More economic warning signs from China

The head of emerging markets at Morgan Stanley Investment Management:

To keep China’s economy growing, panicked officials launched a half-trillion-dollar stimulus and ordered banks to fund a new wave of investment. Investment has risen as a share of gross domestic product to 48% — a record for any large country — from 43%…the amount of new credit generated annually has more than quadrupled to $2.75 trillion in the 12 months through January this year. Last year, roughly half of the new loans came from the “shadow banking system,” private lenders and credit suppliers outside formal lending channels. These outfits lend to borrowers — often local governments pushing increasingly low-quality infrastructure projects — who have run into trouble…

China’s total public and private debt has exploded to more than 200% of GDP — an unprecedented level for any developing country…if private debt as a share of GDP accelerates to a level 6% higher than its trend over the previous decade, the acceleration is an early warning of serious financial distress. In China, private debt as a share of GDP is now 12% above its previous trend, and above the peak levels seen before credit crises hit Japan in 1989, Korea in 1997, the U.S. in 2007 and Spain in 2008…

if private credit grows faster than the economy for three to five years, the increasing ratio of private credit to GDP usually signals financial distress. In China, private credit has been growing much faster than the economy since 2008, and the ratio of private credit to GDP has risen by 50 percentage points to 180%, an increase similar to what the U.S. and Japan witnessed before their most recent financial woes…

Alan Taylor examined the 79 major financial crises in advanced economies over the past 140 years and found that they are just as likely in countries that rely on domestic savings and owe little to foreign creditors. The bulls also argue that China can afford to write off bad debts because it sits on more than $3 trillion in foreign-exchange reserves as well as huge domestic savings. However, while some other Asian nations with high savings and few foreign liabilities did avoid bank crises following credit booms, they nonetheless saw economic growth slow sharply…

Japan used its vast financial resources to put troubled lenders on life support. Debt clogged the system and productivity declined. Once the increase in credit peaked, growth fell sharply over the next five years: to 3% from 8% in the 1970s and to 1% from 4% in the 1980s…

Through 2007, creating a dollar of economic growth in China required just over a dollar of debt. Since then it has taken three dollars of debt to generate a dollar of growth. This is what you normally see in the late stages of a credit binge

China’s credit binge seems rather similar to what the Fed has done with six years of QE. What happens when China’s borrowers can’t repay their loans and the bond market becomes less accommodating of Treasury bonds?

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