I’ve been saying for the past couple of years that the next recession in the US will probably be triggered by an external macro event or cascade of events, coming out of Europe or China.
Ambrose Evans-Pritchard of the London Telegraph sharpens the focus on China. He writes about the recently released quarterly report of the Bank for International Settlements (“the central banks’ bank”). The report repeats Michael Pettis's warning that China faces growing risk of a major debt and banking crisis.
The BIS is also rightly concerned about spillover from China to the global economy. Ambrose notes that outstanding loans in China have reached $28 trillion. This is as much as the commercial banking loan books of the US and Japan combined. Ambrose adds, “The scale is enough to threaten a worldwide shock if China ever loses control. Corporate debt alone has reached 171pc of GDP, and it is this that is keeping global regulators awake at night.”
Total Chinese debt reached 255% of GDP at the end of 2015. That’s a jump of 107% in the past eight years – and still rising fast. Every year, China's leadership promises to rein in debt growth, and every year the growth just keeps accelerating. That’s because China’s GDP growth is fueled by debt, and that debt is becoming increasingly inefficient in producing GDP.
Does China still have the resources to deal with this issue? The answer is a qualified yes – but then there may not be the resources to deal with the other items on China’s shopping list. The New Silk Road is estimated to cost $1 trillion, and that’s without cost overruns. Plus, the Chinese leadership has promised massive spending on the interior part of the country to bring up the quality of people’s lives.
One trillion here and one trillion there, and pretty soon you’ve run through your reserves and are getting into monetization problems. Then you have all sorts of currency issues, not to mention potential inflation, unemployment, the slowing of the economy, the associated public unrest, and so on.
No, I don’t think China will massively implode. But the world is really not ready for a China that is only growing at 2% or 3% a year. (Even though 2–3% growth would sound pretty good if it were happening in the US.) That will feel a lot like a hard landing as far as world growth is concerned. Plus, all of this is happening when there are unsettled political agendas in many countries (starting with the US) with regard to globalization and trade treaties.
John Mauldin is the chairman of Mauldin Economics, which publishes a growing number of investing resources, including both free and paid publications aimed at helping investors do better in today's challenging economy. Mauldin uncovers the truth behind, and beyond, the financial headlines.