Tuesday, August 25, 2015

Chinese Debt Levels Pose a Huge Long Term Problem for China and the Global Economy ... America Will Be the Least Negatively Impacted

Several years ago I read an extremely informative book which detailed the historical lessons to be learned from excessive debt levels of sovereign nations. The book is titled 'This Time Is Different: Eight Centuries of Financial Folly.'

The book's central theme is that after reviewing many centuries of various nations' accumulated excessive debt levels, 'this time' is never different. The story always and invariably ends in financial disaster for the excessively indebted countries.

What we don't know and never really can know, however, is exactly when the disaster will strike.

And that brings us to today's debt ridden situation in China and much of the rest of the world as well. While we don't and can't know when the bad ending will occur, we do know what's ahead.

Debt is never a free lunch for individuals, communities, states or sovereign nations.

The good news for America, however, is that we still have time to clean up our act and stop relying too heavily on government spending and the public sector. While we can't be optimistic about all that, we can look forward to low inflation, low interest rates, low energy prices and relatively inexpensive imported products due to low price commodities.

China's excess capacity is the American consumer's friend.

A Warning on China Seems Prescient summarizes the debt issues confronting China and why this will present huge problems for our global economy in future years:

"Kenneth Rogoff has long warned of a potential financial crisis in China.
Mr. Rogoff, a professor of economics at Harvard University, . . . for years has been telling anyone who would listen that China posed the next big threat to the global economy. He is starting to look right, again.
“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could,” Mr. Rogoff said . . . .
Mr. Rogoff . . . has made a career of studying financial crises. After the 2008 financial crisis, Mr. Rogoff co-wrote “This Time Is Different,” a seminal book that examined eight centuries of financial crises.
Every financial crisis, he and his co-author, Carmen M. Reinhart, concluded, stems from the same simple problem: too much debt. . . .
“China is the classic ‘This time is different’ story,” Mr. Rogoff said, rattling off all the different rationalizations for why the country convinced itself — and many others — that it could load up on debt but was somehow immune to the laws of economic gravity. He cited the government’s control over the markets, the hundreds of millions of workers migrating to cities and the country’s saving rate of about 30 percent of disposable income as just some of the reasons China was said to be impervious to a severe downturn.
“It’s very vulnerable,” Mr. Rogoff added. “There is a lot of debt.
How much debt remains an open question, given the opacity of China’s market. The country’s debt load rose from $7 trillion in 2007 to $28 trillion by mid-2014, according to a report published earlier this year by the consulting firm McKinsey & Company, China. “At 282 percent of G.D.P., China’s debt as a share of G.D.P., while manageable, is larger than that of the United States or Germany,” said the McKinsey study. “Several factors are worrisome: Half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.”
The question then becomes how interconnected China’s economy is to the rest of the world. . . .
“How does all that ricochet to emerging markets?” Mr. Rogoff said in discussing the effect of China’s slowdown on commodity producers like Brazil, whose economy is in a tailspin. “Look at Russia. It’s amazing they haven’t had a financial crisis yet.”
Mr. Rogoff is not the first person to identify China as a potential risk. Earlier this year, this column highlighted the views of Henry M. Paulson Jr., the former Treasury secretary and a Sinophile, who said, “Frankly, it’s not a question of if, but when, China’s financial system will face a reckoning and have to contend with a wave of credit losses and debt restructurings.” And the hedge fund manager James Chanos has been sounding the alarm on China for years, recently declaring, “Whatever you might think, it’s worse.”
There are, of course, significant political reasons China needs to convince the world and its own citizens that it can manage its convulsing financial markets and slowing economy. “Financial meltdown leads to a social meltdown, which leads to a political meltdown,” Mr. Rogoff said. “That’s the real fear.”. . .
So does Mr. Rogoff believe that China is headed for a terrible “hard landing” that will lead to a
global recession?
Well, despite the market tumult and his persistent warnings, Mr. Rogoff says he believes that the last several weeks have raised the prospects of a meaningful crisis. But with China’s trillions of dollars in reserves, he thinks the country may have sufficient tools to prevent a calamity that spreads across the globe — at least for now.
“If you had to bet,” Mr. Rogoff said, “you’d still bet they’d pull it out.”"
Summing Up
China has a great deal of currently underutilized manufacturing capacity and too many indebted government entities, especially municipalities.
In plain terms, the Chinese have an excessively troublesome and perhaps unsustainable debt load.

Other nations that act as suppliers to China of oil and other commodities (Russia, Brazil, OPEC, Venezuela, Australia, Iraq, Iran and so forth) are likely to have huge issues in their own economies as Chinese growth slows, its purchases slow, and its capacity underutilization issues remain unsolved.

On the other hand, American consumers should be the primary beneficiaries of all this global 'deflationary' activity.

That's my take.

Thanks. Bob.

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