1/23
In this piece the author makes a series of very common mistakes about debt – in this case Chinese debt – when he says: "But most of that debt is owed by state-owned enterprises to state-owned banks – which can be thought of as two entries...
theconversation.com/chinas-leaders…
In this piece the author makes a series of very common mistakes about debt – in this case Chinese debt – when he says: "But most of that debt is owed by state-owned enterprises to state-owned banks – which can be thought of as two entries...
theconversation.com/chinas-leaders…
2/23
on opposing sides of the same balance sheet. If a lot of that were to turn 'bad', which is by no means impossible, then the ensuing 'crisis' could be solved by writing it off, and then re-capitalising the state-owned banks...
on opposing sides of the same balance sheet. If a lot of that were to turn 'bad', which is by no means impossible, then the ensuing 'crisis' could be solved by writing it off, and then re-capitalising the state-owned banks...
3/23
by drawing down on the foreign exchange reserves of the People’s Bank of China."
"China", he continues, "has actually done this twice before, in the late 1990s as part of the state-owned enterprise reforms pushed through by then-Premier Zhu Rongji, and again...
by drawing down on the foreign exchange reserves of the People’s Bank of China."
"China", he continues, "has actually done this twice before, in the late 1990s as part of the state-owned enterprise reforms pushed through by then-Premier Zhu Rongji, and again...
4/23
between 2003 and 2005, when the big four state-owned banks were 'cleaned up' ahead of their very partial privatisation and listing on the Hong Kong Stock Exchange."
between 2003 and 2005, when the big four state-owned banks were 'cleaned up' ahead of their very partial privatisation and listing on the Hong Kong Stock Exchange."
5/23
This is incorrect. If that were really all it required, why are the Chinese regulators working so hard to limit credit growth? Why not just write it down to zero, recapitalize the banks, and, presto, no more debt?
This is incorrect. If that were really all it required, why are the Chinese regulators working so hard to limit credit growth? Why not just write it down to zero, recapitalize the banks, and, presto, no more debt?
6/23
Because the losses that have to be absorbed in any meaningful debt write-down in China are huge, and bank capital is nowhere near enough to absorb even a fraction of this loss.
Because the losses that have to be absorbed in any meaningful debt write-down in China are huge, and bank capital is nowhere near enough to absorb even a fraction of this loss.
7/23
This is the real problem, and the fact that much of the debt is with government-controlled entities only means that the government can more easily enforce a solution. It is not in itself a solution.
This is the real problem, and the fact that much of the debt is with government-controlled entities only means that the government can more easily enforce a solution. It is not in itself a solution.
8/23
One entity’s debt is another entity’s asset, and any “solution” requires formally recognizing that the assets that ultimately back the debt are worth less than the debt. The debt cannot be serviced, in other words, except with more debt, which in turn means that debt...
One entity’s debt is another entity’s asset, and any “solution” requires formally recognizing that the assets that ultimately back the debt are worth less than the debt. The debt cannot be serviced, in other words, except with more debt, which in turn means that debt...
9/23
automatically rises relative to assets at an accelerating pace, which also automatically increases the losses that ultimately have to be recognized.
This is what it means to have "too much" debt in an investment-driven economy:
automatically rises relative to assets at an accelerating pace, which also automatically increases the losses that ultimately have to be recognized.
This is what it means to have "too much" debt in an investment-driven economy:
10/23
debt-servicing is backed by assets that don't generate enough to service the debt, and so “real” wealth is less than rising recorded wealth. Those who study debt will quickly recognize this to be a version of what Galbraith referred to as "the bezzle".
debt-servicing is backed by assets that don't generate enough to service the debt, and so “real” wealth is less than rising recorded wealth. Those who study debt will quickly recognize this to be a version of what Galbraith referred to as "the bezzle".
11/23
Writing off the debt means recognizing the bezzle and allocating the cost to some sector or other of the economy. Contrary to what the author here claims, this was exactly what happened in the early 2000s (the “twice before” to which he refers is really the same thing).
Writing off the debt means recognizing the bezzle and allocating the cost to some sector or other of the economy. Contrary to what the author here claims, this was exactly what happened in the early 2000s (the “twice before” to which he refers is really the same thing).
12/23
As an aside, banks were not recapitalized by the PBoC's foreign exchange reserves. To suggest so implies a misunderstanding of how central-bank reserves work. A country cannot capitalize its banking system with foreign currency unless the country has dollarized.
As an aside, banks were not recapitalized by the PBoC's foreign exchange reserves. To suggest so implies a misunderstanding of how central-bank reserves work. A country cannot capitalize its banking system with foreign currency unless the country has dollarized.
