Thread by @michaelxpettis

1/12
A Tsinghua-related think tanks argues that "China should issue 30 trillion yuan in treasury bonds to swap local governments’ hidden liabilities to re-energise growth momentum and cut off financial risks at their root."
via @scmpnewssc.mp/gz8bj?utm_sour…

2/12
This would help in two ways, according to the report. It would transfer debt from local government balance sheets to the central government balance sheet, giving them more breathing space to prop up the economy, and it would reduce interest payments.

3/12
But this is what comes of treating a systemic issue incrementally. The problem is not that local governments have too much debt. The excessive debt burden of local governments is actually a symptom of the real problem.
ft.com/content/630f82…

4/12
The real problem is that for over a decade local governments have had to generate enough economic activity to meet an unrealistic GDP growth target, and the only way they could do so was to engage in massive amounts of non-productive investment.

5/12
If this investment had been productive, rapid increases in debt would have been more than matched by rapid increases in GDP, as they were before 2007-09. That this "investment" since then has led to among the fastest growing debt burdens in history is proof that it wasn't.

6/12
The only meaningful way to resolve the local-government debt problem is to reduce the GDP growth target and to recognize and allocate the existing losses within the economy as efficiently as possible. This means, of course, that some sector or other will take large losses.

7/12
This will be painful, of course, but the historical precedents are pretty clear: postponing a resolution of bad debt and overvalued assets always makes it more costly, and the heavier the resulting debt burden, the harder it is to control the way in which it is resolved.

8/12
Transferring local-government debt to Beijing simply means postponing a resolution even further while ruining the only clean balance sheet left in China. Without a clean central-government balance sheet, the Chinese economy will be much more susceptible to disruption.

9/12
What about the argument that at least such a transfer will reduce debt-servicing costs? That too is questionable, and confuses the systemic problem of Chinese debt with the incremental problem of local government debt.

10/12
That's because while lowering interest rates benefits the specific borrower, it does not make the debt disappear. It just transfers the debt servicing costs, in this case from local governments to the banking system, and the banks already urgently need to be recapitalized.

11/12
Every RMB saved in debt-servicing cost, in other words, increases the government's contingent obligations by the same amount, requiring an additional RMB in recapitalization. This is like taking money from one pocket and putting it in another, and declaring yourself richer.

12/12
This is not just a Chinese problem, of course. Most governments will postpone resolving their debt problems as long as they can, but, as Japan showed in the period from the 1980s through the 2000s, you cannot postpone the cost of non-productive investment forever.