• Mon
  • Dec 22, 2014
  • Updated: 1:44pm
The View
PUBLISHED : Thursday, 10 July, 2014, 10:11am
UPDATED : Friday, 11 July, 2014, 4:33am

China’s debt dominoes could fall fast

Mainland debt points to crisis as profligacy of local governments sees public borrowing hit US$3 trillion

The game of dominoes was invented in mainland China in the 13th century and was brought by Italian merchants to Europe, where it became a great hit.

Modern financial market dominoes has less to do with intellectually matching numerical patterns and more to do with balancing the black rectangular blocks on the short edge and lining them up such that a flick on the first topples them all.

And that is precisely what happens when debt goes wrong.

We know from public, private and anecdotal sources that public debt levels on the mainland are very high. The big debts lie with local governments - there is a combined public debt of US$3 trillion, according to official data released at the start of this year.

Local governments borrowed heavily to build large public-sector infrastructure projects, only some of which were useful.

But in a roughly US$9.4 trillion economy, the question is whether debt at that level really poses a problem.

Only confidence in growth to service the debt will generate a recovery

Those that say there is no problem with debt in China are correctly of the opinion that if there is a debt crisis in China, Beijing will provide the bailout.

The great strength that the central government has in a command economy is the ability to manufacture confidence by quickly covering problems and creating liquidity.

However, the optimists also tend to point - wrongly - to China's US$4 trillion of foreign reserves as being available for a bailout.

Reserves do not equate to the domestic wealth of the country that is available for transfer. Real wealth is built from billions of profitable transactions between individuals and the consequent tax receipts, but that takes a good economy a long time to develop.

Sheer size leads to big numbers, but the mainland's modern economy is very young, and in parts it is still poor, verging on destitute.

Those that say there is a serious problem with debt in China point to the enormity of the numbers in the world's second-largest economy.

Analysts estimate total private and public debt on the mainland is close to 230 per cent of gross domestic product. The Greek economy collapsed in 2010 with debt at about 140 per cent of GDP.

The worriers believe that misreporting of debt to the Chinese financial regulators obscures the true levels and that banks only appear to be strong because they have hidden their most toxic debt in off-balance -sheet vehicles - a tool much loved by pre-crisis US banks.

Add in the rising amounts of unproductive capital invested in industries such as steel and coal, which have huge overcapacity, are run inefficiently, and are still being paid for by interest on debt fixed by the government and the problem looks worse.

A large shadow-banking sector has developed outside the regulatory system to trade money at market rates and now lends as much as the regulated sector.

To attract deposits, unrealistically high-yielding wealth management products have been sold in their billions to individuals. Is not such activity - outside of the highly regulated banking system - that which precipitated the Western global financial crisis?

There is no doubt that the government can support the country's current level of debt. There are few unruly international lenders on the mainland, and domestic state-owned banks will be instructed not to rush for the door - but the write-offs will be at great cost to the nation's balance sheet.

How fast will the central government act to assist profligate, bankrupt provincial governments that have been run into the ground by high-living local potentates?

Clearly the temptation will be to let them sweat. After all, the wealth of the nation belongs to the Chinese people; it is their inheritance, their legacy, and not to be frittered away covering corrupt officials.

If we do see anything less than seamless reporting of debt support, we will see nasty headlines, which will hurt the economy.

Imagine the scenario of a liquidity crunch in a big private property company leading to payment issues for a local government to a regional bank, which then defaults on wealth management products sold illegally to retail clients.

Bad news comes progressively - just like a fall of dominoes.

The gamble is whether economic growth will be fast enough to paper over the cracks. That is no different than it would be in Europe or the United States.

Only confidence in growth to service the debt will generate a recovery.

But when we are no longer relying on economics but on confidence itself - is that not as fragile as a line of dominoes?

