Category: Debt Levels

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What Is China’s Biggest Weakness? | Bloomberg

By William Pesek:

China’s debt reckoning is coming. Maybe not this quarter or this year, but Chinese President Xi Jinping’s unbridled effort to keep growth from falling below the official 7.5 percent target is cementing China’s fate…..

Why then, with so many clear examples of financial excess leading to ruin, is Xi continuing down this road? Blame it on the ghosts of Tiananmen Square. In the aftermath of the crackdown on student protesters on June 4, 1989, China’s leaders made a bargain with their people: We will make you richer, as long as you no longer dissent. After the crash of Lehman Brothers, the regime had to go to extraordinary lengths to keep up its end of the bargain, pumping up what was already the world’s highest investment rate. In doing so, China itself became a Lehman economy…

Read more at What Is China's Biggest Weakness? – Bloomberg View.

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High public debt impedes recovery

This graph from a FRBSF paper Private Credit and Public Debt in Financial Crises, by Òscar Jordà, Moritz Schularick, and Alan M. Taylor, perfectly illustrates how high public debt levels impede the ability of an economy to recover from a financial crisis:

Figure 3……. shows that high levels of public debt can be a considerable drag on the recovery. The figure displays the path of per capita GDP in a typical recession compared with the paths under three scenarios following a financial crisis resulting from excess growth of private credit. Each of the three scenarios corresponds to a specified level of public debt at the start of the recession. The dotted line represents a low level of debt of about 15% as a ratio to GDP; the solid line represents a medium level of debt of about 50% of GDP, which is the historical average; and the dashed line represents a high level of debt of about 85% of GDP.

Recessions and Public Debt Levels

Read more at Federal Reserve Bank San Francisco | Private Credit and Public Debt in Financial Crises.

Hat tip to Barry Ritholz

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High credit growth prolongs recessions

Research by the Federal Reserve Board of San Francisco shows how high credit growth prior to a financial crisis can prolong the recession by three or more years. The graph below compares the average recovery time for a normal recession to recessions preceded by low credit growth [blue or red] and recessions preceded by high credit growth [green or orange].

Recession Recovery Time

Differences in public debt growth appear to have little impact, but public debt levels are another matter.

Read more at Federal Reserve Bank San Francisco | Private Credit and Public Debt in Financial Crises.

Hat tip to Barry Ritholz

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How a private credit boom can lead to a sovereign debt crises | FRBSF

From a FRBSF paper Private Credit and Public Debt in Financial Crises by Òscar Jordà, Moritz Schularick, and Alan M. Taylor:

Recovery from a recession triggered by a financial crisis is greatly influenced by the government’s fiscal position. A financial crisis puts considerable stress on the government’s budget, sometimes triggering attacks on public debt. Historical analysis shows that a private credit boom raises the odds of a financial crisis. Entering such a crisis with a swollen public debt may limit the government’s ability to respond and can result in a considerably slower recovery.

In financial crises, steep declines in output worsen the ratio of public debt to gross domestic product (GDP) even if the nominal amount of debt remains unchanged. Progressive tax systems cause government revenues to decline at a faster rate than output. Meanwhile, other automatic stabilizers, such as unemployment insurance programs, quickly swell public expenditures. The public sector often assumes private-sector debts to prevent a domino effect of defaults from toppling the financial system. Programs to stimulate the economy put further stress on public finances. As budget deficits balloon, deep economic downturns resulting from a private credit crunch often turn into sovereign debt crises.

Read more at Federal Reserve Bank San Francisco | Private Credit and Public Debt in Financial Crises.

Hat tip to Barry Ritholz

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Druckenmiller Sees Storm Worse Than ’08 | Bloomberg

Stan Druckenmiller, George Soros’ former partner and one of the best-performing hedge fund managers of the past three decades, warns of the real long-term threat to the US economy:

Druckenmiller, 59, said the mushrooming costs of Social Security, Medicare and Medicaid, with unfunded liabilities as high as $211 trillion, will bankrupt the nation’s youth and pose a much greater danger than the country’s $16 trillion of debt currently being debated in Congress…… unsustainable spending will eventually result in a crisis worse than the financial meltdown of 2008…

Read more at Druckenmiller Sees Storm Worse Than ’08 as Seniors Steal – Bloomberg.

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How urban Chinese workers helped cause the great recession | Quartz

Hillary Rosner describes how the inflow of savings from China contributed to the US sub-prime crisis:

“The foreign reserve holdings of U.S. Dollars,” the researchers write, “which had been at less than 11% of U.S. GDP prior to 2000, grew rapidly after 2002; in fact they almost doubled over the 5-year period from 2002 to 2007.”

Read more at How urban Chinese workers helped cause the great recession – Quartz.

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EconoMonitor » Beijing’s New Leaders Are Right to Hold Back

Michael Pettis argues that China cannot stimulate its economy out of trouble:

There are still bulls out there who insist that China is out of the woods and making a strong recovery, for example former Deputy Governor of the Reserve Bank of Australia, Stephen Grenville, who argues in his article strangely titled China doomsayers run out of arguments:

“The missing element from the low growth narrative is that unemployment would rise, provoking a stimulatory policy response. China would extend the transition and put up with low-return investment recall that when unemployment was the issue, Keynes was prepared to put people to work digging holes and filling them in rather than have unemployment rise sharply. To be convincing, the low-growth scenario needs to explain why this policy response will not be effective.”

It seems to me that the reason why simply “provoking a stimulatory policy response” won’t help China has been explained many times, even recently by former China bulls. Of course more stimulus will indeed cause GDP growth to pick up, as Grenville notes, but it will do so by exacerbating the gap between the growth in debt and the growth in debt-servicing capacity. Because too much debt and a huge amount of overvalued assets is precisely the problem facing China, it is hard to believe that spending more borrowed money on increasing already excessive capacity can possibly be a useful resolution of slower Chinese growth.

Read more at EconoMonitor : EconoMonitor » Beijing’s New Leaders Are Right to Hold Back.

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Joseph Stiglitz: We have to shift our focus from money to credit | The IMF Blog

Joseph Stiglitz writes:

This might seem obvious. But a focus on the provision of credit has neither been at the center of policy discourse nor of the standard macro-models. We have to shift our focus from money to credit. In any balance sheet, the two sides are usually going to be very highly correlated. But that is not always the case, particularly in the context of large economic perturbations. In these, we ought to be focusing on credit.

This approach should be obvious to bankers who stand astride the two sides of their balance sheet: loan assets (credit) and deposit liabilities (money). Deposit liabilities may at times grow faster than loan assets but not vice versa.

Read more at The Lessons of the North Atlantic Crisis for Economic Theory and Policy | iMFdirect – The IMF Blog.

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