Mountain Or Molehill?

11/03/2016 at 4:22 pm

As market bears know all too well, one of the world’s crushing problems at present is China, and everything connected thereto. At the height of the panic which made for such an enjoyable start to 2016, one specific pointer towards China’s imminent and terminal doom was identified as her debt “binge”. Only this Wednesday, this very same binge headlined a blog post from The Economist magazine which warned:

“DEBT in China is piling up fast. Private debt, at 200% of GDP, is only slightly lower than it was in Japan at the onset of its lost decades . . . and well above the level in America on the eve of the financial crisis of 2007-08 . . . The value of non-performing loans in China rose from 1.2% of GDP in December 2014 to 1.9% a year later. . . .”

Specifics such as these betoken credibility. Yet they also invite questions. What does “private debt” mean? Which matters more: the 1.9%, or the 200%? What are the equivalent numbers for the other economies mentioned?

Let us start with the components of “debt” in China. First of all the only one which the bears seem not to want to mention: sovereign debt. This is estimated at 43% of GDP by the IMF on a gross basis for 2015. At the same time, however, China has huge sovereign reserves – about $3.2trn at the moment, again on IMF numbers, which is about 31% of 2015 GDP. With the country targeting a fiscal deficit of 3% this year and reserves trending downwards since 2014 it is true that the country’s sovereign debt position is deteriorating on a net as well as a gross basis but it should be obvious that it is nobody’s idea of a crisis. (UK sovereign debt was 88% of GDP on the same, gross basis in 2014, the eurozone’s over 90%, the USA’s over 100% and Japan’s approaching 250%.)

The “private debt” figure mentioned in the quote comprises a corporate (non bank) debt ratio of 165% and household ratio of 40%. That sounds a lot scarier than 43%. But it is not far off similar figures in other places. Only yesterday the Federal Reserve published America’s balance sheet for last year showing non-bank corporate and household debt of 74% and 82% respectively, making “private debt” of 156% altogether. Lump in sovereign and financial sector debts too and the total comes out at a cool $63.4trn, or 364% of US GDP. (The equivalent figure for China is 247%.)

The UK’s balance sheet comes out even worse than this on a broad basis due to the massively distorting impact from the financial sector. According to our own balance sheet, our total financial liabilities for 2014 came out at a nice, round £30trn, or about sixteen and a half times our GDP that year. Use net figures for the financial sector, however, and this plunges down to a much less startling 487% of output, of which a mere 349% is that “private debt”.

These sorts of numbers are esoteric territory, and not usually visited by relevant parties such as ratings companies. There are reasons for this. Vast swathes of the figures are prone to uncertainty and conceptual artificiality, for instance. We can look at government budgets, and bond yields, and arrive at a view on the sustainability of a country’s debt position. But what is the household sector surplus, or deficit?

Let us draw a line under these “private” or “total” debt to GDP arguments now and move on to non-performing loans. The banking system NPL ratio did rise from 1.5% to 1.6% in 2014 and will have risen further last year. The government is working on new measures to convert NPLs into equity stakes in struggling companies and one can read this bearishly. Whatever the final announcement and accompanying figures on this front, however, we do know that the required reserve ratio for major banks stands at 17% despite recent monetary loosening, up from 7.5% a decade ago. We must, as always, wait and see. The time bomb expected from Chinese trust investments two years ago failed to detonate, but bond defaults have been making headlines. Perhaps this time the country’s banking system, strongly capitalised as it is, will blow up in the face of an NPL crisis the government is already taking measures to manage.

The Chinese economy, like all economies, has its problems. And like the problems of other countries, some of these are local in nature. But in talking up a catastrophic debt burden where none really exists the bear case overreaches itself. There is enough out there to worry us in the real world – we do not have to look for phantoms.

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