To meet GDP demand of the Chinese Government, unproductive debt in China soared out of sight. Who will pay for the losses and cleanup?
Local Chinese Debt in Need of Bailout
The East is Read reports China’s Local Govt debt in 2020 was 50% Higher than WB, IMF Estimates. Undoubtedly, the situation is much worse today.
Local government debt in China amounted to 90 trillion yuan (12.49 trillion U.S. dollars) in 2020, 50% higher than the World Bank and IMF estimates, according to a recent study by Professor David Daokui Li and Zhang He of the Academic Center for Chinese Economic Practice and Thinking (ACCEPT), Tsinghua University.
Study Findings
- The rapid accumulation of infrastructure debt is the main reason for the rapid rise in the leverage ratio of local governments and the entire real economy.
- China’s local government debt demonstrates a nested structure, where local governments establish entities to secure loans, and these entities, in turn, leverage those borrowed funds to acquire further financing for their subsidiaries.
- Without central government intervention, local debt is unsustainable.
Michael Pettis Chimes In
1/9
The East is Read has just published a translation of an interesting recent speech by Tsinghua's Li Daokui. He makes four points that I think are especially important. Given his prominence, I think his lecture shows how views in China have changed.t.co/JI4xMGwNJy— Michael Pettis (@michaelxpettis) December 22, 2023
Michael Pettis 9 Comments
- The East is Read has just published a translation of an interesting recent speech by Tsinghua’s Li Daokui. He makes four points that I think are especially important. Given his prominence, I think his lecture shows how views in China have changed.
- The first point has to do with the sheer extent of local-government debt. Local government debt, he claims, has been seriously undercounted: “Our analysis revealed that in 2020, China’s local government debt approached 90 trillion yuan, equal to to 88% of GDP at that time.”
- He adds: “This estimate significantly surpasses those commonly cited by most scholars. For instance, the International Monetary Fund or the World Bank typically estimate it around 60 trillion yuan, or roughly 50% of GDP.”
- Second, he notes that infrastructure spending is by far the main source of debt. This has been obvious to some of us for many years, but I think this study may help force recognition that China’s infrastructure investment has been a bigger problem than property investment.
- The third interesting (to me) point he makes reinforces his second point: “without central government intervention, local debt is unsustainable.” Given that most debt went to fund infrastructure, if infrastructure spending had been productive, this could not be the case.
- The fourth point is that the “fundamental” reason for the surge in local government debt is “the prioritization of GDP growth by local governments, with a particular emphasis on short-term GDP gains.”
- I interpret this to mean that in recent years the purpose of infrastructure spending was not to accommodate the growth needs of the economy but rather to generate short-term economic activity. Again, some of us have been making this argument for a long time, but it hasn’t really been a formal part of Chinese macroeconomic thinking.
- I’ve long argued that because this was the year in which it became formally clear that local government debt was unsustainable, this was also the year that a consensus would begin to develop on the adverse impact of excessive spending on infrastructure.
- We have more to go before these views are consensus among policymakers, but I think it is becoming hard to find a Chinese economist who doesn’t recognize the relationship between unsustainable debt, unrecognized losses and infrastructure spending.
Overstated GDP
China hugely overstated GDP. Money went into useless projects that were used to meet artificial goals of 7 percent GDP.
China’s leadership set GDP goals and the local governments were forced to meet them.
The result was massive property bubbles that have now imploded and State Owned Enterprises (SOEs) that are worthless. The debt remains.
We have been discussing this since 2014. Reality has finally set in.
Strains in China’s Banking System; Avoiding the Fall
Flashback December 26, 2014: Pettis on Strains in China’s Banking System; Avoiding the Fall
Pettis provides a great deal of information about the transition of China’s growth, and expectations about that growth.
The four stages he sees are as follows.
Stage 1: The first period of liberalizing reforms under Deng Xiaoping
Stage 2: The investment growth period
Stage 3: The overinvestment period where “miracle” GDP growth was accompanied by a far greater expansion of debt to the point of saturation and malinvestment
Stage 4: The second period of liberalizing reforms under Xi Jinping
The ” liberalizing reforms under Xi Jinping” are now in reverse. Crackdowns are in vogue as Xi scrambles for ways to fix the mess. Criticism of the government is punished severely.
