Rescaling China’s Debt Mountain

by Barry Eichengreen

Barry Eichengreen is Professor of Economics at the University of California, Berkeley.

MONTREAL – There is widespread agreement on two facts about the Chinese economy. First, the slowdown has ended and growth is picking up. Second, not all is well financially. But there is no agreement on what happens next.

The good news is that domestic demand continues to grow. Car sales were up nearly 10% in March over the same month in 2015. And retail spending grew at an annual clip of 10% in the first quarter.

The most dramatic increase, though, is in investment. Real estate investment is growing again, following its collapse in 2015. Industrial investment, especially by state-owned enterprises, has been rallying strongly.

At the root of this turnaround is enormous credit growth, as the authorities, concerned that the earlier slowdown was excessive, encourage China’s banks to lend. Credit growth, known in China as “total social financing,” grew at an annual rate of 13% in the fourth quarter of 2015 and again in the first quarter of this year – that is, double the rate of annual GDP growth. Since the financial crisis erupted in September 2008, China has had the fastest credit growth of any country in the world. Indeed, it is hard to point to another credit boom of this magnitude in recorded history.

The bad news is that credit booms rarely end well, as the economists Moritz Schularick and Alan Taylor have reminded us. China’s credit tsunami is financing investment in steel and property, sectors already burdened by massive excess capacity. The companies doing the borrowing, in other words, are precisely those least capable of repaying.

The International Monetary Fund, which tends to adopt a conservative posture on such matters (not least to avoid antagonizing powerful governments), estimates that 15% of Chinese loans to nonfinancial corporations are at risk. With nonfinancial corporations’ debt currently standing at 150% of GDP, the book value of the bad loans could be a quarter of national income.

It still may be possible to sell off vacant apartments for a fraction of their construction cost. It may be possible to sell off rolling mill machinery to other countries, or as scrap. But where the loans at risk are concentrated – in steel, mining, and real estate – suggests that losses will be substantial.

This is why the supposedly painless solution, debt-for-equity swaps, will not be painless. Yes, bad loans can be purchased by asset-management companies, which can package them up and sell them off to other investors. But if the asset managers pay full book value for those loans, they will incur losses, and the government will have to foot the bill. If they pay only market value, it will be the banks that incur losses, and the government will have to repair their balance sheets.

This leaves three unpalatable options. First, the authorities can issue bonds to raise the funding needed to recapitalize the banks. In doing so, they would effectively transform the corporate debt problem into a public debt problem. This would place the financial burden squarely on the shoulders of future taxpayers, which would not enhance consumer confidence.

It also would not enhance confidence in the public finances. Public debt in China is still relatively low; but, as any citizen of Ireland can tell you, it can balloon when banking crises strike.

Alternatively, the central bank could finance the repair by providing credit. But, while the authorities relied on this approach in 1999, the last time they were faced with a serious bad-loan problem, running the money printing press is not compatible with officials’ other stated goal: a stable exchange rate. We saw last August how investors can panic when the renminbi exchange rate moves unexpectedly. Currency depreciation may not only precipitate a destabilizing spiral of capital flight; it could also destabilize the banks, from which money leaving the country must first be withdrawn.

The final option is to imagine that the bad-loan problem will solve itself. The banks would be encouraged to “evergreen” their loans: to roll them over when repayment falls due. The fiction that the banks are well capitalized will be maintained. Borrowers that need to be liquidated or reorganized will instead stay alive, thanks to the drip-feed of bank finance. The result will look familiar to aficionados of Japan’s banking crisis: zombie banks lending to zombie firms, which apply artificial pressure on viable firms, stifling their growth.

Financing bank recapitalization through bond issuance is probably the least bad option. This doesn’t mean that it will be painless. Nor is there any assurance that Chinese policymakers will opt for it. But if they don’t, the consequences could be dire.


Barry Eichengreen is a professor at the University of California, Berkeley, and the University of Cambridge. His latest book is Hall of Mirrors: The Great Depression, the Great Recession, and the Uses – and Misuses – of History.

