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China's Massive Debt Problem

Walter Russell Mead

Faced with fixing an economy saddled with trillions of dollars of bad loans, China’s policymakers are like “deer in the headlights”, according to one analyst. Dealbook:

China’s financial sector will have loans and other financial assets of $30 trillion at the end of this year, up from $9 trillion seven years ago, said Charlene Chu, an analyst in Hong Kong for Autonomous Research.

“The world has never seen credit growth of this magnitude over a such short time,” she said in an email. “We believe it has directly or indirectly impacted nearly every asset price in the world, which is why the market is so jittery about the idea that credit problems in China could unravel.”

Headline figures for bad loans in China most likely do not capture the size of the problem, analysts say. In her analysis, Ms. Chu estimates that at the end of 2016, as much as 22 percent of the Chinese financial system’s loans and assets will be “nonperforming,” a banking industry term used to describe when a borrower has fallen behind on payments or is stressed in ways that make full repayment unlikely. In dollar terms, that works out to $6.6 trillion of troubled loans and assets.

The huge credit surge was, in part, an attempt by Chinese authorities to keep the old economic model working and growth numbers from falling. The housing bubble and manufacturing and infrastructure bubbles in China were enabled and facilitated by a financial bubble, one of the greatest in the history of the world.

We’re likely to see an unusually high volume of losses: many of these loans were for poorly-conceived, often politically-directed projects that would have struggled to break even if the boom had continued. In a more hostile economic environment, the empty apartment towers, the bridges to nowhere, the state-owned enterprises that exist mainly to keep workers of the unemployment lines (and managers well paid), will not generate enough income to service their debts.

For decades, banks in China haven’t really had to worry very much about whether their loans were smart business decisions. With economic growth at ten percent, even spectacularly stupid investments could break even most of the time—and the government was always there to help one way or another. Now the going is tougher, and the financial industry doesn’t have a lot of experience with bad times.

When Japan went from world-beating whiz kid to economic basket case, Japanese banks suffered badly. They too had loaned too much money to low quality projects, assuming that permanent economic growth and a benevolent government would keep them out of trouble. It’s not possible to say that China is on the Japan path yet: China’s boom was epochal and its bust is going to be complicated and in many respects unique—when and if it comes. But China doesn’t have to stagnate completely for it to cause itself, and the world, a lot of pain.

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