China’s “Lehman Moment?”

Or Decades of Japan-Style Stagnation?

Last year, $674 billion fled China. This year through March, $175 billion did. The Institute of International Finance, in a report released today, estimated that $538 billion would flee China this year.

Reserves have plunged from $4 trillion in June 2014 to $3.2 trillion as of February. Much of it is illiquid and cannot be used to stabilize the currency. So the IIF said that capital flight could accelerate if Chinese investors fret that the yuan could fall in a “disorderly” manner.

This would have broader ramifications:

A sharp drop in the renminbi would likely spark a renewed sell-off of global risk assets and trigger a flight of portfolio capital from emerging markets.

Moreover, a sharp depreciation of the renminbi could lead to a round of competitive devaluation in other emerging markets, particularly in those with close trade linkages to China.

The report warned that an “important unknown” is the level of currency reserves that the Chinese government considers critical. If reserves drop below that level, authorities might either let the yuan fall sharply or tighten currency controls further, both of which would rattle markets around the world.

Add to this environment the growing fear of bond defaults by Chinese state-owned enterprises. Companies have extended large amounts of loans to each other, and defaults would ricochet through Corporate China.

To stimulate the languishing economy and to paper over the structural problems, overcapacity, over-indebtedness, and the mountain of non-performing loans after years of debt-fueled malinvestments, Chinese authorities decided to go on a historic credit binge.

In the first quarter, total domestic and foreign debt, according to calculations by the Financial Times, ballooned by 6.2 trillion yuan ($954 billion), the largest quarterly jump ever, to a record 163 trillion yuan ($25 trillion), or 237% of GDP.

Up from 148% of GDP in 2007. But hard numbers are hard to come by in China. The Financial Times: “Despite increasing attention to the risk from China’s rising debt, there is surprisingly little consensus over basic facts such as how much China actually owes.”

The Bank for International Settlement pegged China’s total indebtedness at 249%. McKinsey, in a report last year that included debt owed by financial institutions, figured China’s total debt as of mid-2014 at 282% of GDP. Others are even gloomier. The FT:

Rodney Jones, principal of Beijing-based Wigram Capital Advisors, provides Asia macro analysis to billionaire investor George Soros, who last week likened China’s economy to the subprime-saddled US before 2008. Mr. Jones says Chinese banks use investments in wealth management products to disguise corporate loans as financial debt. Based on a detailed analysis of financial statements by more than 100 banks, he estimates China’s debt-to-GDP ratio at 280% at the end of 2015.

“The financial engineers have run amok again. They’ve run amok in the US and they’ve run amok here. That’s what George sees,” says Mr. Jones.

So there’s no reliable number on China’s total debt. There isn’t even a reliable number on China’s GDP. If China’s widely pooh-poohed official GDP numbers are inflated, then the actual ratio of total debt to GDP is even worse.

What sets off alarm bells isn’t the total debt per se but the speed with which it has soared. The proceeds from this sudden boost in lending are impossible to invest in productive assets or activities, particularly in an environment of devastating overcapacity after years of government-fostered debt-fueled malinvestment.

When returns on these new investments curdle, China’s non-performing loan fiasco – whose actual size also remains shrouded in mystery – will become even more gigantic.

“Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth,” warned Ha Jiming, Goldman Sachs chief investment strategist.

At the moment, short-term stimulus – however ineffective or destructive over the longer term – is what matters to Chinese authorities who’re desperately trying to keep their elaborate construct from falling apart. The consequences?

Projections range from a “Lehman moment” with banks toppling and credit markets seizing to “a chronic, Japan-style malaise in which growth slows for years or even decades.” The Financial Times:

Jonathan Anderson, principal at Emerging Advisors Group, belongs to the first camp. He warns that banks driving the huge credit expansion since 2008 rely increasingly on volatile short-term funding through sales of high-yielding wealth management products, rather than stable deposits. As Lehman and Bear Stearns proved in 2008, this kind of funding can quickly evaporate when defaults rise and nerves fray.

“At the current rate of expansion, it is only a matter of time before some banks find themselves unable to fund all their assets safely,” Mr. Anderson wrote last month. “And at that point, a financial crisis is likely.”

Others believe the People’s Bank of China will retain its ability to ward off crisis. By flooding the banking system with cash, the PBoC can ensure that banks remain liquid, even if non-performing loans rise sharply. The greater risk from excess debt, they argue, is the Japan scenario: a “lost decade” of slow growth and deflation.

Michael Pettis, professor at Peking University’s Guanghua School of Management, says rising debt inflicts “financial distress costs” on borrowers, which lead to reduced growth long before actual default.

“It is wrong to assume that ‘too much debt’ is bad only if it causes a crisis, and this is a typical assumption made by almost every economist,” Prof Pettis wrote in a draft of an forthcoming paper shared with the Financial Times.

“The most obvious example is Japan after 1990. It had too much debt, all of which was domestic, and as a consequence its growth collapsed.”

No wonder Chinese authorities are obscuring vital economic data. Reality is too ugly to behold. Even a glimpse of it might precipitate a “Lehman Moment” or decades of Japan-style stagnation, the very conditions they’re desperately trying stave off.

