Outside the Box

The BIS Warns on China

September 21, 2016

I’ve been saying for the past couple years that the next recession here in the US will probably be triggered by an external macro event or cascade of events, coming out of Europe or China. Today’s Outside the Box sharpens our focus on China, which had already got quite a lot sharper with Michael Pettis’s piece in Outside the Box on Sept. 2.

Today’s post comes from Ambrose Evans-Pritchard of the London Telegraph. He is commenting on the recently released quarterly report of the Bank for International Settlements (“the central banks’ bank”), in which the BIS repeats Pettis’s warning that China faces escalating risk of a major debt and banking crisis.

The BIS is also rightly concerned about spillover from China to the global economy. After noting that outstanding loans in China have reached $28 trillion – as much as the commercial banking loan books of the US and Japan combined – Ambrose adds, “The scale is enough to threaten a worldwide shock if China ever loses control. Corporate debt alone has reached 171pc of GDP, and it is this that is keeping global regulators awake at night.”

Total Chinese debt reached 255% of GDP at the end of 2015, a jump of 107% in the past eight years – and still rising fast. Every year, China’s leadership promises to rein in debt growth, and every year the growth just keeps accelerating. That is because China’s GDP growth is fueled by debt, and that debt is becoming increasingly inefficient in producing GDP.

Does China still have the resources to deal with this issue? The answer is a qualified yes – but then there may not be the resources to deal with the other little items on China’s shopping list. The New Silk Road that China seems to be actually in the process of building is estimated to cost $1 trillion, and that’s without cost overruns. Plus, the Chinese leadership has promised massive spending on the interior part of the country to bring up the quality of people’s lives there.

One trillion here and one trillion there, and pretty soon you have run through your reserves and are getting into monetization problems; and then you have all sorts of currency and related issues, not to mention potential inflation, unemployment, the slowing of the economy, the associated public unrest, and so on.

No, I do not think China is going to massively implode, but the world is really not ready for a China that is only growing at 2% or 3% a year. (Even though 2–3% growth would sound pretty good if it was happening in the US.) That will feel a lot like a hard landing as far as world growth is concerned. All happening when there are unsettled political agendas in a number of countries (starting with this one) with regard to globalization and trade treaties.

I am back in Dallas after spending the past few days with Shane in Denver. I got to catch up with David Rosenberg and Mark Yusko and have lunch with George Will. George, who is normally upbeat as he looks to the future, spoke after lunch at the conference and delivered one of the most depressing speeches I have heard in a long time. He was just not in a good mood. I should have tried to engage him on baseball, and the afternoon might have been more enjoyable.

Have a great week and savor the last few days of official summer.

Your seeing global risk everywhere he looks analyst,

John Mauldin, Editor
Outside the Box

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China facing full-blown banking crisis, world's top financial watchdog warns

By Ambrose Evans-Pritchard
Originally published in the Telegraph, Sept. 19, 2016

China has failed to curb excesses in its credit system and faces mounting risks of a full-blown banking crisis, according to early warning indicators released by the world’s top financial watchdog.

A key gauge of credit vulnerability is now three times over the danger threshold and has continued to deteriorate, despite pledges by Chinese…

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John Sloan

Sep. 22, 7:03 p.m.

why do you write that China’s expansion is fueled by debt - it is fueled by credit - just like the US was in the 19th century - just like England funded its 18th century wars on credit - The US money supply these days is also mostly credit - And yes, every increment of additional credit can generate a less and less sized result.