China’s credit bubble is one of the largest the world has ever seen. This is true not only of its total size, but also in relation to GDP.
The history of credit bubbles is very clear about what happens next. Anyone who has followed the US subprime lending disaster will know the script already. But the blog worries that too few companies seem to be learning from history, and making the necessary contingency plans.
The great analyst of credit bubbles is Hyman Minsky. We described his insights in Chapter 2 of ‘Boom, Gloom and the New Normal’:
• Long periods of stability lead to complacency
• Lenders no longer check whether borrowers can repay the loan
• They are instead convinced that capital values will always rise
• They therefore believe foreclosed assets can be sold at a profit
China is now going through the late stages of this cycle. The ‘Minsky Moment’ is therefore getting closer. This is when prices begin to fall, and lenders suddenly panic about the real value of their assets. Liquidity dries up, and there is a sudden rush for the exits.
The chart shows how monthly borrowing has grown since 2008. The big jump began in Q4 2008 when the government ordered banks to increase lending, to compensate for the loss of exports:
• Monthly lending averaged RMB 386bn ($57bn) in Q1-Q3 2008 (red line)
• It then jumped 24% to RMB 477bn in Q4
• 2009 saw it jump a further 67% to RMB 796bn (brown line)
• 2010 saw a small decline to RMB 660bn (green line)
Latest figures for July show very little change in 2011 (purple line). Monthly lending has so far averaged RMB 667bn.
The sums involved are huge. Lending doubled in 2009 to $1.4trn, around one third of total GDP. Most of this money went into housing, in the belief that ‘the government would never let property prices fall’.
The rise in lending was great news for the chemical industry. Demand for the most basic polymer, polyethylene, jumped 53% between 2008-10.
But just as Minsky would predict, the government is now worried about what happens next. Bloomberg reports it is introducing new restrictions “to guard against the risk of bad loans should property prices fall“.
Coincidentally, the Financial Times notes that “China’s debt burden is far higher than it likes to admit“. It adds that “people forget that it undertook its fiscal stimulus package through the banking system, rather than by issuing public debt“.
Credit bubbles are like balloons. They expand whilst more air, or debt, is pumped into them. But as soon as this stops, they begin to deflate.
Of course, ‘this time may be different’. But companies cannot afford to plan on the basis of wishful thinking.
China’s own central bank is now planning for a possible property market downturn. Prudent chemical company Boards would be wise to follow its example. The risk of a downturn in China’s chemical demand growth is becoming too great for comfort.