After a nearly disastrous start to the year in January and February, China’s economy steadied itself in March. Now, the early April indicators suggest a continuation of the uptick.
The China bulls, however, are premature in their projections of a sustained recovery. To the contrary, the economy appears poised to be a default or two away from a world-shaking crash.
When economic indicators look too good to be true, as China’s now do, they signal trouble ahead. There are two principal reasons why the present circumstances are cause for alarm.
First, Beijing’s official National Bureau of Statistics appears to be posting fantasy numbers. Notably, for the first time since 2010 when it began providing quarter-on-quarter data, NBS failed to release the quarterly comparison when it reported the year-on-year growth figure for the first calendar quarter of 2016. And when NBS got around to reporting the quarterly number, its figure was not consistent with the year-on-year one. As Sue Trinh of RBC Capital Markets points out, when you annualize NBS’s 1.1% quarter-on-quarter figure, you get only 4.5% growth for the year. That's not anywhere near the 6.7% year-on-year figure.
Yet the story is far worse than Chinese officials embarrassing themselves by reporting irreconcilable numbers. The second explanation for the good first quarter result is that, as the Wall Street Journal noted, the central government simply permitted the creation of “gobs of new debt.”
The surge in lending was stunning. Credit creation during the just-completed quarter was more than twice that in the previous quarter Tim Condon of ING Groep told Bloomberg.
Flooding the economy with easy money permits growth in the short-term, but the tactic is risky because it aggravates the most dangerous of China’s three bubbles. “In our view, China is in the midst of a triple bubble, with the third biggest credit bubble of all time, the largest investment bubble, and the second biggest real estate bubble,” wrote Andrew Garthwaite of Credit Suisse last summer.
Observers are worried that the bulging debt that Beijing has taken on to sustain growth cannot be repaid. China at the end of last year was carrying corporate debt equal to 165% of gross domestic product, and the ratio has obviously deteriorated since then.
And it is also worrisome that the country is now creating obligations about four times faster than it is generating GDP. That just about guarantees a crisis.
Concerns about China’s debt accumulation have existed for years, but seven bond defaults—three by issuers partially owned by the state—since the beginning of the year gripped China’s onshore bond market this month. Bond yields rose, holders dumped junk bonds, and prospective issuers cancelled about $10 billion in bond offerings. A Bloomberg headline earlier this month summed up the situation: “It’s All Suddenly Going Wrong in China’s $3 Trillion Bond Market.”
Time is now the factor. Financial professionals are quietly talking about China’s Minsky moment. In today’s common parlance, that’s the ‘Lehman moment,’ when asset values plunge, borrowers default, and everything falls apart.
Economists and other observers warned that excessive debt would crash the American economy well before that happened in 2008. In China, it’s not clear when things will fall apart, but the conditions for a debt crisis are now in place.