China's historical debt binge

September 2008, pre-Lehman Brothers bankruptcy

In September 2008, China's economy was slowing.   The Shanghai stock market had just crashed.  Property prices were weak.  The Chinese officials said China was entering the middle-income rank of nations, so it was time for it to slow down as previous Asian miracle economies, like Japan, South Korea and Taiwan, had.  They talked about cutting back on investment, downsizing large state companies and letting the market allocate credit, which at this point was not growing faster than the economy.  Between 2003 and 2008, credit had held steady at about 10% of GDP.

October 2008, post Lehman Brothers bankruptcy

Lehman Brothers filed for bankruptcy in the US and global markets went into a tail-spin.  Demand collapsed in the US and Europe, crushing export growth in China, where leaders panicked.

By October 2008, the Chinese government had reversed course, redoubling its commitment to the old investment -led growth model, this time by fueling the engine with debt.   From 2008 through 2018, total debts would increase by $80 trillion worldwide, as countries fought off the effects of the financial crisis, but of that total, $35 trillion, or nearly half, was racked up by China alone.

August 2009

By August 2009, the Chinese government had launched an aggressive spending and lending program that kept China's GDP growth above 8%, while the US and Europe were in recession.  That steadily high GDP growth had convinced many Chinese that their government could produce any growth rate it wanted.

Bank regulators were the only officials who expressed alarm and their main concern was increasingly reckless lending in the private sector.  "Shadow banks" had started to appear, selling credit products with yields that were too high to be true.  

2013

By 2013, shadow banks accounted for half of the trillions of dollars in new yearly credit flows in China.  When Beijing began to limit borrowing by local governments, local authorities set up shell companies to borrow from shadow banks.  Soon these "local government funding vehicles" became the biggest debtors in the shadow banking system.

As the flow of debt accelerated, more lending went to wasteful projects.  By some estimates, 10% of the firms on the mainland stock exchange were "zombie companies." kept alive by government loans.  The state doled out loans to incompetent and failing borrowers.

• Lending started to flow into real estate

Much of the lending started to flow into real estate, the worst target for investment binges.  Easy loans spurred the sale of about 800 million square feet of real estate in 2010, more than in all other market so the world combined.  In big cities, prices were rising at 20% to 30% a year.

Caught up in the excitement, banks stopped looking at whether borrowers had income and started lending on collateral - often property.  This "collateralized lending" works only as long as borrowers short on income can keep making loan payments by borrowing against the rising price of their property.  By 2013, a third of the new loans in China were gong to pay off old loans.  In October 2013, Bank of China chairman warned that shadow banking resembled a "Ponzi scheme," with more and more loans based on "empty real estate."

• At the March 2013 party congress, Li Keqiang came in as prime minister.  

He was one of the Chinese leaders who appeared to accept the reality that a maturing economy needed to slow down, which would allow him to restrain the credit boom.  Yet every time the economy showed signs of slowing, the government would reopen the credit spigot to revive it.

• Dubious creditors grew

The cast of dubious creditors grew increasingly flaky, including coal and steel companies with no experience in finance, guaranteeing billions of dollars in IOUs issued by their clients and partners.  

2014: Chinese urged to buy stocks

By 2014, lending entrepreneurs were shifting their sights from property to new markets - including the stock market.

Even the state-controlled media jumped in the game, urging ordinary Chinese to buy stocks for patriotic reasons.  Their hope was to create a steady bull market and provide debt-laden state companies with a new source of funding.  Instead they got one of the biggest stock bubbles in history.

There are 4 basic signs of a stock bubble:  

• high levels of borrowing for stock purchases; 
• prices rising at a pace that can't be justified by the underlying rate of economic growth; 
• overtrading by retail investors and 
• exorbitant valuation.  

June 2015, Shanghai market started to crash

By April 2015, when the state-run People's Daily crowed that the good times were "just beginning,"  The Shanghai market had reached the extreme end of all four bubble metrics, which is rare.

The amount that Chinese investors borrowed to buy stock had set a world record, equal to 9% of the total value of tradable stocks.  Stock prices were up 70% in just 6 months, despite slowing growth in the economy.  On some days, more stock was changing hands in China than in all other stock markets combined.  In June 2015, the market started to crash and it continued to crash despite government orders to investors not to sell.

[Comments:

This credit binge had some characteristics unique to China's state-run system, including the borrowing by local government fronts and the Communist propaganda cheering on a capitalist bubble.  But its fundamental dynamics were typical of debt mania.  It began with private players, who assume the government would not let them fail, and devolved into a game of whack-a-mole.  As the government fitfully tried to contain the mania, more and more dubious lenders and borrowers got in the game, blowing bubbles in stocks and real estate.  The quality of credit deteriorated sharply, into collateralized loans and IOUs.  These are all important mania warning signals.

The most important sign was, as ever, private credit growing much faster than the economy.   After holding steady before 2008, the debt burden exploded over the next 5 years, increasing by 74 % points as a share of GDP.  This was the largest credit boom ever recorded int he emerging world (though Ireland and Spain have outdone it in the developed world).]

By mid 2019

By mid-2019 China had, in fact, seen economic growth slow by nearly half, from double digits to 6%, right in line with previous extreme binges.  To date then, no country has escaped this rule:  a five-year increase in the ratio of private credit to GDP that is more than 40% points has always led to a sharp slowdown in economic growth.

[Comments:

China did however, dodge the less consistent threat of a financial crisis, aided by some unexpected strengths.  One was the dazzling boom in its tech sector, without which the economy would have slowed much more dramatically.  Another was the fact that Chinese borrowers were in debt mainly to Chinese lenders and in many cases the state owned bother parties to the loan.  In short, /China was well positioned to forgive or roll over its own debts.  And with strong export income, vast foreign exchange reserves, strong domestic savings and still ample bank deposits, it has managed to avert the financial crisis that often accompanies large, debt driven economic slowdowns.]