The move of Chinese money into real estate in the US, Canada, Australia, and New Zealand has become legendary. More recently, Chinese companies, supported by state-owned banks, have pushed into global M&A, buying companies lock, stock, and barrel. At the same time, the Chinese have been dumping US stocks and bonds. What gives? Read… Who the Heck Is Buying the US Stocks that Chinese and other Foreign Investors Are Massively Dumping?

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  23 comments for “China’s “Lehman Moment?”

  1. Wolf Richter says:

    Just got a chance to read the free eBook, “Putting the Economic Puzzle Together,” that was linked here a few days ago. So here are a few comments.

    It’s truly free (and thus even cheaper than my own eBooks). You get in your inbox.

    60 pages. Easy, fast read. Informative, with some good charts.

    I’m not a fan of forecasts. And there are plenty of forecasts. So I could do without them. But I’m a big fan of the thought processes and data that go into forecasts.

    It seems the book was published in early 2015, so the forecasts for 2015 are dated. But that’s just a small part early on.

    Note the section on demographics impacting housing, stocks, etc. Good stuff.

    The section on gold gets into its relationship with inflation, deflation, the dollar, systemic risk…. Gold bulls might be disappointed.

    Sections on copper and other commodities. Oh, and oil. Nailed it!

    The dollar and its complexities on a global scale. Good info (I’ve written about some of it).

    It includes, “How to Profit from the Coming Housing Bust.” As you know, I’ve turned bearish on San Francisco housing recently. A few other cities are also seeing price declines. So we need to keep our eyes on it.

    And gems like, “Why Buy the Cash Cow When the Milk is Free?”

    I don’t agree with everything in the book, but I like reading things that don’t conform to my own ideas. Broadens my perspective. I think many of our readers will find the book useful. And since it’s free, I recommend it.

    You can get it here:

    • MC says:

      Are your books available through Kindle?

      • Wolf Richter says:

        Yes, both of them. I really recommend BIG LIKE (that’s how the Japanese have to say, “I love you” because they don’t have a word for “love” and they avoid pronouns because they’re too direct and impolite). You know Japan. I think you’ll enjoy it. Great story too. Non-fiction.

        Check the Amazon site in your country. They all should have it. If you need the links for a specific country, contact me by email.

        Thanks for your interest!

    • d says:

      The gem in that, is the 4 Macroeconomic cycles.

      Everything he writes levers off of them, if events disrupt them so they disrupt, all his projections.

      For some reason he has not joined them with the commodity or economic super-cycles, perhaps they do not intersect at his desired points.

      Something to look into.

  2. Chip Javert says:

    With an economy the size and as weird (socialist? Communist? Capitalist?) as China’s, I suppose there are an almost infinite variety of “what happens next” predictions.

    I lean toward the “begins to look like Japan” option: aging, declining population, have their own currency and own their own massive debt, lots of infrastructure stuff, declining productivity in most (but not all) industry, most of population detached from rest of world.

    However. this quickly bumps up against an aggressive Communist party. China will have to accommodate relatively wealthy coastal areas (20% population) and much less wealthy inland areas (80%). The population is about to stabilize at around 1.4-1.5B between now and 2050; average age is drastically increasing, workforce about to decrease. Jobs moving from China to lower cost countries.

    I’m not sure where all this goes, but I lean more toward stagnation than continued growth. They are running out of time to upgrade to a consumer economy.

    • d says:

      “They are running out of time to upgrade to a consumer economy.”

      With the TRUE levels of debt they have, they have RUN OUT.

      They stand more chance of morphing into a complete mafia state as they have been in the past, than an advanced consumer economy.

      The advantage they have over Japan, is that as a command controlled economy the central planners can still conduct many manipulations. Japan and other democracy’s, simply can not get away with.

      They can makethe bonds issued to banks by state company’s and Munis to cover NPLS (All of which are underwritten by the state and acceptable at the PBOC as loan collateral). simply disappear inside the PBOC.

      They can continue to under-declare the amount of currency in circulation by hundreds of trillions of $, as they continue to clandestinely physically print cash and pay their accounts with it.

      Weather they succeed in stealing all of the western Philippine sea and Borneo coast Maritime economic zones or not.

      Dont be surprised to see china slowly revert to a, sells an awful lot, buys very little made outside china, other than raw materials, nation again..

      Which slowly drives all foreign entity’s from its internal markets, whilst owning large shareholdings in many multinational corporates.

      Mafia State Russia has done, and is continuing to do, similar slowly.

      China has taken a HUGE , Financial, Infrastructure, and Technology, leap forward, at the expense of the rest of the planet.

      Dont expect anything positive to flow back to the rest of the planet from china. Historically in these situations with china, it never has.

      • chris hauser says:

        good observations. china is an awfully big country, with a lot of people. hard to impossible (how’s that for a waffle?) to know what’s going on in it.

        but i do know they are printing money, lots of it.

      • nick kelly says:

        And the advantage Japan has over China is that Japan makes high quality exports and is a price giver. China’s exports have a deserved reputation for low quality and is a price taker.

