This article was published by The McAlvany Intelligence Advisor on Friday, April 12, 2016:
First it was Fitch. Late last year it downgraded China’s sovereign debt by two notches, from AAA to A, which, according to its own definition, signals debt that is “more vulnerable to adverse business or economic conditions than is the case for [the two] higher ratings.”
In early March, Moody’s Investors Service got on board, knocking China’s debt rating down by one notch, followed by Standard and Poor’s on Thursday, which kept China’s rating at AA but with a negative outlook.
Translation: something’s coming.
We revised [our] outlook to reflect our expectation that the economic and financial risks to the Chinese government’s creditworthiness are increasing. This followed from our belief that, over the next five years, China will show modest progress in economic rebalancing and credit growth deceleration.
This “economic rebalancing” is code for trying to prick the bubble before it gets any bigger. Right now, the Chinese bubble is enormous, almost beyond comprehension. Ten years ago China’s central bank’s balance sheet was $3 trillion. Today: $34.5 trillion, more than a ten-fold increase. Even worse is the total debt in China, counting all that everyone owes to everyone else: government, businesses, and citizens. That number has exploded from $7 trillion to $28 trillion in just the last eight years, and now is three times larger than China’s entire economic output in a year.
This is the result of pure unadulterated Keynesianism: when private demand falters, make up the difference with government demand. But government has no money of its own, of course, so any spending must be paid for by taxes, borrowing, or creating. The Chinese experts chose creating.
And for the last 30 years, the faux money appeared to vault China from a third world economy into a first position, challenging (for the moment) the United States. But when the smoke was blown away and the mirrors removed, what was left were cities without residents, factories without workers, and airports without airlines.
Now, according to the Keynesians, comes the hard part: making the transition from exporting cement, steel, and gadgets of all kinds to internal consumption by the country’s 1.3 billion people. But those experts are having more than a little trouble pulling it off. The government just announced that it will be laying off between three million and five million workers as the “rebalancing” takes place – removing them from basic industries like iron and steel, shipbuilding, and cement. And putting them to work … where? They haven’t figured that part out yet, but never fear. The government is paying them anyway, as they “transition” to new positions.
The credit rating agencies are way behind the curve. Gordon Chang saw the Chinese implosion coming as far back as 2001 when he published his The Coming Collapse of China: “The People’s Republic is a paper dragon … the symptoms of decay are everywhere: deflation grips the economy, state-owned enterprises as failing, banks are hopelessly insolvent, foreign investment continues to decline, and Communist Party corruption eats away at the fabric of society.”
Multi-billionaire George Soros saw it coming, and said so back in January:
China has a major adjustment problem. I would say that it amounts to a crisis. When I look at the financial markets, there is a serious challenge which reminds me of the crisis we [in the United States] had in 2008.
Of course the Chinese have for years printed phony numbers about the growth of their economy, and most mainstream observers appeared to have believed every word and digit: China’s growth was consistently in double digits, far and away superior to growth in other countries, especially the Uniteds States, burdened as it increasingly was with administrative laws, mandates, and regulations. The latest number – 6.9 percent annual GDP growth – however is exposed to be a lie when an observer noted that electric power usage (a number that the Chinese government cannot manipulate) is growing at a paltry, and much more realistic, 0.7 percent a year.
Kyle Bass, the founder of hedge fund Hayman Capital Management, but more importantly the gentleman who successfully called the subprime mortgage crisis, wrote his investors last month telling them that China’s economic challenges are so vast that they “have no precedent,” that the potential implosion of losses by the Chinese banking system could be four times what the U.S. banking sector suffered that triggered the Great Recession:
The unwavering faith that the Chinese will somehow be able to successfully avoid anything more severe than a moderate economic slowdown … reminds us of the belief in 2006 that US home prices would never decline.
Bass remembers those days well. His hedge fund bet against subprime mortgages in 2007 and returned gains of 212 percent to his investors that year.
The Chinese Keynesians face the same challenges that a drug addict faces when he decides (or someone decides for him) to withdraw from his addition. Wikipedia is helpful here: “The disadvantages [of an abrupt withdrawal from the addictive substance] are unbearable withdrawal symptoms … which may cause tremendous stress on the heart … and, in a worst-case scenario, death.”
What they’re hoping for, of course, is a gradual weaning away of the additive substance (paper, or digital, money) without necessarily upsetting the patient or causing him much pain. The only problem is that China’s addiction is four times larger than it was in the United States. And attempts to “wean” the U.S. off cheap money failed miserably, causing economic pain and suffering that remains today.
Economic Times: S&P downgrades China outlook to negative from stable
MarketWatch: S&P revises China credit outlook to negative from stable
Bloomberg: China Rating Outlook Cut to Negative From Stable by S&P
DigitalLook: S&P downgrades China’s credit outlook to negative
Yahoo: S&P downgrades China’s credit outlook to negative
The Wall Street Journal: S&P Lowers Outlook on China’s Credit Rating to Negative
Fortune: Investor Who Called the Financial Crisis Says China’s Going to Be a Lot Worse
Washington Post: How China could trigger a global crisis
Standard & Poor’s Ratings Definitions
Fitch Ratings: Issuer Credit Rating Scales
The New American: China’s Economy Continues to Unravel as Gov’t Lays Off 5M Workers