13/23
That's a common but fairly minor misunderstanding. Much more important is to understand the real way the debt was resolved. Remember that during the first decade of the 2000s, nominal GDP grew by 16-20% annually and the GDP deflator was 8-10%.
That's a common but fairly minor misunderstanding. Much more important is to understand the real way the debt was resolved. Remember that during the first decade of the 2000s, nominal GDP grew by 16-20% annually and the GDP deflator was 8-10%.
14/23
Lending rates however were a very low 6-7% and deposit rates were a terribly low 2.5-3.5%. This is the key to understanding how the banks were "cleaned up". Rolling over debt year after year at rates way below nominal GDP growth, and even below inflation, meant...
Lending rates however were a very low 6-7% and deposit rates were a terribly low 2.5-3.5%. This is the key to understanding how the banks were "cleaned up". Rolling over debt year after year at rates way below nominal GDP growth, and even below inflation, meant...
15/23
that the value of the debt for borrowers – along with the real cost of servicing it – dropped sharply every year until debt levels once again became “manageable” for the formerly insolvent borrowers.
that the value of the debt for borrowers – along with the real cost of servicing it – dropped sharply every year until debt levels once again became “manageable” for the formerly insolvent borrowers.
16/23
Meanwhile the banks were recapitalized partly by the debt write-down and partly by the huge government-mandated spread between the deposit rate and the lending rate. (Similarly the Fed or the ECB forces households to recapitalize banks by engineering steep yield curves.)
Meanwhile the banks were recapitalized partly by the debt write-down and partly by the huge government-mandated spread between the deposit rate and the lending rate. (Similarly the Fed or the ECB forces households to recapitalize banks by engineering steep yield curves.)
17/23
So why can't Beijing do it again? Because the cost was probably too high then and would be much higher if it were tried again. Household savers were forced to pay for the whole thing through hidden transfers associated with incredibly low deposit rates.
So why can't Beijing do it again? Because the cost was probably too high then and would be much higher if it were tried again. Household savers were forced to pay for the whole thing through hidden transfers associated with incredibly low deposit rates.
18/23
The IMF estimated the cost of these transfers to be roughly 4-8% of GDP a year, which Beijing was able to impose on households only because nominal GDP was growing at 16-20% a year, and so household income, while a declining share of GDP, still rose rapidly.
The IMF estimated the cost of these transfers to be roughly 4-8% of GDP a year, which Beijing was able to impose on households only because nominal GDP was growing at 16-20% a year, and so household income, while a declining share of GDP, still rose rapidly.
19/23
During this time, however, household consumption dropped from a very low 46% in 2000 to an astonishing 34% in 2010 (it is now around 38-39%). This way of resolving the debt, in other words, was the main source of the deep imbalances that now plague the Chinese economy.
During this time, however, household consumption dropped from a very low 46% in 2000 to an astonishing 34% in 2010 (it is now around 38-39%). This way of resolving the debt, in other words, was the main source of the deep imbalances that now plague the Chinese economy.
20/23
By reducing the role of consumption in driving growth, ironically, this also forced the Chinese economy to rely even more on the debt needed to fund the bad investment that drives further growth. The idea that Beijing would want to do this again is unrealistic at best.
By reducing the role of consumption in driving growth, ironically, this also forced the Chinese economy to rely even more on the debt needed to fund the bad investment that drives further growth. The idea that Beijing would want to do this again is unrealistic at best.
21/23
Moreover with debt levels 2-3 times higher relative to GDP than what they were in 2000, and nominal GDP growth rates less than half of what they were, it would much harder, if not impossible, to force households once again to absorb the cost of cleaning up the debt.
Moreover with debt levels 2-3 times higher relative to GDP than what they were in 2000, and nominal GDP growth rates less than half of what they were, it would much harder, if not impossible, to force households once again to absorb the cost of cleaning up the debt.
22/23
I could go on, but the point should be clear: we have know since at least the mid 19th century that when bad debt is the result of using debt to fund bad investments that have not yet been written off (the "bezzle"), as China's debt experience of the 2000s clearly...
I could go on, but the point should be clear: we have know since at least the mid 19th century that when bad debt is the result of using debt to fund bad investments that have not yet been written off (the "bezzle"), as China's debt experience of the 2000s clearly...
23/23
shows, their resolution will require the recognition of those losses, and this means that they must be allocated to some sector of the economy or other. This is why bad debt can be so difficult to resolve, and the Beijing regulators clearly understand this.
shows, their resolution will require the recognition of those losses, and this means that they must be allocated to some sector of the economy or other. This is why bad debt can be so difficult to resolve, and the Beijing regulators clearly understand this.
I should point out that this tweet may help explain part of the longer tweet.
https://twitter.com/michaelxpettis/status/1417054801695760395
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