The Biggest Bubble No One’s Warned You About

by Jason Simpkins, Outsider Club It’s hard to think about China as a country with a debt problem, but that’s precisely what it is.

China’s ratio of total debt to GDP is 282%, according to the McKinsey Global Institute. That includes borrowing by the government, banks, corporations, and households.

By comparison, the United States’ ratio of total debt to GDP is 269%. Greece’s was 260% at the time of its crisis. China’s debt level is growing fast, too — about twice as fast as its economy. In fact, China’s economy has added $20.8 trillion in new debt since 2007, accounting for more than a third of total global debt growth in that period. How can this be? Well, what you have to realize about China is that it doesn’t just lend to the United States — it also lends to itself. That is, the government gives money to banks, and then instructs them on how generous or frugal they should be. And since the financial crisis struck in 2007, China’s banks have been very generous — especially when it comes to property development. The problem is, not all the money that gets lent out is put to efficient use. A huge portion of it is wasted on projects for which there is no demand, and thus, no return. It’s being wasted, funneled into bubbles that will inevitably pop. So the problem isn’t with the government direct, it’s with China’s banking sector, particularly its shadow banking sector. The risk is China’s lenders won’t recoup their losses, become insolvent, and a banking crisis will ensue. But it’s Beijing that will have to clean up that mess, bailing out its banking sector the same way the U.S. government did in 2008. I’ll say that again, to be clear: We could be in for a repeat of the 2008 financial crisis, except this time with China’s real estate market and financial sector serving as the epicenter. Drowning In Debt If you take a look at the chart below you’ll see where the problem lies. It’s in China’s corporate debt. At 125% of GDP, China now has the highest level of corporate debt in the developed world… China Debt Load Chinese companies hold a staggering $14.2 trillion of debt, according to a recent report by Standard & Poor’s. Much of this debt was accrued during the country’s massive real estate boom. Indeed, one of the ways China manufactures growth is by funding large construction projects for which there is no demand — the infamous ghost cities. More than 60 million empty apartments await buyers in China, and some 6.7 billion square feet of commercial office space remains unsold. This development is a key cog in China’s economic engine. The real estate sector accounts for between 25% and 30% of China’s GDP, if you include both upstream and downstream industries such as steel, cement, glass, furniture, and appliances. The problem is, it’s grinding to a halt. After years of blistering growth, oversupply, low demand, and soaring property prices have caused the property market to stall. The average prices for new homes in China’s 70 major cities fell for the fifth consecutive month in January. Prices for new homes fell 5.1% last month, accelerating from the annual 4.3% fall in December. This regression is a big reason why China failed to meet its growth target last year. And if it deepens, the economy could be in real trouble. Consultancy firm IHS recently predicted that a property crash could reduce China’s GDP from to 6.6% this year, and to 4.8% in 2016. That may not sound like much, but it would be a disaster by China’s standards. High unemployment and a drop in consumption would be bad enough, but what about all those heavily indebted companies? Many would go under, pulling the rug out from under China’s banks. But the real mess would be in China’s “shadow” banking sector. Continue Reading>>>

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