Is China’s credit boom going to trigger a global financial crisis? Don’t bet on it
Nicholas Spiro says there is no real cause to worry that China’s credit boom will end badly for the global economy. As a one-party system with huge resources, the country is well placed to navigate whatever turbulence comes its way
This past weekend marked the 10th anniversary of the fall of Lehman Brothers, the American investment bank whose bankruptcy on September 15, 2008 turned a fierce credit crunch into the most severe financial crisis since the Great Depression.
One of the most startling after-effects of the crisis is the surge in public and private indebtedness in both developed and developing economies.
Although many observers expected a wave of deleveraging to result in a decrease in the global stock of debt, the combined debt of governments, non-financial corporations and households rose by US$72 trillion over 10 years to US$169 trillion by the first half of 2017, or 236 per cent of global gross domestic product. That’s according to a report published this month by McKinsey, the consultancy, and based on data from the Bank for International Settlements.
Although governments, mainly in advanced economies, account for the bulk of the increase, growth in non-financial corporate debt in developing nations, which includes bonds and loans, makes up just over a quarter of the rise. According to the report, China alone accounts for more than half of the increase in global corporate debt, with its companies, many in construction and real estate, adding a staggering US$15 trillion in debt since 2007; China has one of the highest corporate debt ratios in the world.
The surge in corporate debt has been the main contributor to the rapid increase in China’s total debt (excluding financial-sector debt), from 135 per cent of GDP just before the crisis to 235 per cent by the end of 2016, according to data from the International Monetary Fund. Such an explosion in debt within such a short time frame invariably leads to a hard landing, and quite often a banking crisis.
China’s credit boom began in 2008, following the unleashing of a massive stimulus programme, but it was also aggressive between 2011 and 2016, when nominal credit to the non-financial sector more than doubled, according to data from the IMF.
Many experts see China’s credit boom as one of the most likely triggers for the next crisis. In an IMF paper published in January, the authors studied 43 credit-boom cases around the world, and noted that those which “began when [countries’ credit-to-gross domestic product] ratios were above 100 per cent – as in China’s case – ended badly”.
Chinese policymakers themselves have warned of the risk of a debt crisis. Last October, Zhou Xiaochuan, the outgoing governor of the People’s Bank of China, cautioned that corporate debt was “very high” and that complacency “could lead to a sharp correction, what we call a Minsky moment” – the point when a credit bubble bursts and markets start to unravel.
Yet, despite such significant vulnerabilities, periods of market turbulence in China – the most dangerous moment was the sharp sell-off after the unexpected devaluation of the yuan in 2015 – have not led to a full-blown crisis.
Bets against the world’s second-largest economy looked like they had a chance of paying off in 2015-6, when the PBOC burned through about a quarter of foreign reserves to prop up the yuan and US$1.4 trillion in capital fled the country, according to data from the Institute of International Finance. Yet Beijing held the line.
Indeed, in a sign that international investors never saw China as another Lehman, the S&P 500 index rose nearly 10 per cent in 2016 while emerging market bond and equity funds drew almost US$40 billion in net inflows, according to data from JPMorgan, their best year since 2012.
Although the spillover effects of events in China’s economy and markets have become more evident as the country has become more integrated into the global economy – a risk that is likely to become more pronounced following the inclusion of domestic equities and bonds in benchmark indices – China has become something of a “widow-maker trade”, like Japan, another excessively indebted economy, which wagers against have not paid off.
This is mainly attributable to a number of idiosyncratic factors that mitigate the risks of a liquidity crisis. These include a current account surplus, low levels of foreign debt, and a banking system with a much lower ratio of loans to deposits than in other countries that have suffered funding crises.
However, China’s strongest asset – the one that investors rightly attach the most importance to – is the huge financial and economic resources at Beijing’s disposal. As a one-party system and state-controlled economy, China is better placed to manage periods of turmoil and has a track record of doing so. Not only does the government have control over the banking sector, and the fiscal means to backstop the financial system and broader economy, tighter capital controls have also proved effective.
Just as importantly, from a market standpoint, China’s role as an anchor of developing economies is taking hold at a time when America is turning increasingly protectionist and quantitative easing is nearing its end in Europe, thus tilting the balance of risks in the global economy away from China. That is despite this year’s sharp fall in the yuan; many fund managers believe the 2015-16 sell-off has, if anything, bolstered Beijing’s resolve to guard against further instability.
Markets were complacent about China in 2015 and suffered the consequences. While the country’s vulnerabilities should not be downplayed in any way, the evidence suggests China is unlikely to be the source of the next global meltdown.
Nicholas Spiro is a partner at Lauressa Advisory