Earlier this month, the governor of China’s central bank came out publically to suggest that China is dancing on an economic volacano. There is much to suggest he is right.
He warned of “hidden, complex, sudden, contagious and hazardous” dangers which lurked in chinese economy…
For years, China has powered its growth by manufacturing goods and building infrastructure. The latter has created a virtuous cycle in the economy, where builders are lent money, build projects and move onto new projects.
In a traditionally capitalistic society, non-performing loans would be weeded out. But in China, the government has long intervened with poor projects. This has created a culture where the economic value of a project is not even important…
This means that Chinese banks have a growing portfolio of long-term loans:
This problem is systematic and has never been addressed. In fact, its getting worse;. Although the party have sought to reign in debt, it has actually accelerated since 2012.
For decades, the Chinese miracle has been powered by enormous infrastructure spending and the debt to accompany if…
The Everyone Wins Economy
This cycle has created a Ponzi scheme, where debt is used to fuel uneconomic infrastructure projects. And everyone benefits from keeping it all going.
Local governors (who are judged one economic performance) ensure the credit taps are flowing and look great in the process, the people become more prosperous and the Chinese communist party look like economic geniuses (we’ll show you IMF!)
The power dynamics of the communist party are also important to consider. Xi has been trying to cement his power in the party and the appearance of an economic powerhouse has been central to that. To keep the party going, the Chinese
communist party are going doing that they have always done: turn on the credit taps.
They have said they would reign in debt publicly, but Xi needed the credit taps on full blast so he could cement his power at the recent party conference in November! The problem here is that debt has gotten dramatically out of hand this time!
But the virtuous circle of lending money, building projects which do not always have economic value and increasing credit further cannot go on forever. Because the rising rate of uneconomic loans cannot be left alone forever…
Sooner or later… large portion of China’s debts are going to be written off completely and the party is going to end…
When that happens there will likely be a market correction, as investors realise that everything was not as it seems…
When that happens… make sure you are prepared!
If you are interested in learning more, read this: