How China accumulated $28T in debt
businessinsider.com
businessinsider.com
For the government debt it isn't a huge issue because the Government can essentially decide not to pay itself back. But for public debt it means that the economy is held back. Imagine if the trillions of dollars corporations in the US are currently holding in "cash" was all going to paying off previous bond holders. That money would not be available for acquisitions or new investment. So those companies would grow slowly or not at all.
"Public debt" is another name for "Government debt"[0]. From the rest of your description, you means "debt owed by the non-government public", private debt, or "household debt" (which doesn't strictly include corporate debt like your example outlines).
The only money that I know is a) a metal coin and b) a contract. Now, the contract naturally deals with future expectations as does the stock market. The stock market, however, does not create money. It distributes money.
One problem that arises in this regard is making contracts about money (which is other contracts). When the expectations fail, the contracts fail and if the contract was used to create money, you now have a problem. The money supply ultimately shrinks and the contracts about money start to fail. This is usually the point where the government announces big spending programs to lessen the pain.
You may ask where does the government get that money?
There are two fundamentally different methods.
1) from people who accumulated money. They give it to the government and the government spends it. In turn the government needs more money to pay those people back.
Does the money supply increase this way? Kind of, but not really. It just helps to bring existing money back into circulation but does not create new money. It is therefore only a temporary fix. One day the government will stop paying those people back.
2) The government just creates new money. They can do this if they control the currency (sorry, Greece). The dangerous part about this is that it is so easy to create new money once the dam has been broken and this new money isn't backed up with value. When this goes out of hand it leads to hyperinflation (as in Germany 1920s) where the currency is devalued.
By having a really strong and reasonable government, you can force 1) at low cost and control 2) without going overboard. China might be in a position where they can do that for a long time.
Simple example: I borrow $50,000 from a bank to open a restaurant.
Lets split that into two bets:
First, I bet that from my future revenue, I'll be able to pay back the bank and keep operating my restaurant. So in my own time line if you will I am taking money I'll be earning from paying customers in the future and using it in the present to actually build my restaurant. The way I do this is with a bank.
Second, the bank kind of believes and kind of doesn't believe that I can pay it back. So it says "we'll take some money we have laying about and give it to you to open a restaurant, but you have to pay it all back to us in 10 years and every year we want an additional 7.2% from you. What that means is that after 10 years you will have paid them back double the amount of money you borrowed.
So I've taken $50,000 of my future revenue, and turned it into a monthly obligation to the bank of $834. So if I sell my pies for $8.34, the first 100 pies of every month end up having all that money going to the bank which loaned me the money. So in my "present" money is going to pay off my "past" borrowing. Had I not taken the loan that $834 would go right into my pocket.
In a Macro Economic sense, if you take on debt, and invest the capital represented by that debt to grow the economy, then in the future the larger economy, some of the GDP is going to servicing (or paying off) that debt rather than additional growth. If your economy cannot sustain that drag (debt service) then it tends to contract, which makes it even less able to support that drag. If you read George Soros he will tell you that any day now the entire world is going to implode in just that fashion :-).
The careful thing you have to watch out for is talking about "money" which everyone thinks of as bills and coins or balances in a bank account, and "GDP" which is essentially the "value" created by all of the economic activity in an economy. Governments try to manage their economy to grow its GDP, and because transactions in the economy are often (but not always!) transacted using the national currency, economic figures are often reported in terms of dollars or yuan or yen or what have you. But you have to remember that you can have an economy that doubles in size, the the size of the monetary denominational transactions might be the same, more (inflation), or less (deflation).
China is in the situation of trying to show the world a growing GDP (their economy). They have a spotty track record when it comes to how accurately they compute that :-) but fundamentally if they cannot actually grow it, then the debt they hold which they created in order to grow, will not be serviceable without shrinking the size of their economy. The traditional "fix" for that is that the exchange rate between economic value and currency changes so that the numbers match. China allows the Yuan to "inflate" to 10x its current value, and then services the debt with this inflated value.
But what that really means is you aren't selling enough pizzas so you start charging $834 per pizza and just by selling one a month you can meet your monthly debt payment. And the citizen says "Gee, remember when you could get a nice pizza for less than $10? I miss those days."
Another thing is unclear now:
> China allows the Yuan to "inflate" to 10x its current value, and then services the debt with this inflated value.
What do you mean with "allow to inflate"?
Inflation is growth of the amount of money == new debt needs to be created. How is this done? Who takes on new debt?
[1] We have an interesting (if not unprecedented) situation in the USA where low interest rates have resulted in capital accumulation at companies rather than investment, and stagnant wage growth. It is, at Tim Geitner once said, "The part of the economics textbook that hasn't been written yet." And while I got to experience the "unheard of" condition known as "stagflation" (a stagnant economy but high inflation" my kids get to experience this thing we're currently experiencing. If it turns into a deflationary spiral it will mean that things like real property prices will go down.
[2] Much of the housing bubble has been blamed not only on lowering standards for mortgages but also the lower costs of mortgages which means the same house can be priced higher and still be affordable by the target buyer.
One day, you get a pay cut of 20%, and you choose to stay in your job.
You don't have enough income to cover your expenses. So you make a deal with yourself to borrow from your retirement fund, at 5% interest. You tell yourself you will pay it back eventually.
Month after month, you borrow from your retirement fund, which dwindles slowly.
Your retirement fund's balance sheet looks fine, because you're still accumulating assets, like the loan it made to you, which is growing in value by 5% per year.
You are also accruing a lot of debt to yourself, in the meantime.
One day, you find yourself having so much debt to yourself, you can't service the 5% interest rate.
That's when you face the music and realise you've spent all your capital away.
That's what "Taking money from the future" means.
That's what's happening when a country lends lots of money to itself, and eventually has a debt problem.
It's also what's happening when Social Security is "investing" in government bonds, investing in a government that's never repaying it's loans.
Where did that spent capital go in China? Concrete buildings.
5% turns out to be too much -> you lower it to 4%. You simply legislate this.
You loan more. Until 4% is too much as well ...
4% too much ... 3% ... 2% ... 1.5%
Once you go below a reasonable chance of non-repayment (countries have survived on average ~60 years, because a lot were "interrupted" or ... during WWII and a lot of debt was "forgiven" at the point of a gun)
Now you're a country ... so you legislate that people loan you money, making it sound vaguely reasonable by saying that's what they're paying for FDIC insurance (or equivalent, in Europe). Of course you don't have the money, nor the ability to borrow the money, that you'd need to actually satisfy a "real" FDIC incident (one component of "too big to fail" banks).
The banks realize that you've done this, so what do they do ? They borrow massive amounts of money to one another. Why does this help ? Well it guarantees that anyone who's done this borrowing of large amounts of money can't be thrown under the bus. Why not ? Because if one of them goes down, it will take down others (by not repaying the loan). So the government is forced to save even the ones where the FDIC reserves might actually suffice. Also, you pay out this loan to your shareholders and management (to yourself, essentially).
1.5% ... 1% ... 0.5%
The banks are losing money, because they can't convince investors their loans are probably backed. But you're a government ... you simply legislate that these companies that loan you lots of money exist, and you save them. And then they take more risk, and more risk, and fuck up, and get bailed out, and take yet more risk, maybe get bailed out a bit more. Your interest rate devaluations let you borrow more, but you have to use it to save the "too big to fail" banks/companies.
Note that the government is not innocent in the risk taking : because the government is effectively taxing loans (by making sure they can't get a proper risk premium, and have to loan to the government -> other parts of the bank need to make enough profit to make up).
And of course you're still borrowing money for the reasons you started to borrow money.
0.5 ... 0.25 ... 0 ... -0.05 ... -0.3%
Now you're having the problem that these banks are bleeding money - fast. And they can't charge their customers, because they can simply withdraw money and keep it in their mattress.
So you ... well this is where we are today ... what's next ? Outlawing cash, gold, a lot of types of stock, and directly taxing all bank deposits is the obvious answer. And the only other option is to lower global government expenses by ~12%. Essentially a wealth tax.
There is of course another option: if they don't make a choice there is one other solution : having 10%+ inflation in Europe and America. All mortgages at 15% for a year or two and just deal with the miser that'll cause. This is what will happen "by default": if the central banks fail to agree on a course of action.
- Debt owed by Chinese citizens?
- Debt owed by companies headquartered in China?
- Debt owed by the Chinese Govt?
What about a Chinese multinational that has offices all over the world, and has incurred debt all over the world? Is all their debt considered as Chinese debt?
[1] http://www.economist.com/news/business-and-finance/21679341-...
* Who owes to whom?
* In what currency?
* How could it be enforced?
If China is in debt to China in Chinese currency the Chinese state has very good leverage to handle the situation. It could even make the debt disappear.
The central government could:
1) Transfer the debt to itself (a bailout) this leaves the central government with a very high (although sustainable) debt load but doesn't address any of the underlying problems.
2) Inflate the debt away. This doesn't address any of the underlying problems but it also impoverishes a lot of people who thought they were doing well. It also increases capital flight pressure.
3) "Stress test" the banks, requiring loans in arrears be paid, bad loans be written off, stopping the process of sending good money after bad. This is the only move that address the underlying problems, but it means the banks collapse (because they're already insolvent), the SOEs go bust, plus the problem of insolvent local governments would have to be addressed; people lose their old age pensions, massive unemployment. Plus most of the PRC's members wealth is in SOEs so this will affect them personally. Also the government will have to recapitalize the banks if it wants a financial sector at all (see option 2).
4) Claiming to do 3 while actually doing a combination of 1 and 2. This is probably what they will do and if they succeed, at the end of the day, the can will be a little further down the road.
5) Do nothing about the problem while attempting to hide as much as possible, silencing any whistle-blowers or sources of accurate information.
1: http://www.bloomberg.com/news/articles/2015-10-18/china-s-se...
I don't know about the dynamics of this selloff. It's very hard to argue without seeing the whole picture but it indicates that _something_ is going on.
I have a number of friends there who are entrepreneurs/small business owners in China. Over the past few years, they have regularly been "asked" by local government to pre-pay the current year's taxes. One friend has now pre-paid three years' worth of tax after successive approaches by tax authorities. (The conversation went like this: "We need you to pre-pay this year's taxes." "But I already did." "Then you can pre-pay for the coming year.")
Interestingly, the U.S. outlook is brighter today than China's, in contrast with a mere couple of years ago when China looked destined to be the dominant economy.
There are a couple of reasons why. The U.S. has enormous energy reserves and will in the long run emerge as the major energy exporter in the world, helping reverse the perennial balance of trade deficit to a surplus, potentially $500 billion to a trillion annually.
Also, Chinese wages are rising even as manufacturing technologies such as 3-D printing and other software-driven approaches are helping bring factories back to the West. The Chinese model of cheap outsourcing is just about tapped out or will be in the next ten years.
A lot of it is news hype. Disaster sells stories, a "2% decrease in growth" doesn't. The US wasn't doing badly a few years ago, and China isn't doing all that badly now.
Something to remember when the hype and stories come up in the next few years. We'll all muddle through, just like we always do.
For comparison, the US is at a debt to GDP ratio of 270+%.
The public + private US debt/gdp ratio is ~270%.
https://en.wikipedia.org/wiki/Financial_position_of_the_Unit...
From what I understand (something may be getting lost in translation)
- The increasing debt is being used to keep up growth
- The growth that is being bought by the debt isn't enough to service the debt
- Some sector of the economy will have to pay for it, because growth will wither until it is paid.
Quoting: China is also constrained from reducing the debt burden though monetization, financial repression, or taxes on households because in each case the cost is indirectly allocated to the household sector, which simply exacerbates the original imbalance. This leaves only two alternatives. First, Beijing can expropriate the wealth of small and medium enterprises directly or indirectly (in the latter case by raising taxes), although this means undermining the most productive part of the Chinese economy. Second, Beijing can liquidate government assets and use the proceeds to pay down debt. There are no other plausible options.
edit:
also: the process of deciding who gets forced to bear the debt will be highly politicized and contentious. The blog post explains how there are strong negative consequences to each choice.
https://en.wikipedia.org/wiki/Financial_position_of_the_Unit...
"The financial position of the United States includes assets of at least $269.6 trillion (1576% of GDP) and debts of $145.8 trillion (852% of GDP) to produce a net worth of at least $123.8 trillion (723% of GDP) as of Q1 2014."
Prices would literally go up two or three times a day. If you had Zimbabwe dollars, you would try to get rid of them as fast as possible, either by exchanging them on the black market, or by buying something. If you waited until the next day, you would lose a lot of money.
Moderate amounts of inflation (Under 10%), on the other hand, has worked 'fine' for the better part of a century.
Short term, the Chinese stock market will continue to fall - it's still incredibly overvalued from the bubble. US and European stocks should continue to be slightly affected. Anyone with a clue has already priced the Chinese effect into stock prices.
Short and mid term, any money that can will continue to attempt to escape China. Land/Houses/Industries in popular areas may be a little overvalued in the popular places in the US and Europe.
As services and particularly technological services become more important and create more value, the value of land proximate to these activities will continue to increase, because the business depends on talent, and network power i.e. relationships with other individuals (which require proximity). As for interest rates, I forecast they stay low for decades as inflation will remain suppressed.
There could be several cyclical downturns along the way but I can't see any way land values in the Bay Area don't appreciate at an annual rate greater than national CPI ~30 years from now.
Facing an economic crisis, Japan's ruling corporate cabal, led by Yamata, decides to take military action against the U.S. Along with covert support from China and India, they plot to curtail the American presence in the Pacific and re-establish the Greater East Asia Co-Prosperity Sphere.
China still holds large amounts of US debt. Refinancing US debt might become problematic if the Chinese need to stop lending.
I just read that house prices in Sydney, Australia are dropping month by month for the first time in very very long time.
Probably more things if you look around a bit.
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I don't think we will see the growth rates in China drop below 5% as the growth is very different from what we have in the west. Essentially it is the rapid modernisation of an economy via strict central governance.
Think about it. Why would the GDP pr person in China be much different from the GDP pr person in Taiwan?
China will continue to have "supernatural" growth for the next many years.
I guess the second headline answers the first headline's question.
So is this referring to debt that America owes China?
That's unlikely to happen in China's case - but we're in novel territory politically and economically, so I think it's impossible for anyone to guess how it will play out.
They don't go around demanding that the interest and the principal on a bond due 20 years from now gets paid tomorrow.
What they can do is start selling the debts they own for cash on the open market.
A holder of government debt can have much sharper knives than a loan shark.
Or, they can threaten to nuke South Korea if you don't send them food.
As it's not ran by people with the financial and diplomatic acumen of either the Tea Party, or the Kim family, China's not likely to do either.
Actually, the difference you point to is really with a government holder of debt (regardless of whether the debt is government debt), not with a holder of government debt.