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Title: China’s Monumental Debt Trap—-Why It Will Rock The Global Economy
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Contra Corner
URL Source: http://davidstockmanscontracorner.c ... -will-rock-the-global-economy/
Published: Feb 8, 2015
Author: David Stockman
Post Date: 2015-02-08 12:09:11 by nativist nationalist
Keywords: None
Views: 361
Comments: 1
Bloomberg News finally did something useful this morning by publishing some startling graphs from McKinsey’s latest update on the worldwide debt tsunami. If you don’t mind a tad of rounding, the planetary debt total now stands at $200 trillion compared to world GDP of just $70 trillion. Source: McKinsey The implied 2.9X global leverage ratio is daunting in itself. But now would be an excellent time to recall the lessons of Greece because the true implications are far more ominous. Today’s raging crisis in Greece was hidden from view for many years in the run-up to its first EU bailout in 2010 because the denominator of its reported leverage ratio—national income or GDP—–was artificially inflated by the debt fueled boom underway in its economy. In other words, it was caught in a feedback loop. The more it borrowed to finance government deficit spending and business investment, whether profitable or not, the more its Keynesian macro metrics—-that is, GDP accounts based on spending, not real wealth—-registered a falsely rising level of prosperity and capacity to carry its ballooning debt. Five years later, of course, the picture is much different. Greece’s GDP has now shrunk by more than 25%. The abysmal picture depicted in the graph below explains what really happened. Namely, that the bloated denominator of GDP came crashing back to earth, exposing that Greece’s true leverage was dramatically higher than the 100% ratio reported in the years before the crisis. In economic terms, the graph below simply documents how the false prosperity from Greece’s hand-over-fist borrowing binge was purged from the GDP accounts after the debt party came to a halt in 2009. Needless to say, the reason the Greek story is so relevant is that this condition is nearly universal, meaning that the 2.9X leverage ratio for the global economy pictured above is also drastically understated. The fact is, since 2010 Greece’s total debts outstanding have risen only modestly. The reason that the debt-to-GDP ratio shown below has gone parabolic is that Greece’s phony boom time GDP has been sharply deflated. To be sure, today’s Keynesian pettifoggers insist these pictures reflect a big policy mistake. Namely, that the consequence of “austerity” policies forced on Greece by the Germans was the evisceration of its “aggregate demand” and therefore an unnecessary intensification of its debt burden. By allegedly causing Greece’s GDP to fall, austerity policies forced its leverage ratio to keep rising—-even after a lid was placed on its borrowing. That contention is not just baloney; its a stark example of the incendiary circular logic by which the Keynesian apparatchiks of the world’s governing class and their fellow travelers on Wall Street are pushing the global economy and financial system to the brink of disaster. Put a ruler from the beginning to the end of the graph above, and you get a doubling of nominal GDP and a 14-year CAGR of 5.5%. That’s probably more nominal growth than could reasonably have been expected from the Greek economy at the turn of the century—–given the debilitating inefficiency and corruption of its long standing crony capitalist oligarchy and Athens’ devotion to mercantilist waste, bloated state payrolls and unaffordable welfare state pensions, among countless other economic sins. Accordingly, the huge bulge in reported GDP from 2001-2009—reflecting a 13% annual gain—–did not even remotely reflect sustainable output growth; its was merely the feedback loop of exuberant debt financed spending that had not been earned by new inputs of labor, productivity and entrepreneurial activity. Accordingly, the big hump of GDP recorded during the pre-crisis boom was phantom GDP; it was not remotely sustainable, and it most surely does not represent “aggregate demand” lost owing to “austerity” policies. Instead, the subsequent deflation merely tracks the permanent evaporation of public and private spending that could not be supported by current production and income. The truth of the matter is that production and income come first. “Spending” or GDP growth can only exceed production growth when leverage ratios are rising. Indeed, the very concept of “aggregate demand” is nothing more than an academician’s word trick. It has no substance beyond the sum of changes in production and changes in leverage. Consequently, when Keynesian economists jabber about “stimulating” or “recovering” putatively lost “aggregate demand” they are talking about an economic unicorn. Aggregate demand can only be accelerated beyond production by new borrowing, and that can’t happen when balance sheets are tapped out. Needless to say, Greece is only the poster child. The McKinsey numbers above suggest that “peak debt” is becoming a universal condition, and that today’s Keynesian central bankers and policy apparatchiks are only pushing on a giant and dangerous global string. Moreover, bad as this is, its only half the story. Not only do unsustainable debt booms eventually stop, as depicted in Greece GDP accounts above, but they also generate enormous deformations and malinvestments while they are inflating. That is, they cause economic waste in the form of capital investments which are latter written down or abandoned because they do not produce sufficient returns to cover their front-end financing cost; and they also result in the allocation of labor to activities and occupations that disappear when the debt boom ends, generating unemployment and skill redundancy