China's Black Hole of Corporate Debt
Board: Macro Economics
If you're trying to look at macro trends to improve micro investment decisions, it's crucial to avoid "momentum thinking" -- extrapolating current interpretations of current trends out to infinity and concluding the end of the world is near. A few years back, I posted a comment about how China was becoming the world's critical patient -- the canary in the world economy's coal mine, the patient whose sniffles soon become everyone else's flu epidemic. Over the past 15-20 years, US manufacturers shipped tens of thousands of jobs to China and China gained political and financial leverage over the US by using cash from its trade surplus to sop up trillions in US government debt. The flood of cheap Chinese labor contributed to a worldwide downward wage spiral in multiple sectors (clothing, electronics, etc).
As mentioned in the prior post, the potential for failure lurks in every success, especially when you're trying to operate a cutting edge industrial market economy with only a decade or two of market experience and a political system 180 degrees out of phase with the needs of a nimble market economy. Bloomberg BusinessWeek has a story on an interesting statistic about the current Chinese economy:
In a nutshell, the debt load of Chinese corporations has reached 122 percent of China's yearly GDP. This is occuring at the same time that Chinese exports increased 11.6 percent (not sure if that's actual or annualized but impressive either way...) just in October 2012.
If exports (sales) are skyrocketing yet corporate debt is growing, a few things can be deduced:
* Chinese firms cannot fund capital investment for growth out of profits
* Profit margins are unsustainably small (but positive) or are actually negative
* Since some key firms are state owned, massive amounts of private debt are being transferred to state debt
* the Chinese state was likely no better at picking loan bailout targets when it attempted to fend off the 2008 meltdown than American banks were when allocating trillions to mortgage backed securities that CAUSED the 2008 meltdown
In short, this rapid increase in debt load seems to be a public sign of a much larger scale misallocation of public and private capital, which inevitably results in a painful economic shock at some point in the future.
To be fair, the US picture doesn't sound much better at first glance. Non-financial sector corporate debt in the US was 76.4% of GDP as of 2009. That's better than China. Unfortunately, financial sector debt (which includes GSE related obligations that back our mortgage fiasco) is about 109% of yearly US GDP. Federal and state government debt is another roughly 70% of GDP. However, these US figures didn't jump forty percent in a single year.
This may be the signal of a significant simultaneous macro threat and opportunity for the American economy. On one hand, a continued spiral of debt within China could produce massive losses which will likely transfer directly to the Chinese state, likely curtailing its ability to continue buying US debt, dropping demand for US treasuries and raising American interest rates. On the other hand, this seems to indicate the Chinese model of industrial competition is not reaching a healthy equilibrium but racing past it to a region of over-capacity and squandered, mis-allocated capital. A major contraction in the Chinese economy will ratchet up internal Chinese political pressures, producing years (decades?) of internal squabbling and distraction while helping return US manufacturing to competitiveness.
Maybe this is just wishful thinking on my part but I tend to be pretty pessimistic. However, maybe there's more room for pessimism about China and its attempt to bolt capitalism on top of communism than pessimism about America, a nation with 130+ years of experience in mixing industrial capitalism and democracy. We may forget a few lessons every few decades and may need to adjust the balance here and there but at least we've seen the movie before.