It is a cliché that Chinese consumers are frugal and that they maintain a high savings ratio because of a lack of a social safety net. While that may still be true, it is becoming less so each year. Indeed, Chinese consumers are facing a real stress test in the wake of a sluggish economy, a trade war with the US and the coronavirus pandemic. As recently as the 1980s, consumer credit was unheard of in China. But it has surged to make up 36 per cent of total assets of a banking sector that has grown over 100-fold. Today, millions of consumers are choking on debt . But do not hold your breath for an official announcement of a debt crisis, even though we are clearly deep in one. At YX Asset Recovery, we are inundated with requests from lenders to take on more assignments from them. Our rivals such as Asset 360 and China Data Group are in the same boat. And a leading online lender, Qudian, which is listed on the New York Stock Exchange, just reported an 88 per cent sequential drop in its fourth-quarter earnings after citing rising rates of delinquency. It looks certain that the lender will plunge into big losses in the first half of this year. Five other online lenders I spoke with in recent weeks have reported extreme difficulties in debt recovery. In addition, traditional nonbank lenders are only fairing marginally better. How did China get here? In hindsight, I think four decades of high-income growth has fooled consumers into believing that the high growth is sustainable, even perpetual. Along the way, household debt has surged to fund consumption, education, homes, speculation, and businesses that have mostly hit the wall. Unlike poorer developing countries, China has pushed banking outlets to its most remote corners. A study by Baoshang Bank shows that even in sparsely populated Inner Mongolia, there is at least one bank branch (often a few) in each township. There is no doubt that China has achieved universal coverage as far as access to banking is concerned. In fact, it was so overdone a decade ago that many banks have had to reduce their number of banking outlets since. In the meantime, electronic banking has hugely improved universal coverage. It is no longer true to say that a large segment of the population is unbanked or underserved. Having maxed out their credit cards, tens of millions of Chinese consumers have turned to peer-to-peer lenders and other online lenders with a vengeance in the past six to seven years. These lenders were equally zealous. A spark of a good idea quickly turned to a raging bush fire, thanks to smartphones. Armed with an infectious slogan of “financial disruption based on algorithms”, thinly capitalised lending platforms expanded exponentially between 2012 and 2017. But their quick success became their own enemy. Weak compliance and pervasive wrongdoings forced regulators into a brutal clampdown in 2017, effectively bringing the whole sector to a sad ending. The unravelling is creating millions of disputes, lawsuits and unpaid debts. A 71-year-old victim’s tale reveals the greed in China’s P2P lending fiasco There has been an intellectual underpinning to China’s journey from an economic autarky of the 1980s to today’s overflowing financial excesses. In 1973, Ronald McKinnon, an economics professor at Stanford University, published his first book, Money and Capital in Economic Development , and shot to fame in development economics. When China started to implement its open-door policies, McKinnon acquired the status of a spiritual leader in China’s bureaucracy and economics profession. He and his colleague Edward Shaw had a simple diagnosis for poor countries: they were suffering under “financial repression”, such as official controls over interest rates and external trade on the one hand, and a bloated state sector receiving a favourable allocation of resources on the other. One of the indicators often cited by the professors’ Chinese disciples was China’s low ratio of money supply to gross domestic product in those years. The higher credit, the better. Or so they argued. They have certainly succeeded on that front. How, then, should China and other poor countries minimise financial repression? In the interpretation of their Chinese disciples, the pair offered a simple prescription: implement “financial deepening”, which means making credit and banking services available to everyone, including the poorest, while improving capital mobility. So, it is little surprise that China’s financial sector reforms since the 1980s have centred on financial deepening. But, so far, China has failed to reduce “financial repression”. Today, interest rates and exchange rates remain controlled. And the state sector is more dominant than it was 15 years ago, and is consuming ever more resources. China’s state-owned enterprises ‘prime target’ of new EU competition plan The only real achievement seems to have been the proliferation of credit and good access for everyone. Probably too good. Today, China’s ratio of money supply to GDP has surged to one of the highest in the world, and the professors’ disciples at the People’s Bank of China feel too embarrassed to refer to that ratio again. How is this consumer debt crisis going to play out? I think what happened in the Indian state of Andhra Pradesh, and Central American countries about a decade ago, can provide good hints. In the case of Andhra Pradesh, the state government enacted punitive laws to effectively wipe out all microfinance lenders. And in the case of Central American countries, a mass revolt by poor borrowers achieved the same goal. Today, China’s weak legal infrastructure and the government’s populist bent should conspire to hurt banks and destroy most nonbank financial institutions. Call it a Proletariat Revenge. If there is one lesson China should learn from the consumer debt crisis, it is this: if a family cannot get rich by living beyond their means, how can a country prosper by endlessly inflating its credit sector? This happens to be the central theme of Hugh Sinclair’s 2012 book, Confessions of A Microfinance Heretic . Joe Zhang is vice-chairman of YX Asset Recovery, the biggest consumer debt restructuring agency with 13,000 employees, and author of Inside China’s Shadow Banking: The Next Subprime Crisis? Purchase the China AI Report 2020 brought to you by SCMP Research and enjoy a 20% discount (original price US$400). 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