        • d says:

          Quality never goes out of style, problem being. a much smaller segment of consumers understand that these days.

          The,Vampire, American, Globalized, Corporates, and their chinese allies.

          Have the world hooked on “it only has to last five minutes as then it will be out of fashion. BUY BUY BUY” consume now fool.

          Once a generation is conditioned to that it is very hard to change.

    • Nicko says:

      Very difficult to foster an innovative consumer economy without democracy and freedom of speech. City states like UAE and Singapore have been successful….but a gigantic beast of a country like China? The odds are against them.

    • alexaisback says:

      This is all you need to know. Whether US Japan Yellen or Draghi China everyone is the same ( it only seems to drive the Germans a bit crazy )

      short-term stimulus – however ineffective or destructive over the longer term – is what matters

      short-term stimulus – however ineffective or destructive over the longer term – is what matters

      short-term stimulus – however ineffective or destructive over the longer term – is what matters

  3. Michael Francis says:

    I always wondered if Japan’s ‘Lost Decade’ would have been more of a ‘Lehmans Meltdown’ if it wasn’t for the West’s insatiable demand for Japanese cars, computers and electrical goods funded ponzi HELOC loans and cheap, easy credit.

    • d says:


      The lost decade came about as they used multiple forms of QE to stave off the “Lehmans Moment” Like spain and italy they built among other things, many unjustifiable bridges to Nowhere.

      I was there, a Business customer would ask a bank for 20 K to buy a new truck. they would asses him, then say no.

      10 days +- later a bank rep would call on the customer and offer a MUCH larger “property or business development loan” to extend buildings or buy new unneeded production machinery which would also leave enough to purchase a new truck or 3.

      A lot of small businesses took these loans and built or brought much they simply did not need. They could fund the interest it would take them DECADES to possibly fund the principle.

      Many of those loans went informally NPL and are still on the bank asset books.

      As time passes more of these issues are being resolved by Deceased Estate lawyers. Many of the loans included death cover policy’s. If the loan has not been formalized as an NPL, the death cover still applies.

      Japan is still the land of Zombie company’s and Banks.

      Both the Japanese and the chinese, can be very patient people.

      Inflation, will eventually come.

    • nick kelly says:

      You mean the West’s demand for quality affordable fuel efficient vehicles instead of the bloated Big Three crap that has bankrupted one of them twice and GM once.
      BTW: back out trucks from GM and you aren’t left with much.
      The (October?) 1987 Popular Mechanics did a comparison review of the Cadillac Brougham D’ Elegance ( barf) and the Lincoln Town Car.
      Describing them as ‘wretched excess on wheels’ it went on to note that the Lincoln had far better build- the Caddy at one place having two shims to make a door fit, hood gaps etc.
      Just one problem with the Lincoln: “even our professional drivers could not keep it in a straight line”
      Oh sure they’ve got better- what was the alternative?- but for value, low budget or high budget- buyers of Japanese cars are happier.
      As for all those chrome do-dads hanging off an Escalade…

  4. walter map says:

    Both. First the one, then the other. This isn’t a polarity or a duality. And not just China.

  5. Petunia says:

    While the west sees Japan as a democracy experiencing stagnation, I see it as a fascist state in occupation. Everything Japan, Inc. does conforms to their history, of the state and economy, being one. The west as usual sees everything through their own myopic lens, democracy, capitalism, free markets, global governance… While Japan is waiting out the occupation, as well as it can. They are conserving and protecting their financial infrastructure, currency, and culture, for the day when they can stop pretending. So far, they are doing a good job of it.

    • Nicko says:

      Actually, Japan has begun to relax their immigration rules to encourage population growth to offset the catastrophic aging problem. For all their faults, Japan is still one of the most successful, innovative countries ever.

    • d says:

      A segment of it is most defiantly as you describe.

      That segment is being empowered by the current, unnecessary, greedy arrogant, chinese, aggression, and attempted theft of resources. Belonging to, the Philippines, Borneo, and Indonesia..

      I would rather not see that segment return to power.

      It is really chinas decision.

    • Aussie & Harriet says:

      A collapsing fascist state in occupation by another collapsing fascist state.

  6. CENTURION says:

    I believe sometime in the 1300 and 1400 Century, merchants and bankers from all over Europe would meet at a annual Fair. There, they would get together and balance and cancel debts.

    If the Medici owed the Lombardi family 1,000 ducats, and the Lombardi Family owned the Duke of Naples 1,000 ducats and the Duke of Naples owed the Medici 1,000, then they just worked it out without ANY money.

    The Knights Templar served this purpose as Europe’s first International Banking and Trade house. Gold never moved, but rather, bills and letter’s of credit traveled all over the continent and Mediterranean to facilitate trade. After Friday the 13, around the year 1300 (?), when the Templar’s ships left Paris (the day before to America and Scotland…protected by the Sinclair Family), trade collapsed and the Muslims (Barbary Coast Raiders) destroyed the Mediterranean Trade.

    That is why Prince Henry of Portugal started the search Around Africa to India so as to avoid the Arabs (somethings never change).

    The State Owned Chinese entities should do the same thing.

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