that lowers output and efficiency. In Greece’s case, its debt binge got up a full head of steam at the time of the 2004 Summer Olympics in Athens. I was there that summer and marveled at the skyline of construction cranes, the oppressive din of jackhammers and the bustling constructions sites that were so numerous and expansive that traffic had virtually ground to a halt. The Greek government spent something like $15 billion on the Olympics, but that was just the tip of the iceberg. With cheap euro denominated debt literally falling from the northern skies of the French and German banking system, there was no end to the commercial construction of hotels, retail, offices and apartments designed to feed on the alleged multiplier effect of the Olympics and the belief that they were a catalyst for permanent growth. Below is an epigrammatic picture of the 2004 Olympics boom today. In a narrow sense, the whole boom was a debt fueled national vanity project that is not atypical of these promotional event schemes. But it illustrates a crucial point that has universal application in today’s global financial Ponzi. Namely, that the value of assets generated during the debt boom can shrink drastically or disappear entirely after the party ends if they do not produce useful services and a commensurate cash flow. By contrast, the debt is fixed and contractual until its is written off and holders of the paper take a current loss. Upon that liquidation event, of course, balance sheets shrink and paper wealth evaporates. That’s why debt booms are inherently and ultimately deflationary. Needless to say, the abandoned multi-million dollar Athens stadium pictured below is worth nothing, yet the debt which funded it has not been liquidated. It still hangs somewhere in financial hyperspace—- having been transferred by the EU superstate politicians and bureaucrats from the accounts of the banks or bond investors which originated the funding to Greece’s make pretend IOU accounts at the IMF and EU. Call this financial constipation—-the end result of the current global game of “extend and pretend”. It amounts to a financial Ponzi in which current debt is serviced with more debt, and in which the unsustainability of the entire edifice is obfuscated by the zero interest rate policies and massive debt buying campaigns of the world’s central banks. When bad debts are not liquidated—– we already know that you get a Greece calamity with $350 billion of debt that cannot possibly be serviced or repaid by its now ruptured economy. But what will only become evident with time is that the entire global economy is not too far behind. It is now burdened with $200 trillion in debt, but owing to debt-bloated GDP, its true leverage ratio, like that of Greece in 2009, is far higher than the 2.9X computed in the McKinsey charts above. So now we get to ground zero of the global Ponzi. That is the monumental pile of construction and debt that is otherwise known on Wall Street as the miracle of “red capitalism”. In truth, however, China is not an economic miracle at all; its just a case of the above abandoned Athens stadium writ large. The McKinsey graph on China tells it all. For the moment, forget about leverage ratios, debt carrying capacity and all the other fancy economic metrics. Does it seem likely that a country which is still run by a communist dictatorship and which was on the verge of mass starvation and utter impoverishment only 35 years ago could have prudently increased its outstanding total debt (public and private) from $2 trillion to $28 trillion or by 14X in the short span of 14 years? And especially when half of this period encompassed what is held to be the greatest global financial crisis of modern times And don’t forget that most of this staggering sum of debt was issued by a “banking” system (and its shadow banking affiliates) which is bereft of any and every known mechanism of financial discipline and market constraints on risk and credit extension. In effect, it is simply a vast pyramidal appendage of the Chinese state in which credit is conjured from thin air by the trillions, and then cascaded in plans and quotas down through regions, counties, cities and towns. When it reaches its end destination it finances the building of anything that local politicians, bureaucrats and red capitalists can dream up. That includes factories, roads, ports, subways, bridges, airports, malls, apartments and all the rest of the construction projects being undertaken on Beijing’s Noah’s ark. Undoubtedly, the plentitude of ghost cities, malls, apartment buildings and factories that are everywhere now evident in China do not look much different than Greece’s Olympic stadiums did circa 2006—-that is, gleaming but silent. It will take another decade for the weeds to spring up and the rust and decay to become visible. So it might be a good time to get a grip on the China Ponzi. There is virtually not a single honest price in the entire $28 trillion tower of debt shown below. When loans to coal mine operators got in trouble, for example, the so-called “bankers” at the big state banks simply invited their clients in the side door where they paid back the “bank” with a trust loan at 18% interest—-which “loan” was then resold to bank customers at 12%. Hence, no NPLs and no need for new loss provisions. Indeed, China’s big state banks book billions of profits each quarter—notwithstanding the absurd extent of the nation’s credit pyramid. Likewise, how did the local party cadres use the loans that cascaded down the system to their town? Why they established non-governmental development agencies—thousands of them—- that paid hugely inflated prices for city lands in order to build empty luxury apartments and zoos that are bereft of both people and animals. Meanwhile, local governments run huge GDP enhancing budgets that are funded by the false revenue of hyper-bloated