01.06.20 - If, in China, 2019 was the year of trade risk, 2020 might be the year of debt risk. Even Bloomberg News, whose sister company is set to launch a Bloomberg / Barclays index fund (and receive undisclosed fees for the service) that includes Chinese policy-bank and troubled local government bonds, weighed in on the trending topic of China’s growing debt defaults to express their belief that the extent of the problem is “big” (a welcome departure from their troubled history of suppressing news that might upset the Chinese Communist Party). Yet the Bloomberg article generously describes the problem as a ‘liquidity’ crunch stemming from Chinese banks (the big four domestic banks: Bank of China (BOC), Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), and the Agricultural Bank of China (ABC)) preferentially lending to State-Owned Enterprises (SOEs). The bigger, but related, problem that undergirds China’s debt problem, though, is the years of misallocated investment. Over the last several decades, investment’s share of China’s GDP has been well over 40% (compare that to ~20% in developed economies). Not only has that investment-binge artificially increased China’s GDP, the net result of substantial investment in unproductive assets is, eventually, insolvency, as the assets created by investment are worth less than the value of the debt. Eventually, the pied paper has to be paid, and Xi Jinping and the CCP have committed to a deleveraging campaign. The question is whether the steps needed to unwind and heal from such massively unproductive investment can realistically be dealt with in a system whose legitimacy is based upon continued growth and job creation (some have noted that, realistically, deleveraging is already dead). Maybe 2020 will just be another year of inflating the Chinese hot air balloon.
