When the Western economic world collapsed in 2008 there was only one beacon of light: China.
For decades China has grown at nose-bleed speeds and looked like an unstoppable economic miracle. Now the foundations of that miracle are exposed and the house of cards is in peril. Shadow banks and ghost cities are only the tip of the ice berg.
Speculation over the years of fudged official economic numbers coming out of Beijing is starting to haunt the government there. As 2018 came to a close the government reported the slowest growth in 28 years. This was still a bit north of 6%.
Unfortunately, these slower growth numbers are probably a wildly exaggerated lie. Recently, a former chief economist for the Agricultural Bank of China mentioned a report that two recent studies show China’s economy growing at a mere 1.67% and another showing the economy actually declined.
While there is no doubt China has made massive economic leaps over the past several decades, much of the recent growth is built on a shaky foundation.
In many Western nations an economic crisis can ensue from excessive indebtedness. The difference between Western nations and China is what the debt funding was used for. In the U.S., for example, corporations can over-extend themselves, causing over-production and an inventory hangover. Household debt might be wasted on stuff that has virtually no value. But homes and autos have at least some value and a good amount of utility. Something we will see China wasn’t spending on.
China is mired in a massive amount of debt. Trustworthy numbers are hard to come by, but many reports claim China’s government and municipal debt are several times larger than the annual economic output of the country.
What China spent the money on is a bigger problem than the excessive debt! The growing mountain of debt is difficult to manage. However, if the debt was used to produce something of value it would be possible to work through the financial problems with only modest economic pain.
China did some of that (spending on productive investments) and a whole lot more creating rubble.
People inside China have captured videos of buildings built in the last decade tipping over and put them on YouTube. Ghost cities in China are well known outside the country. Whole cities with virtually no people living there.
What is worse is the quality of construction. A large number (based upon information from people living in China a long time) of buildings only a few years old look like they are more than a century old! It is hard to imagine the crumbling facade and disrepair huge parts of these cities can fall into after only two or three years. Again, YouTube videos allow you to glimpse the slow moving disaster in the works.
The layers of debt these unlivable buildings have is equally ill-constructed. Municipalities borrow so they can encourage growth which generates tax revenue. (The tax system in China is untenable as local governments frequently find the greatest source of funds though the crazy financial deals with developers.)
Builders, which are frequently state-owned and very inefficient, pile on more debt to build the structures.
Then the final layer of debt is added when individuals buy, believing real estate never goes down in value. People in China buy real estate because they consider it a good investment even when they don’t live there or rent it out.
Renting is also far cheaper than buying a property in the populated areas of China. Rents frequently only cover a fraction of the mortgage payment so ownership is even more financially demanding.
A year-and-a-half ago this blog was one of the few websites allowed inside China by the government. Today it is officially banned!
My oldest daughter spent time in China last year and was able to pull up this blog. She taught English as a second language and lived with a host family. That is no longer possible.
Many foreigners teaching English as a second language in China are sheltered from the worst parts of China. My daughter, Heather, sought the real experience and got it. Fortunately she had a host family who considered themselves unconventional and enjoyed Heather’s presence. Her friend stayed with a family that wasn’t unconventional and had a miserable experience.
When Heather returned home she stayed in contact with her host family. She grew a bond with the host mom and their 5 year old daughter.
In the last few months contact has been more difficult. We actually lost contact for over a month and feared the worst. These are good people and we worry about them because they are friends.
As we started to give up hope of ever hearing from our extended Chinese family the host mom made contact. The story was grim.
This family had another foreign teacher and they had to send her home early over safety concerns. From the inside China has already started to implode.
The government’s solution to the stagnant economy was to set off another round of debt spending. With state-owned firms extremely inefficient and getting a large portion of the additional spending it is like doubling down on stupid.
You can hide fiscal malfeasance for a very long time if the government want the facts hidden. However, the natural laws of economics still apply and eventually assert themselves.
The growing mountain of debt will eventually cause a crisis. The longer the delay before appropriate remedial action is taken the more pain will be measured out.
China had started steps to resolve the issues. It would have taken a long time to fix the worst of the financial problems. However, the risk was high China would implode before they resolved the worst of the imbalances. The world community, knowing the approximate depth of the problems, quietly played along. What other choice did they have.
Unfortunately for China, the new American president had no patience for such slow resolutions. The trade spat exposed the underlying weakness of China’s economy quicker than expected and might be the trigger to set off the avalanche.
The Los Angeles Times recently reported China announced more than $600 billion of economic stimulus. The goal is to fix the problem as fast as possible before catastrophe strikes. More debt seems a poor choice of ointment.
China’s history in not encouraging if the slowdown is too fast and/or a currency or debt crisis occurs before adequate safeguards are in place.
The debt may be too large for an economy the size of China’s to navigate to calm waters. Many Chinese banks are insolvent because they can hide behind government censors. In a true capitalist economy these banks and other companies would have been shuttered long ago. So the inefficiency of the system trudges on and deepens.
Normally I would have an optimistic option at this point. And while I think this could be the next financial crisis to strike, I don’t think it will be the end of good times forever. All I’m saying is there will be a few moments when people get really scared if China collapses.
Preparing for the Storm
Dinny McMahon in his book, China’s Great Wall of Debt, does a better job digging deeper into the debt issues in China. This short post can’t cover the details the way a book can. The issues are deeper than I mention with shadow banks and incredible debt loads even greater than the government in China understands since they also know much of their data is faulty. I recommend reading this book.
