By John Richardson
CHINA has had debt crises before that have been very easily resolved. In the late 1990s, for instance, as business and economics professor, Christopher Balding, points out, China’s government created state-owned asset management companies to clean-up the balance sheets of banks. These management companies bought debt off troubled banks and held it for periods of time with minimal returns, enabling the banks to return to financial health.
This time around, though, there has been no use of public assets to cancel-out bad lending. Perhaps this relates to the scale of the problem: In 1998-2004, China spent $200bn resolving problem lending, but S&P Global Ratings has calculated today’s final bill at $1.7trn.
Crucially, also, Balding makes these following two points:
- From 1999 to 2008, growth in loans totalled 14%, but there was 15% growth in nominal GDP. China was therefore able to outgrow its debt crisis.
- Since September 2011, nominal GDP growth in China has averaged 8.6% per annum, whilst total loans have grown by 14.5% year. China is clearly no longer able to outgrow its debts.
Why is it in this predicament? Firstly, because of the scale of this latest lending bubble. The Bank for International Settlements says that China’s debt is now 250% of GDP compared with 150% before 2008. You would struggle to find a country with such a high percentage of debt that has in the past avoided a major financial upheaval.
And by some measures what China has done is completely unprecedented. Take this year’s alarming re-inflation of the real-estate bubble. At the height of the US sub-prime crisis in 2006 the total value of US residential housing was 1.75 times GDP, according to HSBC. Right now it is 3.27 times GDP, and is forecast to hit 3.72 times by year-end. Japan’s great bubble peaked in 1990 at 3.7 times GDP. Shortly after that, Japanese property prices fell through the floor, losing 67%.
The second reason relates to the decline in nominal GDP growth since September 2011. As Balding again writes global GDP grew by 3% per year in 2000-2008. This allowed China to export its way out of debt issues. But since 2008, global growth has slowed.
The problem for China is that it can no longer rely on the Babyboomers to absorb is vast supply of manufactured goods. The Boomers started to retire in 2005 with not enough young, and so working, people replacing all of these retirees. Even the US Fed now accepts that when people are living on pensions they spend less money.
Foreign Reserves, High Savings Rate Won’t Solve the Problem
“Yes, but what about its foreign reserves?” I can hear you say, “China has vast foreign reserves that it can withdraw at a moment’s notice to easily repay its debts.”
No, the maths simply didn’t add up in September last year, and is even less likely to add up now following the H1 2016 surge in lending.
Plus, just imagine the effect on the US and global economies if say China was to suddenly sell a substantial portion of its $1.19trn of US Treasuries, which is actually close to a four-year low. Lower global growth would further reduce China’s ability to use exports to cancel-out bad debts.
Another problem with the foreign reserve argument is that many of these reserves – up to a third – are illiquid, and so it is impossible to sell them down in a hurry.
The IMF has also calculated that, based on previous currency crises, countries should maintain foreign reserves equivalent to the sum of 30% of their short-term foreign-denominated debt, 15% of other portfolio liabilities, 10% of the M2 or broad money supply and 10% of yearly exports. On this basis you can argue that China’s liabilities are already ahead of its foreign reserves.
“Hold on, though,” I can again here you saying, “what about China’s incredibly-high personal savings rates? These can surely be deployed to easily pay-off all the bad lending.” China’s household savings are twice as large as debt. Deposits were about 55trn Yuan ($8.4trn) at the end of 2015, while debt was 27.4trn Yuan.
But people have to be persuaded to spend this money to enable China to grow domestically by a sufficient amount to again wipe out all that debt.
Consumer spending is likely to fall rather than rise if the latest real estate bubble deflates, leading to many millions of families losing money on their property investments. It is also worth noting that whilst savings are high, household debt has increased. It now stands at 40% of GDP, up by 23% percentage points over the last ten years.
What really, though, entirely scuppers the personal savings argument is the issue of China’s ageing population. As we discuss on our Study, Demand: The New Direction for Profit, quoting OECD data:
- China’s basic pension pays just 1% of average individual/province earnings for each year of coverage, subject to a minimum 15 years of contributions.
- 30 years’ employment provides a pension of just 30% of this average wage.
- Some employees also pay 8% of their wages into a retirement fund and receive top-up annuities based on individual savings – but this only covers 210m urban employees.
Until or unless the government can close this gap, Chinese families will want to save rather than spend money. The gap will only be closed if China can escape its middle-income trap. This could take a decade or more to achieve, assuming that it can be achieved at all.
There is thus no getting away from the fact that this time is surely going to be different. China cannot escape this latest debt crisis without significant economic damage.
The Implications for Chemicals Demand
As the chart at the beginning of this blog post indicates, China’s polypropylene (PP) demand declined by 2% in 2008. This was the result of the Global Financial Crisis which badly dented GDP growth,
Remarkably, PP demand then grew by 25% in 2009 because of the huge economic stimulus package. The story was similar in all other chemicals and polymers.
You have to ask yourself this question: Will China have the ability and inclination to respond in the same way if history repeats itself?
As I first discussed last week, I see three scenarios for 2017:
- The government kicks the can down the road and the real estate bubble continues. There are plenty of people who still want this to happen.
- Reforms gather pace and we see a slight reduction in crude prices, chemicals prices and chemicals demand as the air is gradually taken out of the bubble
- A collapse in crude, chemicals prices and demand occurs because of a financial sector crisis.
If 1 happens this just delays the eventual reckoning to another day, and would make debt problems even worse. Xi Jinping doesn’t want to run this risk. And given that he, and his other pro-reformers, are now more firmly in control you have to plan for both 2 and 3.
What would these second and third outcomes mean for chemicals and polymers demand in 2017, both in China and globally? This will be the subject of a series of further posts, product by product, starting with PP on Friday. Each of these posts will provide you with different demand-growth scenarios.