China FlagThe Chinese have their own debt issues and this has caused some discussion over whether the country is going to experience a meltdown on the order of what has happened in the US and Europe in recent years.

The US has a debt that is just shy of 100% of its GDP and that is estimated to be 40% higher than a nation should be able to sustain.  Many nations in Europe have a far more dangerous level of debt – 130% in Spain and 160% in Greece.  If one looks at many of the developing and emerging markets the debt levels are even more threatening.  Japan has a debt load that is estimated to be 260% of their GDP and China seems to have a debt that is at least 210% of its GDP. Does this mean that China is about to collapse in a financial heap as the US and Europe did in 2008-2009?  A couple of recent studies would suggest that this is not likely as China does not share some of the vulnerabilities that other nations have endured.

Analysis:  To begin with the debt that China has built is different in the sense that it is owed to itself as opposed to the debt in Europe and the US where the debt is owed to outside investors of one kind or another. In fact the US debt situation is a little more like China’s than it used to be as more and more of the US debt has been purchased by the Federal Reserve and that translates into one part of the system owing money to another. Not that this changes the burden of debt service on the annual federal budget nor does it mean that the US no longer has to worry about paying its debt off. Like China the debt owed by the US is different than debt loads that are owed by other nations and that affects policy.

China got into its debt crisis in much the same way that the US and Europe did but with some crucial differences. In the last decade the growth rates in China were nothing less than spectacular and the country reacted to all this new found wealth. In the US the boom was concentrated in the hands of the consumer and it seemed that everyone in the country was seeking to buy a new house. The frenzy of the private sector housing market felled the housing market and that eventually dragged the whole economy into recession. In China the building frenzy was concentrated in the government sector as every city and province was seeking to expand and announce their arrival on the world stage. The overbuilding was staggering and today it is estimated that fully one third of all the buildings put up after 2005 are empty and have always been empty. The “see-throughs” are a major drain on the country’s economy and are the prime mover as far as the debt is concerned. There is a key difference between China’s crisis and that of the US and Europe for that matter. In the US it was the private banks that engaged with the consumer eager to buy a new home and it was the private banks that were left holding the bad debt as the market fell apart. In China the pattern was different as the Chinese governments entitles essentially seized the land they wanted and sold it to the property developers who then borrowed from the state banks to do the project. The failure of many of these projects ended up as bad debt on the books of the government banks and that meant there was no real outside pressure. The damage is not insignificant but it is different and not rooted in the same market pressure as in the US.

According to the studies there are two other reasons that Chinese debt is not as threatening to their economy as that which plagues the US and Europe. The first is that China has a much lower loan-to-deposit ratio. Of all the nations that were examined the Chinese has by far the lowest and that gives the banks far more of a cushion against a rapid drop in asset prices. This is one of the key problems that overtook the US and other states. The banks couldn’t cope with the drastic collapse of the assets they had booked and that thrust the whole financial system into the kind of chaos that necessitated the bail outs under TARP and other programs. Chinese banks appear to have more flexibility – at least at the moment.

The second advantage stems from the fact that China has a current account surplus and a substantial one at that. The other nations have been suffering from major current account deficits throughout the crisis and that severely limits their options. The Chinese have been accumulating a lot of money over the years through their massive exports and that is a significant cushion for the country and one that few other nations have had. Not only is China somewhat immune to the outflow of capital that has plunged many other nations into distress there is that fact that China has very strict capital controls that limit the departure of money. This is a tactic that many nations have tried but with nothing close to the success in China. The trick is to have a highly lucrative and compelling economy that will attract investors even when they are faced with limits on getting their money out. The nations like Thailand and Brazil lack that kind of compelling situation and capital controls essentially drive the investors away permanently.

The bottom line is China has a debt issue and one that will require attention sooner than later. There are already signs that this debt has affected the economy’s performance but it is equally clear that debt is not forcing decisions in China just yet. The major impact is that domestic debt is slowing the country’s progress towards becoming more reliant on the domestic economy for future growth. China has made it clear it intends to transition and that debt is going to make that process much harder.

Courtesy Dr. Chris Kuehl, Armada Corporate Intelligence