Michael Pettis Chimes in China’s Growth and Debt
Flashback November 22, 2020: Michael Pettis Chimes in China’s Growth and Debt
Beijing’s goal of doubling GDP by 2035 requires very rapid growth in debt, so much so that after a few years I am pretty sure they’ll quietly abandon that goal.
Pettis’ 2012 Bet With the Economist
The Economist made a bet with Pettis that China would overtake the US in GDP by 2018.
I found that laughable and so did Pettis.
The Dating Game: Michael Pettis Challenges The Economist to a Bet on China
Somehow my original post never migrated to my current blog, but here is my original GlobalEconomicAnalysis post The Dating Game: Michael Pettis Challenges The Economist to a Bet on China
The Economist paid off. Amusingly China is still not close and is headed in reverse.
In 2012, I commented “I wonder if the year 2030 is still far too optimistic from the standpoint of China.“
On the basis of alleged “Purchasing Power Parity” some tout China did pass the US. But comparing countries so dissimilar on a PPP basis is totally flawed.
The Myth China Passed the US in GDP
On August 8, 2023, I discussed Purchasing Power Parity Silliness and the Myth China Passed the US in GDP
Michael Pettis: “Adjusting GDP for differences in purchasing power makes a great deal of sense in certain cases, but the way it is done is so filled with problems that it is extremely difficult to find any economist who takes these measures very seriously.“
One ironic implication of course is that if China were to engage in an orgy of bad investment, it would get poorer (as more and more money goes to what in reality are expenses) while artificially boosting its GDP growth (as more and more expenses are converted into assets). This seems to have been what happened in 2009-10 and thereafter.
Unless you believe that the US fails to recognize losses on investments to anywhere near the same extent, if you really want to compare the two economies more usefully you would have to do at least two adjustments: you would have to adjust China’s GDP upwards for price differentials and also adjust it downwards for unrecorded losses.
My point is a lot smaller and a lot more precise. China and the US compile their GDP data implicitly in very different ways, among the most notable of which is the way Chinese lenders, banks as well as households, treat a substantial portion of the debt as if it were implicitly or explicitly guaranteed by central or local government agencies. This means investment losses don’t show up as losses (expenses) because it is politically difficult to do so, and are instead rolled over and so show up as assets.
Bonds of China’s Largest Property Developer Crash
On August 10, 2023 I noted Bonds of China’s Largest Property Developer Crash to 25 Percent of Notional Value.
In the above post, I mockingly equate GDP to “Grossly Distorted Procedures”
Grossly Distorted Procedures
I have picked on the US countless times over GDP calling it “Grossly Distorted Procedures”. Many have not read my past comments questioning US GDP.
But the property bubble in China is unlike anything else in the rest of the world. China has vacant malls, vacant airport, vacant entire cities. The State Owned Enterprises are all insolvent.
US corporations recognize losses when property goes under. China carries SOEs at book value.
The US drop bombs all over the world, making enemies in the process. What exactly is productive in that? Yet, government spending adds to GDP by definition.
However, no one will revise GDP lower. Not in the US, and certainly not in China.
The Secret Behind China’s Ghost Cities
Curiously, vacant, crumbling, uninhabited buildings are worth more than if someone tried to make them livable.
Rent would not come close to paying the mortgage and you would have unhappy tenants anyway.
How Does China Allocate the Losses?
Who pays to cleanup this mess is the big question at hand.
Most likely, future growth will be restrained, effectively hiding the losses over long periods of time. This will be difficult for China given its big demographic problem.
China is walking a tightrope. It needs to boost consumption.
Note that China has totally been reliant on SOEs, property bubbles, and export subsidies for growth.
So, in addition to allocating losses (or continually hiding them), what does China do for growth? That’s the second key question.
Silly BRICS Talk
Despite the above, people still think China will rule the world, the dollar will go to hell, and a BRICS-based currency led by China will soon rule the world.
Few bother to ask the key question: What Would it Take for a BRIC-Based Currency to Succeed?
China and the BRICS fail every condition needed to succeed as a trading replacement for the dollar.
However, if the measure of success is defined as limited use of a BRICS currency to avoid US sanctions, it can succeed. See the above link for discussion.