Three Reasons To Worry About A Crisis in China

IMF: Three Reasons Not to Worry About a Crisis in China
1. China’s owes most of its debt to itself. True, China’s debt – some tallies put the sum of private and government debt at double China’s gross domestic product – is scary. How companies and local governments will manage to service that debt as growth cools and interest rates rise is a puzzler. The IMF’s latest Regional Economic Outlook, released Monday, predicts China’s economic growth will slow to 7.5% this year from 7.7% last year, then further to 7.3% in 2015.

Mr. Rhee says China is bound to see a rising number of credit defaults. But unlike Thailand or South Korea before the Asian financial crisis erupted in 1997, China hasn’t borrowed heavily abroad in foreign currencies. China’s total foreign debt amounts to only about 9% of its GDP, according to the country’s foreign-exchange regulator. South Korea’s was roughly one-third of GDP back in 1997.

That means that if China’s currency falls further (it has dropped roughly 3% so far this year), it won’t necessarily cause a dramatic increase in borrowers’ debts in local-currency terms that then causes bankruptcies to snowball.
Debt deflation is debt deflation. China has a far smaller risk of a crisis originating in the currency market in response to debt deflation, but this doesn't remove the risk of debt deflation. The idea that debt levels don't matter is nonsense. If an entity cannot pay the debt, the debt has lower value and the losses have to borne by someone, or they get socialized by the central government via inflation.

2. China’s government debt is low. Like many governments in advanced economies, Beijing runs a budget deficit. But that deficit is relatively small – about 2.1% of GDP. And total government debt, both those owed by the national government and China’s much more heavily indebted provinces, still add up to only about 53% of GDP, according to Bank of America Merrill Lynch. Compare that with the U.S., where government debt is roughly as big as GDP, or Japan, where government debt has ballooned to roughly 240% of GDP.

That means China can afford to spend more to offset the economic slowdown if it becomes too painful to borrowers. It can even afford to bail out banks or borrowers it deems too big to fail. In the worst case scenario, China’s central bank can follow the lead of the U.S. Federal Reserve and the Bank of Japan and create money by buying up assets – a policy known as quantitative easing. “If something bad happens, they will muddle through,” said Mr. Rhee.
U.S. debt is higher because the U.S. offset $3 trillion in deleveraging by the financial sector with a big increase in federal debt. The U.S. federal government had a debt to GDP ratio of about 60% before the financial crisis and now it is over 100%. Things always look better before the bailout.

3. China’s slowdown, like its economy, is central planned. While it’s easy to overestimate the degree of control Communist Party leaders have over economic decision making on the ground, they nonetheless are able to exert their influence in a way that policy makers in the United States and other democratic nations can only envy.

The U.S. Congress rebuffed former Treasury Secretary Henry Paulson’s first plan for halting the financial crisis in late-2008. China’s economic mandarins have much wider latitude to implement policy without the say-so of China’s National People’s Congress. Most of the country’s banks are state-controlled and state-run companies still dominate the economy.

China can instruct banks how to lend and to whom, and can even tell big companies how and where to invest. That’s a solution China’s leaders seem eager to avoid, but it remains an option. On the contrary, central bankers in the U.S. and Europe have found that even record-low interest rates could not compel banks to lend or companies to borrow, a situation that made their economic crises worse.
The entire reason why people are looking for a crisis in China instead of a normal slowdown as part of a rebalancing is because in 2008 the central planners forced the banks to lend. Absent that huge run-up in debt, China would have had a longer recession in 2008, but it would have rebalanced some and be a much stronger economy today, with lower debt levels.

Number 4: The IMF doesn't know what it is talking about.

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