I was in China a few months after Lehman Brothers collapsed. Guangdong, the manufacturing heartland bordering Hong Kong, was a mess. Factories were closing and previously buzzing night spots were shuttered. Yet the economy kept chugging along according to official statistics. I assumed they were making them up.
The Chinese government response to the Global Financial Crisis, was to order a massive indiscriminate lending binge. They responded to a crisis caused by sub-prime lending, by accelerating their own sub-prime-lending. China undoubtedly cooks its GDP figures, but the lending binge did support the economy.
The below chart shows the Chinese miracle has involved an unprecedented acceleration in indebtedness.
China’s private debt-to-gross domestic product (GDP) ratio has surged to more than 200%. Never has a big economy piled up so much debt so quickly…
…Thanks to its large domestic savings rate, it has little external debt—the original sin that has sparked many emerging market (EM) crises. Beijing is working on fixes for internal debt issues, such as turning short-term bank debt into long-term bonds and redirecting credit to the private sector and households. But ultimately, China needs to find more sustainable engines of growth beyond further debt accumulation by unproductive national and local SOEs, or accept slower growth.
High foreign debt prevents aggressive currency devaluations. By choosing not to borrow from foreigners, China has left open their ability to significantly devalue the currency to enable export fuelled growth. It will be interesting to see if China will risk a devaluation, with an US President more focused on protecting jobs than his predecessors. A currency devaluation won’t work if the response from the developed world is tariffs.
There are two other key unresolved questions when looking at China’s medium to long-term prospects. (1) How much longer can China keep piling on debt?; and (2) Will the political system be able to absorb lower growth?
On China, stay sceptical.
NB: If you want to see how your country I positioned on the above chart, go here.