Debt is a funny old thing. It’s a bit like quicksand. Easy to get into…very hard to get out of.
Just ask China. After resorting to debt growth (AKA credit growth) to get out of the 2008/09 global recession, the Middle Kingdom is having a hard time getting off it.
Often, the only way you can get off anything addictive is via a stint in rehab. In finance or economic terms, that means dealing with a recession.
But China has control of its banking system. This means that, absent an external shock like a sharp US slowdown, it can manage its debt addiction without the rehab.
Even so, the following report and analysis from Reuters must be a little worrying…
‘For years China’s top officials have touted their ambitious policy priority to wean the world’s second-largest economy off high levels of debt, but there is not much to show for it.
‘On the contrary, a Reuters analysis shows the debt pile at Chinese firms has been climbing in that time, with levels at the end of September growing at the fastest pace in four years.
‘Reuters analysis of 2,146 China listed firms showed their total debt at the end of September jumped 23 percent from a year ago, the highest pace of growth since 2013. The analysis covered three-fifths of the country’s listed firms, but excluded financials, which have seen the brunt of government de-risking and deleveraging efforts so far.
‘The analysis revealed that debt in the real estate sector multiplied the most over last five years, followed by industrials.’
Access to debt is no doubt provided by central government decree via the state owned banking system. And the banking system has ample reserves to finance this lending through the large savings of the household sector.
Remember, China runs a large trade surplus with the rest of the world. This translates into a current account surplus of around US$140 billion annually (I extrapolated the first nine months of 2017 of US$106 billion to get that figure).
That’s another way of saying that China produces around US$140 billion worth of goods and services (and net return on foreign investments) more than it consumes. That is, it’s on track to save US$140 billion this year.
These savings go into the domestic banking system.
Without getting too technical, the point is that China’s savings form the reserves of the banking system. It is the monetary base from which credit grows.
And when the authorities dictate the pace of this growth, well, who knows how long it can continue?
And that’s the problem with trying to work out what’s going on in China.
You can’t make an assessment by looking at China through a western lens. Yes, debt is high. Yes, debt keeps growing beyond what you think is sustainable or healthy. Yet it keeps growing.
That’s partly because China’s trade and current account surpluses provide the fuel for the credit fire to keep burning.
To get a better idea of how the Chinese economy is travelling, keep an eye on commodity prices like iron ore and oil. China is the major buyer of these crucial commodities. While their prices remain supported, you know the Chinese economy is doing OK.
Right now, some commodities are suffering thanks to China’s attempts to control financial speculation. From Reuters…
‘Nickel prices fell nearly 4 per cent, pressured by weakening demand for stainless steel in China, rising Chinese borrowing costs and Beijing’s regulatory crackdown on risky financing.
‘Chinese stocks fell sharply amid worries that rising borrowing costs will hit company profits and that fresh moves to reduce risks in the asset management industry could hit banks and millions of small investors.’
The trick is to distinguish between the effects of a ‘crackdown’ and something more widespread and worrying…something outside the control of the authorities.
But the fact is, China and the rest of the world’s economies are chugging along at a decent pace. And commodity prices are still emerging from a long bear market, as you can see in the chart below. It shows the Thompson Reuters CRB commodity index from the peak in 2011.
[Click to enlarge]
In other words, there are no obvious signs that China is overheated. The conclusion I would draw here is that the Communist Party is doing a reasonable job in trying to manage China’s credit bubble.
That doesn’t mean China won’t run into some serious debt issues in the future. But while its economy grows fast enough to service the debts, it should be OK. And while the economy continues to generate substantial savings, that’s a plus too.
Remember a little while ago the big worry about China was capital outflows?
In October, the country recorded its ninth straight month of rising foreign exchange reserves. The capital account saw an inflow of US$60 billion in the first nine months of the year, compared to an outflow of nearly US$390 billion in the same period last year.
Like most other economies, China has its challenges. But its political system is uniquely placed to meet them.
Given this view, I’m tipping the commodity bull market will continue into 2018.
Editor, Crisis & Opportunity