Copyright: Project Syndicate, 2016.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Added 18.06.2018
Daniel Wagner: "My prediction Korean War will be formally ended, the peninsula will be denuclearised, and a lasting peace will be the result."
Added 14.06.2018
Extract: PiS [ the ruling Law and Justice party] has established the most significant addition to the Polish social safety net since 1989: the Family 500+ program. Launched in 2016, Family 500+ embodies the nationalism, traditional family values, and social consciousness that the PiS seeks to promote. The program pays families 500 złoty ($144) per month to provide care for a second or subsequent child...........The program has been enormously popular. Some 2.4 million families took advantage of it in the first two years. The benefit, equivalent to 40% of the minimum wage, has almost wiped out extreme poverty for children in Poland, reducing it by an estimated 70-80%........... Liberal pro-European politicians and policymakers are not convinced. They complain that such a generous family benefit will weaken work incentives and blow up the government budget. But initial evidence suggests that Family 500+ has actually increased economic activity. It has also reversed the post-communist decline in fertility, increased wages (particularly for women), and enabled families to buy school materials, take vacations, buy more clothes for their kids, and rely less on high-priced credit for basic household needs. And, thanks to rapid economic growth, the government deficit has steadily fallen, not grown.
Added 12.06.2018
The depths of hypocrisy of the Republican Party in supporting Trump’s meeting with the North Korean dictator in Singapore are hard to plumb. This is a party whose leading members adopted the Ostrich Foreign Policy Principle for decades. If you don’t like a country’s government or political and economic system, pretend it does not exist.
Added 12.06.2018
US Defense Secretary Jim Mattis has spoken out against China’s strategy of “intimidation and coercion” in the South China Sea, including the deployment of anti-ship missiles, surface-to-air missiles, and electronic jammers, and, more recently, the landing of nuclear-capable bomber aircraft at Woody Island. There are, Mattis warned, “consequences to China ignoring the international community.” But what consequences?
Added 12.06.2018
With a general election approaching in September, Swedish voters are being warned that now it’s their turn to be targeted by Russian interference in the democratic process. According to Sweden’s Civil Contingencies Agency (MSB), which is leading the country’s efforts to counter foreign-influence operations, such interference is very likely, and citizens should be on the lookout for disinformation and fake news.
Added 11.06.2018
Extract: "While the presidency has grown stronger over the years, during the Trump administration Congress has been timid and subordinate. That is because the leaders of the Republican Party – which controls both the House of Representatives and the Senate – are frightened of Trump’s base. They cannot afford to alienate the roughly 30-35% of Americans who passionately back him, ignore his personal transgressions, tolerate his degradation of the country’s civil discourse, favor his brutal treatment of immigrant families, and don’t mind that he is leaving the US almost friendless in the world."
Added 08.06.2018
Has North Korea’s ruler, Kim Jong-un, made a strategic decision to trade away his nuclear program, or is he just engaged in another round of deceptive diplomacy, pretending that he will denuclearize in exchange for material benefits for his impoverished country? This is, perhaps, the key question in the run-up to the summit between Kim and US President Donald Trump in Singapore on June 12. Until then, no one will know the answer, perhaps not even Kim himself.
Added 07.06.2018
Some analysts even project that, before long, Facebook will hold more data on its users than any government. Meanwhile, it makes a lot of money from this data. Its advertising revenues came up to around US$40 billion in 2017 (up 50% from 2016). With Google, it holds an 84% market share in online advertising.
Added 05.06.2018
Roseanne Barr is an American comedian whose fictional TV character of the same name is a working-class Trump supporter. For those who remember the show “All in the Family,” she might be usefully compared to Archie Bunker, the crude proletarian patriarch from Queens, New York. Barr’s show was swiftly canceled late last month by the television network ABC, not for anything her “character” said in her show, but for a tweet in which she described Valerie Jarrett, an African-American former adviser to Barack Obama, as the offspring of the Muslim Brotherhood and “Planet of the Apes.”
Added 04.06.2018
 

When Donald Trump was elected, I, like many others feared what his presidency might do to the country. A year and a half into his term in office, our concerns have been justified. 

