….and China has US$50.1 Trillion of new Financial Assets!”
    The purpose of the PBOC’s Financial Stability Report, as far as I can tell, is to fully describe the financial condition of the Chinese economy and let the world know that “China” is on top its game and doing a great job ….at everything. All’s well…..nothing to see here…

  12. Chauncey Gardiner

    Is the situation less dire, or under the “first cockroach” analogy is it even worse than outlined here? Given the size of China’s economy, the numbers cited in the linked South China Morning Post article don’t appear to be overly alarming. But although we don’t know the total losses involved, a debt-fueled “Minsky Moment” financial collapse concentrated in China’s private sector property developers and private corporations, shadow banks, and banks appears to be underway. This is being exacerbated by a network of cross guarantees and capital flight. If debt servicing and repayments continue to deteriorate, it will likely have further secondary economic, financial and political effects both within China and elsewhere in the world, not unlike those caused by the contagion from derivatives and credit linkages between large western banks in 2008. We have already seen signs of those secondary effects in decreased Chinese demand for Vancouver and Sydney real estate, Apple iPhones, and in the Baltic Dry Index.

    Should that occur with regard to its banks, will the Chinese – like Japan, the EU and the U.S. – adopt a state-subsidized neoliberal QE-ZIRP “markets-based” policy route through China’s central bank for lost decades; Look to and enable the nation’s bankruptcy courts, creditors and bank regulators to write off and restructure the debts – including the contingent liabilities under the cross-guarantees; Retreat back into a framework dominated by state-owned enterprises and banks; Retain a material component of Xi’s neoliberal “socialism with Chinese characteristics”; Pursue constructive sovereign fiscal spending policies under an MMT framework to mitigate the worst social effects; or undertake a combination of such policies?

    Given the ambiguity about the magnitude of the losses, the answer(s) are as yet unknown. But it does seem both counterintuitive and counterproductive that the government is presently calling on state banks to further boost lending to the private sector into this deteriorating environment.

  13. John Beech

    Naysayers have been predicting the collapse for so long I’ve gone gray waiting. Me? I am rather more sanguine about it because this debt is denominated in Renminbi Yuan. Could I be wrong e.g. it’ll blow up tomorrow and take the world down with it? Yes, I suppose the results could be less than optimal for the western world’s credit markets. Meanwhile, I continue to have faith in President Xi and his advisors to a) make a deal with President Trump, and b) to somehow keep the balls in the air a while longer. Time will tell.

  14. Franziska

    If MMT is the answer and in China everything is mostly state owned or state controlled and there is no inflation and the country has huge reserves and a huge positive foreign account, so where is the problem? They are just doing what MMTers would like to do here that is government financed investments to achieve world class technology in every sector and full employnment.

    1. Yves Smith Post author

      Help me. In China, most of the debt is either private or local government debt, which is NOT debt of a currency issuer. And China has had an inflation problem for years.

      1. Franziska

        Thanks for your answer but I think you’re wrong. SOE debt is public debt in disguise, local province debt also. The only real private debt is shadow banking debt which is mostly unknown. China is not a capitalist economy or a communist one, it’s much more like a national socialist economy (like in Germany or Italy in the ’30) and the sheer fact that was much more successful than any other in the last 30 years should be quite frightneening. I like Pettis but he is looking at it with western eyes. Econony is not a science, much more like an informed opinion with a strong political and cultural bias. One way or another all our countries are transforming for the worst, be it the Bolsonaro way or the way that a younger and much more powerful and assettive Trump will show in the near future. People who is used to consume a lot want to continue to do so and people left behind want to consume much more. China model will follow, but we will need one more planet every 10 years. By the way I lived in China for most of the last 10 years years working there for a german giant, no more inflation than here, but a lot of people experienced a huge step forward in income. Millions of chinese tourists fly to the US, Europe, even Iceland and Morocco. Poor people, drawned in debt don’t travel and don’t show the most expensive cameras on the market. China will sink but not now, we are sinking now or we already did it and they are not steeling western technology now (they did it in the past of course) because they are leaders in telecoms, electric transports, new materials, optoelectronics etc… every year 10 new graduated engineers for only 1 in the US and much less here in Germany. Americans are just trying to block Huawei because they are much more advanced than Apple. I don’t know if there will be a chinese century but we’ve already lost and soon we will loose our last semblance of democracy. Sorry be used to that and sorry for this rant.

        1. Yves Smith Post author

          First, I did NOT say SOE debt, I said corporate debt. There are many Chinese companies that are not SOEs that are large borrowers. That’s where the Chinese billionaires and other wealthy come from. They are significant players. For instance, wealthy individuals, via their companies, have been significant enough speculator in the commodity markets (they’d stockpile actual end materials, like tons of tin, as an inflation hedge) are seen as having had an impact on global prices.

          Second, the local governments are not the same as the national government, and the past bailouts of WMPs were narrow, not broad, and not directed to the local governments. Local governments are not currency issuers. Unlike the national government, they can’t create currency out of thin air. On top of that, they are seen as competitors for power with the national government, and so letting them suffer a bit is an important disciplinary process.

          Experts have repeatedly commented that any bailout of WMPs is difficult due to the not knowing where/who owns them and what many of the structures are.

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