Richard Harris has built investment businesses across Asia and is the founder of Port Shelter Investment Management in Hong Kong

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This article is now closed to comments

ejmciii
Who would be so daft as to question the masters. They never make a mistake. This is clearly a carefully thought out strategy. Why would a developing economy which utterly depends on exports for its lifeblood worry about having a large quantum of debt stuck in failed or failing infrastructure projects, inefficient manufacturing operations or dodgy investment vehicles in a nation with no rule of law or transparency in financial reporting or legal process. How silly.
captam
@"Analysts estimate total private and public debt on the mainland is close to 230 per cent of gross domestic product. The Greek economy collapsed in 2010 with debt at about 140 per cent of GDP."
This is only an "analysts estimate" ( I call that an uninformed guess) .
However the USA's private and public debt figure is PUBLISHED as some 240% of GDP, so when is the US economy due for a collapse (again) Mr Harris?
53b54824-ef50-4ebb-bcd2-08dc0a3209ca
with china's economy, it is very simple.
there is no law in china because the ccp trumps all law.
the ccp don't want people to bring it down so it never teach morals to chinese, hence chinese have no morals.
with no laws and no morals, china's economy will never move up from the 3rd rate chaotic country it is now.
china's economy may or may not "crash" because the ccp can manipulate everything, but it will never advance.
lucifer
Eventually, albeit too late, everyone will figure out that China's economy is one big pyramid scheme....
cooliesons
It is another "enron" in the making in the financial market --With all those "money laundering " "****www.scmp.com/business/banking-finance/article/1550351/bank-china-laundering-money-would-be-emigrants-cctv-reports" that shift assets or debts to offshore related company, while pushing higher service revenues, and bases for lending. Without independent auditors, willing to go against the Management Board, these hidden related parties will not be disclosed.
singleline
The following article shows that the problem of adverse selection happens not only in the bank-loan sector, where the country's banks mostly lend money to 'their own people', but occurs in the stock-IPO sector as well.
In order to satisfy the stringent IPO requirements, some potential candidates even engage in various kinds of financial shenanigans to enable their businesses to be quickly listed in the stock exchange, thereby turning an original positive-sum game into a zero-sum game --- those people gain immensely at the expense of the country's innocent but greedy stock 'investors'.
But the honest businesses tend to lose out as a result.
Adding insult to injury, unlike those Enron bad people in the US which were heavily punished years ago, even though some of them were related directly to the US president, those Chinese bad people were just slightly fined and were not sent to jail !
I think not even Warren Buffet dares to invest in those IPOs.
(Chinese readers: ****finance.sina.com.cn/zl/china/20140706/105719620155.shtml)
It seems that the more I understand China, the more I can't comprehend her.
Perhaps this is because the more things change there, the more they remain the same.
In the arena of the financial markets, faith or credit is the name of the intertemporal game.
It also seems that those having-been-poor-for-too-long and too-clever people are not very suitable participants for this game.
captam
Could you possibly take guidance from your own pseudonym and cut your last five posts to a "singleline"
singleline
'The paradox of thrift (or paradox of saving) is a paradox of economics, popularized by John Maynard Keynes, though it had been stated as early as 1714 in The Fable of the Bees, and similar sentiments date to antiquity.
The paradox states that if everyone tries to save more money during times of economic recession, then aggregate demand will fall and will in turn lower total savings in the population because of the decrease in consumption and economic growth.
The paradox is, narrowly speaking, that total savings may fall even when individual savings attempt to rise, and, broadly speaking, that increase in savings may be harmful to an economy.'
(****en.wikipedia.org/wiki/Paradox_of_thrift)
singleline
Obviously there is no way I'm able to do as you suggest.
No matter --- I haven't chopped down any trees !
singleline
But he (or she) who says A must say B.
For every debtor there is a corresponding creditor --- they are two sides of the same coin.
China has relatively very few external debts, at least for now.
And because of the country’s still-effective capital control, most of the money still have to stay inside the country.
So, in effect, the debt money is mostly owed by some Chinese people to still other Chinese people.
After offseting each other, the debts just sum to zero.
It’s like the situation in which the different family members are owing each other some amount of money, but from the point of view of an outsider, they have no external debts whatsoever.
That’s more or less the situation of Japan at present.
From the point of view of the trees, the debt of course matters;
but from the point of view of the forest, it doesn’t really matter.
Every student who has studied macroeconomics should have learnt the fallacy of composition --- the fallacy of inferring that a property of parts or members of a whole is also a property of the whole.

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