China Reckons With Years of Excess. Here’s How Bad It Really Is…
For the first time in decades, the Chinese government has embarked on a radical overhaul of the country’s economic and financial systems. Beijing is confronting a complex web of debt, inflated asset prices, and unsustainable policies that have ravaged the national economy. China’s reckoning with its own excesses could have far-reaching implications for global markets and investors.
The statistics are staggering: China’s overall debt has more than quadrupled since 2007, exceeding 300 trillion yuan ($45 trillion). Minsky Moment Alert! The level of debt to GDP is almost as high as Greece’s was at the peak of the euro crisis. The rapid growth of wealth management products has turned China into the world’s largest shadow banking system, hiding a significant chunk of debt under the radar of official statistics. As a result, the majority of China’s banking system operates in the shadow of the “wall of WMPs”.
Chinese policymakers, aware of the growing risks, are scrambling to clean up the mess. This involves a gradual deleveraging process, implemented through a variety of measures such as debt swaps, asset confiscation, and restrictions on debt-fueled investment. One notable example is the “four to one” rule, forcing state-owned companies to reduce debt by 100 billion yuan in exchange for cash injections.
It is crucial for investors to differentiate between the economic reality and market perceptions. Some may argue that the Chinese central bank has gained greater control over the economy after implementing a comprehensive financial regulatory reform, which was initially seen as a positive catalyst. However, a closer inspection reveals that credit growth remains slow, and high-quality assets for investors are few and far between.
The “excesses” in question can be classified into three areas:
1. Debt: Both corporate and local government debt in China has escalated, with credit growth slowing.
2. Excessive speculation in assets: From stocks to commodities, China has experienced a flurry of speculative fervor, mainly fueled by zero-interest rates, abundant liquidity, and the misallocation of capital.
3. Systemic failures: The reliance on shadow banks, wealth management products, and underground lending indicates that the underlying financial system in China is both opaque and volatile.
The market may be anticipating a “K-shaped” economic recovery, which is characterized by the divergence in fortunes between corporate winners and losers. In fact, the trend has already set in, driven by the differential in debt structure, asset pricing, and operational performance. Chinese authorities are fighting a losing battle in trying to boost the domestic economy through cheap money and large-scale infrastructure investments, as private sector growth suffers.
The end result is the rise of private debt, increasing income inequality, and a precarious asset bubble on the verge of bursting. Anecdotal evidence from the once-booming manufacturing sectors suggests a dire situation with layoffs, forced bankruptcies, and a steady stream of entrepreneurs who have left the country seeking better opportunities.