China Is Digging Itself Into A Deeper Hole by John Mauldin
Chinese “depreciation” and all its ensuing hysteria occurred just about a year ago. It has also been a about a year since I co-wrote a book on China with Worth Wray titled A Great Leap Forward?
The title was meant to be ironic. The original Great Leap Forward was imposed by Mao in the 1960s. It was one of the most economically disastrous times in Chinese history. Food production increased, yet 30 million people starved. China underwent a true financial and economic crisis due to the insanity of central control of markets.
China now attempts something that is as powerful in scope as Mao’s Great Leap Forward. It has amassed a huge amount of debt in its drive to enter the modern world. China has succeeded in becoming a major force. But those who are paying attention see the country’s debt growing at a phenomenal rate.
It is much higher than the economy’s rate of growth, which is shrinking. That means the ability to service the debt is shrinking, too. And we are talking about massive amounts of debt in relation to GDP.
There is a lot to like and appreciate about China. But it isn’t clear what they are going to do about their current circumstances. This includes the inevitable shift from being a manufacturing powerhouse to being a consumer powerhouse. It’s not an easy transition.
My friend Michael Pettis is a professor at the Guanghua School of Management at Peking University in Beijing. I think it’s safe to label him a long-term China insider. He’s possibly the most knowledgeable person I know on China’s inner workings.
Here is his latest article on the nature of Chinese debt and the problems that the resolution of that debt is going to create.
Does It Matter If China Cleans Up Its Banks?
By Michael Pettis
I’ve always thought that Shirley Yam of the South China Morning Post has a great nose for financial risk, and this shows in an article she published last week on mainland real estate. For anyone knowledgeable about the history of financial bubbles and crises, much of the following story will seem extremely familiar. The point to remember is that what is normally recorded as business operations in activities described in the article, results in fixed payments that are inversely correlated with underlying conditions, and so is really no different than debt in the way it will begin to generate financial distress costs when the economy turns—goosing economic activity on the way up while exacerbating the contraction when it comes.
Yam discusses how building contractors must pay developers to build real estate projects and write about one such contractor, whom she calls “George”:
She goes on to talk about the desperate competition among developers to get new projects, and what is driving the record-beating real estate prices:
Keep all of this in mind when thinking about stepped-up efforts to clean up China’s banking system. There has been a flurry of reports recently about steps taken to clean up the banking system, but from an economy-wide point of view, it is not clear that any reduction in debt burden’s for the banking system actually reflect a reduction in the debt burden for the economy as a whole. And anyway, new kinds of debt are growing quickly enough that even if it did, the country’s debt burden is almost certainly rising.
Here is Bloomberg on a UBS report two weeks ago on the topic of bank clean-ups:
I think a lot of this misses the point, and not just because there is a lot more debt out there than we think. I think the optimism with which this news has been received reflects a failure to think systemically about the Chinese economy. The fact that bad loans overwhelm the capital of the banking system should not blind us to the fact that China’s problem is excessive debt in the economy, and not a banking system that risks collapse because of insolvency. The only “solution” to excessive debt within the economy is to allocate the costs of that debt, and not to transfer it from one entity to another.
The recapitalization of the banks is nice, in other words, but it is hardly necessary if we believe—and most