Category: Debt Levels

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Warning sign of China bank crisis | Business Insider

From Engen Tham, Reuters:

Excessive credit growth in China is signaling an increasing risk of a banking crisis in the next three years, a report from the Bank for International Settlements says.

The credit-to-gross-domestic-product gap, an early warning of financial overheating, hit 30.1 in China in the first quarter of this year, the financial watchdog said in a review of international banking and financial markets published Sunday.

Any level above 10 signals a crisis “occurs in any of the three years ahead,” the BIS said. China’s indicator is way above the second-highest level of 12.1 for Canada and the highest of the countries assessed by the BIS….

From the BIS:

The credit-to-GDP gap captures the build-up of excessive credit in a reduced-form fashion. It is defined as the difference between the credit-to-GDP ratio and its long-run trend, and it has been found to be a useful early warning indicator of financial crises.

In the BIS Table of credit-to-GDP gaps, Hong Kong was second highest at 18.1. Chile (15.7), Singapore (14.8), Thailand (14.5), Saudi Arabia (14.0) and Belgium (12.2) are higher than Canada (12.1). Australia (4.5), USA (-9.9) and UK (-27.0) are far lower. In fact, UK looks like a credit contraction.

Source: Credit-to-GDP warning sign of bank crisis China – Business Insider

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Rising debt—not a crisis, but a serious problem | Brookings

Testimony by Alice M. Rivlin, Senior Fellow – Economic Studies, Center for Health Policy, before the Joint Economic Committee of the United States Congress on September 8, 2016:

…..our national debt is high in relation to the size of our economy and will likely rise faster than the economy can grow over the next several decades if budget policies are not changed. Debt held by public is about 74 percent of GDP and likely to rise to about 87 percent in ten years and to keep rising after that.

This rising debt burden is a particularly hard problem for our political system to handle because it is not a crisis. Nothing terrible will happen if we take no action this year or next. Investors here and around the world will continue to lend us all the money we need at low interest rates with touching confidence that they are buying the safest securities money can buy. Rather, the prospect of a rising debt burden is a serious problem that demands sensible management beginning now and continuing for the foreseeable future.

What makes reducing the debt burden so challenging is that we need to tackle two aspects of the debt burden at the same time. We need policies that help grow the GDP faster and slow the growth of debt simultaneously. To grow faster we need a substantial sustained increase in public and private investment aimed at accelerating the growth of productivity and incomes in ways that benefit average workers and provide opportunities for those stuck in low wage jobs. At the same time we need to adjust our tax and entitlement programs to reverse the growth in the ratio of debt to GDP. Winning broad public understanding and support of basic elements of this agenda will require the leadership of the both parties to work together, which would be difficult even in a less polarized atmosphere. The big uncertainty is whether our deeply broken political system is still up to the challenge.

…..There are three necessary elements of a long-run debt reduction plan:

  • Putting the Social Security program on sustainable track for the long run with some combination higher revenues and reductions in benefits for higher earners.
  • Gradually adjusting Medicare and Medicaid so that federal health spending is not rising faster than the economy is growing….
  • Adjusting our complex, inefficient tax system so that we raise more revenue in a more progressive and growth-friendly way and encourage the shift from fossil fuels to sustainable energy sources…..

Source: Rising debt—not a crisis, but a serious problem to be managed | Brookings Institution

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Credit bubbles and GDP targeting

In 2010 Scott Sumner first proposed that the Fed use GDP targeting rather than targeting inflation, which is prone to measurement error. Since then support for this approach has grown, with Lars Christensen, an economist with the Danish central bank, coining the term Market Monetarism.

Sumner holds that inflation is “measured inaccurately and does not discriminate between demand versus supply shocks” and that “Inflation often changes with a lag… but nominal GDP growth falls very quickly, so it’ll give you a more timely signal….” [Bloomberg]

The ratio of US credit to GDP highlights credit bubbles in the economy. The ratio rises when credit is growing faster than GDP and falls when credit bubbles burst. The graph below compares credit growth/GDP to actual GDP growth (on the right-hand scale). The red line illustrates a proposed GDP target at 5.0% growth.

US Credit Growth & GDP Targeting

What this shows is that the Fed would have adopted tighter monetary policies through most of the 1990s in order to keep GDP growth at the 5% target. That would have avoided the credit spike ahead of the Dotcom crash. More importantly, tighter monetary policy from 2003 to 2006 would have cut the last credit bubble off at the knees — avoiding the debacle we now face, with a massive spike in credit and declining GDP growth.