The risks posed by China should not cause undue alarm. Planning for the possibility is wise, but no one knows when, or even if (the miracle could actually be a miracle), the boom will drop.
Since timing a crisis of this nature is impossible you can’t sell all your investments and hope it is the right move. The investments you sell might benefit from the Chinese crisis or the market could rally for years before the flood of Chinese debt consumes the news feeds.
There are some steps you can take to protect yourself if China implodes and if it doesn’t will bolster your financial situation regardless.
The 2008 financial crisis that started in the U.S. was a debt crisis. Home lending was out of control. Appraisals were based on fantasy and fake documents. Almost sounds like what China is dealing with today.
Debt crisis are always painful events. Companies fail and jobs are lost. People with money hold it tight for fear things will never improve.
As we saw in 2008, a financial crisis in a major world economy spreads. Very few parts of the world went unscathed by the 2008 events in the U.S. Even China was affected. 2008 set China on a massive borrowing for growth scheme they can’t seem to get off. Once the lie starts you need bigger and bigger lies to keep the charade going.
Since debt is the cause of so many financial crisis I suggest you insulate yourself by reducing or eliminating debt. (I prefer the elimination of debt because the seriousness of the China issue is large enough to harm virtually anyone holding debt.)
Reducing debt is an easy (relatively) and simple (relatively, again) way to insure your fiscal soundness if China stumbles. Like all debt, it takes time to pay off. Today is the best day to start the process. When the tsunami is visible on the horizon it’s too late; there will only be time to grab something solid and hold tight.
A second security procedure is to keep some of your finances liquid. Most of your money should probably be invested in broad-based index funds all the time. Market timing just doesn’t work. Having two years of spending in a money market fund might also be a good idea. This is a similar tactic people in or near retirement use so they don’t have to dip into investments when the market is down.
Final Planning Tips
I wish I could share more, but I fear if I was totally blunt it might harm my friends in China.
This is a serious issue China works hard to keep from the press around the world. It is easy to think China is loaded with cash since they hold so many U.S. Treasuries. In a crisis China may have to sell large amounts of these Treasuries to defend their currency causing an interest rate spike in the U.S. This would be economically disruptive even if the Federal Reserve fights to counter the effects of such a liquidation.
The most serious issue happened when we lost contact with Heather’s host family for over a month. They only contacted us because they were traveling outside China. This is very concerning. When things get really bad (and usually just before), totalitarian governments clamp down hard. Foreigners in China have been learning this. The security alert for Americans traveling in China is elevated and travel there is not recommended. This is not a warning to be disregarded.
If the same thing happened in Russia it would be less an issue since their economy is so much smaller. Even with inflated numbers, China’s economy is still one of the largest on the planet. If China stumbles we will all feel the ground quake, especially since some of the debt is in U.S. denominations.
This post is not about inciting panic, rather the opposite. Risk is high and even the U.S economy looks to be softening. Smaller refund checks this tax season means people were enjoying a slightly higher take-home pay during the previous year. That could lead to a softer U.S. economy for a while.
You can weather almost any economic storm without debt. Even in good times debt can be a burden.
I worry because a family in China close to my heart is living dead center of where the storm will strike. I wish them and all of China well.
We are all in this together. So take precautions, reduce debt, increase your financial cushion and be well.
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Friday 27th of December 2019
I am a middle-aged Chinese who can read some English. I can not help laughing when I read. You pretend to know China. Actually you know nothing, you just repeat some views and phrases ten years ago
Friday 27th of December 2019
Eric, I do not pretend to know China. I make it clear my information comes from third-party sources, including my daughter who has lived in China, in writing this post.
The goal of this blog is helping people with personal finance issues. China is a very large economy, affecting every corner of the planet. We must discuss the issues where China is involved because it affects us all.
You understand China better than I ever will, Eric. That is why you can't just say I don't understand without educating me (and all the readers here) as to how China has evolved economically. Please correct me where I am wrong and add to what I have already addressed. China is too important to ignore or only give a footnote.
J @ Wealthier Lives
Monday 25th of February 2019
Very interesting post. I have witnessed many of these fantom residential projects, manufacturing plants, even "mini-cities" over the past 10 years while working in China. Sometimes gigantic factories with no workers. Lights are not even on. Enormous residential complexes (100+ towers) without a signle occupant. This unlimited credit to generate growth will soon catch up to them. Of course, any government data can't be really audited. Interesting country to say the least. Stay diversified!
Friday 22nd of February 2019
Who is China in debt with?
Friday 22nd of February 2019
That's part of the problem, Dave. China hides pertinent data on who they owe. They are probably printing money like no tomorrow and the banks are saddled with bad loans at high levels and the government refuses to open the books (always a good sign). They hold ~ $1.3 trillion is U.S. Treasuries, but do so to stabilize their currency. It is likely a large portion of these bonds are collateralized so their "real" reserves could be much lower.
In the end it doesn't matter who is owed the debt. Much of it is internal so at some point their banking system enjoys what we did in 2008, only on a much larger scale.You can only hide that amount of bad loans before the natural laws of economics catch up.
Thursday 21st of February 2019
Very informative post, and something I've been thinking about for a while. If I recall correctly, you mentioned in another post that your index funds are 70% S&P and 30% international. Has your thinking changed on this?
Thursday 21st of February 2019
Wednesday 13th of February 2019
Buy the dollar