China’s Debt Bubble Raises Fears of Hard Landing

For more than 10 years, China’s economy has been the backbone of world growth. A few months ago, the country’s stock market experienced a big crash sending industry experts into a prediction tizzy. Some claim that if the nation’s economy comes to a halt, countries that depend on their trade agreements with China should prepare for a major recession. Other experts state that it’s not the country’s stock market woes that are cause for concern. Instead, apprehensions should lie with China’s debt bubble as crashes involving these economic conditions are likely to have lasting effects and take years to repair.

A Rocky Start

Since the beginning of 2016, Chinese markets have experienced major turbulence for a number of reasons. These include the yuan becoming weaker than the U.S. dollar, stock exchange suspensions and uneasiness about approaching share sales by key stakeholders due to an expiring ban on these types of sales.

When Do Debt Levels Become Scary?

In China, the debt against the country’s Gross Domestic Product, or GDP, is estimated to be at around 200 percent. This percentage has been financing the country’s remarkable growth rates. While the percentage is worrisome, it’s important to note that some countries have had higher debt levels than this, and they have been able to sustain them without facing an economic crisis.

For China to follow suit, the country will need to figure out how to expand its economy without borrowing. If it cannot, then at some point, the debt amount will reach crisis levels. The disconnect between China’s stock market and the country’s actual economy is another problem. From June 2014 to June 2015, the stock market rose by 135 percent, but it crashed by 50 percent between the end of 2015 and the beginning of 2016.

Falling property prices are another indicator of the problems that China’s actual economy is facing. During the later months of 2014 and throughout 2015, property prices fell steadily. It would seem that the long predicted Chinese housing market deflation is currently in the works.

A Tough Situation for Policymakers

China’s policymakers have a lot on their plates. First, they need to deal with the volatility and the instability of the stock market. Policymakers also have to limit capital flight while figuring out how to cut interest rates, stimulate the country’s domestic economy and maintain growth with a stimulus package. Policymakers also need to free up the country’s currency without causing the yuan to plummet.

About China’s Debt Problem

In recent years, local governments, Chinese banks and business organizations have relied on different types of debt channels that have been sold directly to individual people through a network of financial institutions referred to as shadow banks. With this kind of arrangement, a financial institution establishes a trust company. This organization borrows funds from individual investors. It does this by selling them securities that are mainly high-yield junk bonds. The earnings on these bond sales are usually invested in real estate or in businesses that develop real estate like construction companies.

By supporting and allowing a shadow banking system, China has facilitated a major bad debt buildup. Most of it is tied to real estate, which is what makes the recent drop in property prices a scary situation. Falling property prices will bankrupt trust companies leaving banks on the hook for their debt. This will also create conditions that are especially damaging to the economy.

Learning from Japan’s Crash

China’s stock market fluctuations are likely a symptom of the culmination of its debt that’s been fueled by property-based expansions. Japan experienced a similar collapse during the late ‘80s when the Nikkei 225 fizzled and crashed. After the carnage, industry experts were able to determine that it was actually Japan’s housing market that undermined the country’s economy and caused it to breakdown.

China is likely facing one of two possible consequences from its debt woes. The first scenario involves many of the country’s enterprises becoming deeply indebted to the point where they will be unable to repay their debt. This will cause them to default, which will damage the economy. The other possibility is that the government could use its fiscal resources to support and save these companies from going bankrupt. This option is likely to disrupt the country’s growth.

Watch and Wait

China’s policymakers have time to develop a plan to avert a debt crash. If they fail, those who are in charge of developed economies will be paying close attention to see if their country’s own fiscal health will suffer. The only thing to do is watch and wait. For more details about China’s debt struggles, visit the Personal Money Store.

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