While poor monetary policy may have caused the problem, correcting those policies is unlikely to rectify it. The genie has escaped from the bottle. The only viable solution now seems to be fiscal policy, with massive infrastructure investment to restore GDP growth. That may seem counter-intuitive as it means fighting fire with fire, increasing public debt in order to remedy ballooning private debt.

Rising public debt is only sustainable if invested in productive infrastructure that yields market-related returns. Not in sports stadiums and public libraries. Difficult as this may be to achieve — with politicians poor history of selecting projects based on their ability to garner votes rather than economic criteria — it is our best bet. What is required is bi-partisan selection of projects and of private partners to construct and maintain the infrastructure. And private partners with enough skin in the game to enforce market discipline. I have discussed this at length in earlier posts.

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Does Government Spending Create Jobs?

By William Dupor, Assistant Vice President and Economist

The most recent U.S. expansion, however lackluster, entered its eighth year in June.1 In anticipation of the possibility (or perhaps inevitability) of another recession, observers have remarked on how and whether countercyclical fiscal policy should be used to combat an economic downturn….

Gauging Effects through Military Spending
Research Analyst Rodrigo Guerrero and I took up the issue of the efficacy of government spending at increasing employment. We looked specifically at over 120 years of U.S. military spending, which provides a kind of “natural experiment” for our analysis.

Looking at government spending more generally suffers from the problem that the spending may be correlated with economic activity: The government may spend more during a recession (as with ARRA) or more during an expansion (when tax revenues are high). This might bias the results, which economists call “an endogeneity bias.”

Military spending, on the other hand, is likely to be determined primarily by international geopolitical factors rather than the nation’s business cycle.

….We used a similar methodology and found that military spending shocks had a small effect on civilian employment. Following a policy change that began when the unemployment rate was high, if government spending increased by 1 percent of GDP, then total employment increased by between 0 percent and 0.15 percent. Following a policy change that began when the unemployment rate was low, the effect on employment was even smaller.

In the event of another recession, policymakers have a number of stabilization tools at their disposal, including quantitative easing, negative interest rates and tax relief. The research discussed above suggests that one other device, namely countercyclical government spending, may not be very effective, even when the economy is slack.

I think the authors of this research come to the wrong conclusion. Instead they should have concluded that military spending is not very effective in creating jobs.

Military spending provides no lasting benefit to the economy in terms of tax revenue or saleable assets, leaving future taxpayers with public debt and no means of repayment. Other than an austerity budget which would risk another recession.

Whereas infrastructure projects can be selected on their ability to generate market-related returns on investment, providing revenue to service the public debt incurred…..and saleable assets that can be used to repay debt.

But there are two caveats.

First, project selection must not be a political decision. Else projects likely to win votes will be selected ahead of those that generate decent financial returns.

Second, the private sector must have skin in the game to ensure that #1 is adhered to. Also to reduce cost blowouts. Private companies are not immune to blowouts but government projects are in a league of their own.

The added benefit of infrastructure spending is the free lunch government gets from reduced unemployment benefits. Money they would have spent anyway is now put to a more productive use.

Source: Does Government Spending Create Jobs?

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The real problem: Private Investment

Want to know the real cause of low GDP growth? Look no further than Private Investment.

Private Investment over Nominal GDP

Private Investment ran with peaks around 10 percent of GDP and troughs around 4 percent throughout the 1960s, 70s and most of the 80s. Since then Private Investment has declined to the point that the latest peak is close to 4 percent.

It is highly unlikely that the US will be able to sustain GDP growth if the rate of investment continues to decline. GDP growth is a factor of population growth and productivity growth. Productivity growth is not primarily caused by people working harder but by working more efficiently, with better tools and equipment. Using an earthmover rather than a wheelbarrow and shovel for example. Falling investment means fewer new tools and efficiencies.

Private Investment & Debt over Nominal GDP

The second graph plots the annual increase in private debt against GDP. You would think that this figure would fall — in line with falling rates of investment. Quite the opposite. Private debt growth is rising. While annual debt growth is nowhere near the red flag of 5 percent of GDP, if it crosses above the rate of private investment — as in 2006 to 2009 — I would consider that a harbinger of another crash.

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Rebalancing, wealth transfers, and the growth of Chinese debt | Michael Pettis

Michael Pettis summarizes China’s debt dilemna:

This, I think, is really the key point. There is no way Beijing can address the debt without a sharp drop in GDP growth, but as unwilling as Beijing may be to see much lower growth, it doesn’t have any other option. It must choose either much lower but manageable growth today or a chaotic decline in growth tomorrow.

