While China normally dominates headlines for its stunning economic growth and rapid development, new estimates suggest that a massive bubble of bad loans could be building up. Now, analysts believe that China’s total debt, including household, government, and corporate debt, could be as high as 200%.

China shadow banking

China’s investments

China is often thought of as the world’s lender of first choice. Supposedly flush with cash, China has been buying up assets and making investments across the world, including in the United Kingdom, mainland Europe, and elsewhere. As has already been noted elsewhere, China owns more U.S. debt than any other country. China is also a major player in developing infrastructure in Africa and elsewhere. No wonder then that many people look to China as the world’s current financial super power.

Yet this account doesn’t paint the full picture, however, as China has been fueling its economic development and lending through a complex system of lending and borrowing. China’s public debt is officially estimated to be about 31.8% of the country’s of the country’s GDP—however, this number does not take into full account municipal debt, which has proven difficult to estimate. In fact, estimates range from about 2.5 trillion dollars to nearly 5 trillion dollars.

Problems for Chinese debt

One of the problems with estimating Chinese debt at the municipal and local level  is the way in which local governments have been able to borrow money. Local governments are not actually allowed to spend more than they bring in, nor are they allowed to issue bonds. In order to get around the central government’s regulations, local governments create “local government financing vehicles”, which are essentially state-owned companies, in order to borrow money indirectly. While China’s central government tries to project a sense of complete control, domestic politics are actually far more complex.

Worse, much of the money borrowed has been squandered on questionable projects and in some cases downright corruption. While the central government originally encouraged local governments to borrow money in order to invest in the local economy, it has been trying to reign in the building problem. Already faced with a potential housing bubble, a slowing economy, and increasing demands from its citizenry, the Chinese central government doesn’t need a bubble to build and pop in the local debt markets.

Chinese government under pressure

Now, analysts are wondering if the central government will back up cities and local governments if they fall behind on payments. Many believe that the Chinese government might let some of the loans flop to send a message to both lenders and local governments. What effects this could have on the overall financial market are difficult to predict. Still, because so many investors believe that the government will in fact back up bad loans, it could send shock waves through the market and lead investors to sell off their debts.

And these losses could quickly add up for the government. Most Chinese debt is owned by local investors. Bond and lending markets being under tight control of the central government. Generally, the Chinese government has discouraged international lenders from investing in China’s local level debt. This means that China itself will pay the price if a bubble ultimately does build and pop.

Still, the Chinese government almost certainly will not allow anything to threaten the country’s national economy. This means that the government will likely have to step in and pick up the tab. This would be in stark contrast United States, which has generally refused to get to deeply involved in local affair. For example, the Federal government declined to step in when the city of Detroit declared bankruptcy.

For now, the debt issue in China does not present an immediate risk. Still, the harsh crackdown on lending could lead to constrained growth as fewer projects will be initiated. Further, if the global economy were to suddenly slow down dramatically, or if the housing market should pop, there is a very real risk that the situation can go from bad to worse in a short amount of time. For now, the Chinese government will have to maintain a close eye on the issue and hope that it can sort it out before anything dramatic happens.