Added 01.06.2018
Extract from the article: "While the West’s relative decline is almost inevitable, its economic dysfunction is not. Yet pessimism can be self-fulfilling. Why undertake difficult reforms if a dark future seems preordained? As a result, accepting and anxious pessimists tend to elect governments that duck difficult decisions (witness Germany’s grand coalition), while angry pessimists make matters worse (by voting for Donald Trump’s “America First” agenda or for Brexit, for example). It doesn’t have to be this way. As French President Emmanuel Macron has demonstrated, bold leaders can succeed with a message of hope, openness, and inclusion, and by promoting a vision of progress based on credible reforms."
Added 30.05.2018
It has been nearly two years since the United Kingdom narrowly voted in favor of leaving the European Union. As the march toward Brexit – formally set for the end of next March – proceeds, fundamental questions about the nature of the future UK-EU relationship remain unanswered. Instead, every time a tough decision must be made in the negotiations in Brussels, British ministers kick the can down the road, or even into the long grass. This is somewhat surprising. Apparently, none of the politicians and newspaper editors who plotted for years to get the UK out of the EU thought much about what would happen if their machinations succeeded.
Added 30.05.2018
Discussions are now underway to establish a system of joint deposit insurance for eurozone banks. Proponents of the scheme, with the European Commission and the European Central Bank (ECB) taking the lead, point out that deposit insurance would avert the danger of a run on banks in times of crisis. While this argument is true, critics emphasize the disparity in risks, owing to the high share of bad loans on the balance sheets of banks in some countries. To address this risk disparity and move ahead with the plan, balance sheets will need to be cleaned up before considering the next step. While the share of bad loans for banks in the stable eurozone countries is just 2%, the most recently published International Monetary Fund statistics, from last April, show a share of 11% for Ireland, 16% for Italy, 40% for Cyprus, and 46% for Greece.
Added 29.05.2018
Trump’s decision cannot be justified by any breach of the agreement on Iran’s part. It is, rather, a return to the old, largely unsuccessful US policy of confrontation with Iran. The only difference this time is that the Trump administration seems determined to go to the brink of war – or even beyond – to get its way. If the administration has any plans for keeping Iran’s nuclear program in check in the absence of the nuclear deal, then it is keeping them a secret. Judging by some of the administration’s rhetoric, it would appear that airstrikes against Iran’s nuclear facilities are on the table. But bombing would only delay Iran’s nuclear program, not stop it. Would Trump then consider a massive ground war to occupy the country and topple the regime? We know all too well how that strategy worked the last time it was tried.
Added 28.05.2018
US President Donald Trump’s abrupt decision to cancel his planned June 12 summit with Kim Jong-un represents a diplomatic coup for the North Korean leader, and an even bigger victory for China. In the space of just a few months, Kim’s image has gone from that of international pariah to that of thwarted peacemaker.
Added 23.05.2018
The good news is that the United States and China appear to have backed away from the precipice of a trade war. While vague in detail, a May 19 agreement defuses tension and commits to further negotiation. The bad news is that the framework of negotiations is flawed: A deal with any one country will do little to resolve America’s fundamental economic imbalances that have arisen in an interconnected world.
Added 21.05.2018
The cryptocurrency revolution, which started with bitcoin in 2009, claims to be inventing new kinds of money. There are now nearly 2,000 cryptocurrencies, and millions of people worldwide are excited by them. What accounts for this enthusiasm, which so far remains undampened by warnings that the revolution is a sham? One must bear in mind that attempts to reinvent money have a long history. As the sociologist Viviana Zelizer points out in her book The Social Meaning of Money: “Despite the commonsense idea that ‘a dollar is a dollar is a dollar,’ everywhere we look people are constantly creating different kinds of money.” Many of these innovations generate real excitement, at least for a while. As the medium of exchange throughout the world, money, in its various embodiments, is rich in mystique. We tend to measure people’s value by it. It sums things up like nothing else. And yet it may consist of nothing more than pieces of paper that just go round and round in circles of spending. So its value depends on belief and trust in those pieces of paper. One might call it faith.
Added 19.05.2018
The protests that rippled across Russia ahead of Vladimir Putin’s fourth inauguration as president followed a familiar script. Police declared the gatherings illegal, and the media downplayed their size. Alexey Navalny, the main organizer and Russia’s de facto opposition leader, was arrested in dramatic fashion, dragged out of a rally in Moscow by police. On May 15, he was sentenced to 30 days in prison. More than 1,600 protesters across the country were beaten and detained.
Added 16.05.2018
Many knowledgeable people dismiss the prospect of advanced AGI [=Artificial General Intelligence]. Some, ..........,argue that it is impossible for AI to outsmart humanity........Yet other distinguished scholars........do worry that AGI could pose a serious or even existential threat to humanity. With experts lining up on both sides of the debate, the rest of us should keep an open mind.
Added 15.05.2018
The world’s most important bilateral relationship – between the United States and China – is also one of its most inscrutable. Bedeviled by paradoxes, misperceptions, and mistrust, it is a relationship that has become a source of considerable uncertainty and, potentially, severe instability. Nowhere is this more apparent than in the brewing bilateral trade war.