…..History suggests that developing countries that have experienced growth “miracles” tend to develop risky financial systems and unstable national balance sheets. The longer the miracle, the greater the tendency. That’s because in periods of rapid growth, riskier institutions do well. Soon balance sheets across the economy incorporate similar types of risk.

….Over time, this means the entire financial system is built around the same set of optimistic expectations. But when growth slows, balance sheets that did well during expansionary phases will now systematically fall short of expectations, and their disappointing performance will further reinforce the economic deceleration. This is when it suddenly becomes costlier to refinance the gap, and the practice of mismatching assets and liabilities causes debt, not profits, to rise.

Xi Jinping doesn’t have the short-term focus of most developed economies, where leaders are primarily concerned with the next election, but even he has failed to grasp the nettle. Cutting GDP growth may fuel greater political instability but this is a price China has to pay.

Source: Rebalancing, wealth transfers, and the growth of Chinese debt | Michael Pettis’ CHINA FINANCIAL MARKETS

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Stan Druckenmiller: This Is The Endgame | Zero Hedge

Hedge fund legend Stan Druckenmiller, founder of Duquesne, addressing the Sohn Conference:

….The Fed has no end game. The Fed’s objective seems to be getting by another 6 months without a 20% decline in the S&P and avoiding a recession over the near term. In doing so, they are enabling the opposite of needed reform and increasing, not lowering, the odds of the economic tail risk they are trying to avoid. At the government level, the impeding of market signals has allowed politicians to continue to ignore badly needed entitlement and tax reform.

Look at the slide behind me. The doves keep asking where is the evidence of mal-investment? As you can see, the growth in operating cash flow peaked 5 years ago and turned negative year over year recently even as net debt continues to grow at an incredibly high pace. Never in the post-World War II period has this happened. Until the cycle preceding the great recession, the peaks had been pretty much coincident. Even during that cycle, they only diverged for 2 years, and by the time EBITDA turned negative year over year, as it has today, growth in net debt had been declining for over 2 years. Again, the current 5-year divergence is unprecedented in financial history!

And if this wasn’t disturbing enough, take a look at the use of that debt in this cycle. While the debt in the 1990’s financed the construction of the internet, most of the debt today has been used for financial engineering, not productive investments….

Source: For Stan Druckenmiller This Is “The Endgame” – His Full ‘Apocalyptic’ Presentation | Zero Hedge

Hat tip to Houses & Holes at Macrobusiness.

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IMF warns about Chinese debt

From FT (via the Coppo Report at Bell Potter):

China’s leaders need to look beyond the current solutions being floated to tackle the country’s mounting corporate debt problems and come up with a bigger plan to do so, the International Monetary Fund’s top China expert has warned. The IMF has been expressing growing concern about China’s debt issues and pushing for an urgent response by Beijing to what the fund sees as a serious problem for the Chinese economy. It warned in a report earlier this month that $1.3tn in corporate debt — or almost one in six of the business loans on Chinese banks’ books — was owed by companies who brought in less in revenues than they owed in interest payments alone. In a paper published on Tuesday, James Daniel, the fund’s China mission chief, and two co­authors, went further and warned that Beijing needed a comprehensive strategy to tackle the problem. They warned that the two main responses Beijing was planning to the problem — debt­-for­-equity swaps and the securitization of non­performing loans — could in fact make the problem worse if underlying issues were not dealt with. The plan for debt­ for equity swaps could end up offering a temporary lifeline to unviable state­ owned companies, they warned. It could also leave them managed by state­ owned banks or other officials with little experience in doing so.

Bad debt is bad debt …… and nonproductive assets are nonproductive assets. Financial window-dressing like securitization or debt-for-equity swaps will not change this. The assets are still unproductive. Effectively, China has to stump up $1.3 trillion to re-capitalize its banks. And that may be the tip of the iceberg.

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China’s resurgent construction boom | MacroBusiness

Societie General on China’s resurgence:

In our view, the most obvious underlying factor behind this recovery is credit. In Q1, increases in total credit exploded to CNY7.5tn, up 58% yoy and equivalent to 46.5% of nominal GDP – one of the highest ratios ever. Credit growth accelerated to 15.8% yoy to end-March, the quickest pace in 20 months.

Credit growing faster than nominal GDP is unsustainable in the long-term.

Source: Special report: Measuring China’s resurgent construction boom – MacroBusiness

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