Andrew Ross Sorkin:
Kenneth Rogoff has long warned of a potential financial crisis in China. Mr. Rogoff, a professor of economics at Harvard University, accurately predicted the eurozone debt crisis and for years has been telling anyone who would listen that China posed the next big threat to the global economy. He is starting to look right, again.
“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could,” Mr. Rogoff said on Monday from Cambridge, Mass., repeating a favorite line from Rudi Dornbusch, the German economist. (Mr. Rogoff sat in on Mr. Dornbusch’s class at M.I.T. in 1977.)
Mr. Rogoff, who is a chess grandmaster, has made a career of studying financial crises. After the 2008 financial crisis, Mr. Rogoff co-wrote “This Time Is Different,” a seminal book that examined eight centuries of financial crises. Every financial crisis, he and his co-author, Carmen M. Reinhart, concluded, stems from the same simple problem: too much debt.
To understand the wild machinations of the stock market in recent days in the United States and abroad, you need to look no further than China’s astounding debt load and sputtering economy — and its ability to infect the rest of the world.
“China is the classic ‘This time is different’ story,” Mr. Rogoff said, rattling off all the different rationalizations for why the country convinced itself — and many others — that it could load up on debt but was somehow immune to the laws of economic gravity. He cited the government’s control over the markets, the hundreds of millions of workers migrating to cities and the country’s saving rate of about 30 percent of disposable income as just some of the reasons China was said to be impervious to a severe downturn.
“It’s very vulnerable,” Mr. Rogoff added. “There is a lot of debt.” How much debt remains an open question, given the opacity of China’s market. The country’s debt load rose from $7 trillion in 2007 to $28 trillion by mid-2014, according to a report published earlier this year by the consulting firm McKinsey & Company, China.
“At 282 percent of G.D.P., China’s debt as a share of G.D.P., while manageable, is larger than that of the United States or Germany,” said the McKinsey study. “Several factors are worrisome: Half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.”
Excerpts from Ambrose Evans-Pritchard:
The world financial system is at a dangerous juncture. Markets no longer believe that China’s Communist leaders are in full control of the country’s $27 trillion debt bubble, or know how to manage fast-moving events beyond their ken. This could be the early stage of a very serious situation,” said Larry Summers, the former US Treasury Secretary. He compared it to the two spasms of the Asian crisis in the summer of 1997 and again in August 1998. Ominously, he also compared it to the “heart attack” of August 2007.
Professor Christopher Balding from Peking University wrote on FT Alphaville that China is lurching from one incoherent policy to another, shedding credibility and its aura of omnipotence at every stage. “There is a very real risk that Beijing is losing control of the story,” he said. The speed with which this episode has now engulfed US markets – trading at 50pc above their historic average on the long-term Shiller price/earnings ratio, and primed for trouble – suggests that events could all too easily metastasize into a self-perpetuating crisis of confidence.
Martin Feldstein sees the market troubles coming from QE by the Fed. Our view is pretty idiosyncratic. The US has had 6-7 years of subpar growth and no meaningful inflation, and that’s with QE plus China’s spending spree. Without them it would have been much worse. If the Fed now wants to raise interest rates, as many continue to suggest, why doesn’t the Treasury 10x increase the sales of the 30 year bond, compared to the minuscule $16 billion in May?
Final point: with the $27-28 trillion China debt versus their $8-10 trillion GDP (who knows what the real number is?), China really needs to put in place a comprehensive Action Plan ASAP, but it will be shocking if it does. We suspect that the problem is that the people with the knowledge to do so and the people who can make such decisions are two distinct groups that do not overlap.