land sales. The skunk in the woodpile is self evident even in the simplified chart below. At least prior to the 2008 crisis, it could be said that part of the China boom was being financed by the Fed and other DM central banks which enabled their domestic consumers to borrow themselves silly, thereby fueling the China export boom. That’s pretty much over in terms of growth owing to the tepid recoveries and outright economic stagnation in the US, Europe and Japan. But never mind. The aging black-haired men who learned their economics from the Mao’s Little Red Book had a solution. They would lift GDP and jobs by their own bootstraps, dispensing virtually unlimited credit to build public pyramids, otherwise known as infrastructure, at rates not seen since the Egyptian pharaohs. Thus, since the eve of the crisis in 2007, China’s GDP has doubled, expanding by $5 trillion in 7 years. But as shown below, it took a $21 trillion expansion of debt outstanding to accomplish that outcome. That’s right. The China Ponzi took on $4 of debt for every new dollar of freshly constructed GDP. And “constructed” is exactly the correct term because all of this new debt funded a orgy of construction—-much of which is for public facilities that will never produce enough user revenues to service the debt or which are essentially owned by local governments which have no tax revenue. Source: McKinsey In any event, China’s $10 trillion of GDP is exactly at the Greek bulge stage. Its not replicable and sustainable unless the bosses in Beijing truly do intend to pave the entire country. In fact, the Chinese economy is addicted to construction, and its rulers can’t seem to let go—-even as they recognize they are heading straight toward the wall. At the present time, nearly 50% of GDP is accounted for by fixed asset investment—–that is, housing, commercial real estate, industry and public infrastructure. This ratio is so far off the historical and comparative charts as to be in a freakish class all of its own. Even during the peak “take-off” phase of economic development in Japan and South Korea this ratio never exceeded 30% and did not dwell there for long, either. So China is caught in a monumental debt trap. Its rulers fear social upheaval unless they keep pumping GDP—and the associated rise of jobs, incomes and financial asset values—-with more credit and construction. Even then, they know better and have therefore hop-scotched from credit restraint to credit curtailment almost on alternate days of the week. But now the edifice is beginning to roll over. Housing prices are falling and new footage put under construction has dropped by 30% over the last three months—something which has not even remotely happened during the last 15 years. At the same time, the consequent cooling of demand for construction materials and equipment is evident in China’s faltering industrial production numbers and the global commodity deflation that has resulted from its vast excess capacity in steel, shipbuilding, cement, aluminum, copper fabrication and all the rest. The excruciating debt trap in China was addressed recently by the redoubtable Ambrose Evans-Pritchard of the Telegraph, who has never seen a deflation crisis that he believed could not be relieved by the central bank’s printing press. But in the case of China, even he has thrown in the towel: China is trapped. The Communist authorities have discovered, like the Japanese in the early 1990s and the US in the inter-war years, that they cannot deflate a credit bubble safely…… China faces a Morton’s Fork. Li Keqiang has made it his life’s mission to stop his country drifting into the middle income trap. He says himself that the investment-led model of past 30 years is obsolete. The low-hanging fruit of catch-up growth has been picked. For two years he has been trying to tame the state’s industrial behemoths, and trying to wean the economy off credit. Yet virtuous intent has run into cold reality. It cannot be done. China passed the point of no return five years ago. Needless to say, this stunning conclusion from one of the world’s greatest and most erudite believes in the power of money printing has enormous implications for the global economy and financial system. It means that China is the New Greece—-but one sporting 40X more GDP and 70X more debt. Indeed, last year China spent upwards of $5 trillion on fixed asset investment—-a figure that is greater than the sum total for Europe and the US combined. Behind that towering number is an immense caravan of cement, structural steel, glass, copper and all the rest of the industrial commodities. So when the China Ponzi finally crashes, the deflationary gales will propagate violently through the global economy and financial system. China’s $28 trillion tower of debt will come tumbling down in the process; and a world floating on $200 trillion of the stuff will not be far behind.By Ambrose Evans-Pritchard
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#1. To: nativist nationalist (#0)
(Edited)
It may "rock" parts of the global economy, but I doubt that it will disturb China. Maybe the Chinese know something we don't or are reluctant to examine. It seems odd that we can talk about our economy, when we don't have one. For 70 years we have produced little but spoiled kids with loud evasive ignorant mouths and prestigious contentless high-sounding college degrees who never grow up. And don't forget that one of our biggest and most influential industries in this country is politics. Every third person in this country is running for political office. The most successful of the useless political assholes have been our last four presidents none of whom have done a honest day's work in their life and have done nothing but talk flowery empty words.
China’s Monumental Debt Trap—-Why It Will Rock The Global Economy
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