The Chinese Solution for Too Much Debt? More Debt

During the first quarter of the year, China’s debt grew to 237 percent of its gross domestic product or GDP. While this level matches that of the Eurozone or the United States, it’s much bigger than the debt levels of most developing economies. What is the Chinese solution for too much debt? Clearly, it’s more debt.

The Chinese Solution for Too Much Debt? More Debt

Economists report that China’s ratio of debt to its GDP has grown at a worryingly fast pace while its economy is slowing down. Toward the end of 2007, the country’s debt was 148 percent of its GDP. How will China’s debt affect the health of its economy? According to investment professional George Soros, the country’s current situation is likely to cause a financial meltdown that’s akin to the one that happened in 2008.

Instead of taking steps to mitigate the situation, it seems that China intends to continue down the path to financial ruin. For instance, the country is using the same stimulus tools that caused its financial mess to begin with to delay the consequences of a slowing economy. Meanwhile, China’s decision to continue these practices is increasing its debt.

How much debt is too much for China? AEI reports that it is an amount that prevents the country from enacting tough reforms. Financial experts in the United States realized that China had a debt problem in 2015. The country initiated the debt problems in response to the global financial crisis that occurred in 2009. China’s response to a severe contraction in demand was to create the largest credit stimulus in history. This turned out to be a major mistake.

It Will Be Years Before an Acute Debt Crisis Arrives

Despite the warnings, a critical debt crisis is years away. Major institutions continue to do business even when they experience persistent losses. In addition, speculators are not able to attack them directly. Last August, the country’s economy gained worldwide attention when outflows gathered speed. These outflows consisted of people and institutions moving their money to other investments. However, that moment of outflow along with another one that occurred in January happened because of a poor exchange rate policy.

The country’s financial experts attempted to tweak the dollar peg without clearly conveying their preferred valuation. This uncertainty caused yuan-holders to unload their investments. Unless China makes another error of this size, additional outflow is likely to be limited.

China is Facing Three Big Problems

China’s massive debt has created three major problems. The first one is that the majority of the stimulus money has gone to only a few of the economy’s sectors, which are steel, housing and cement. The added money in these segments caused a glut that is sending prices too low for companies to make profits. In a traditional economy, this situation would be a bankrupt one, but China does not operate traditionally. The government has complete control of the banks, so it can dictate when they should lend, borrow or restructure.

The second problem that the country is facing is that it’s lending out so much money so quickly that a large amount of these funds are going to people who are unable to pay them back. Reports show that nonperforming loans make up about 14 percent of China’s GDP.

The country’s last and largest problem is that it hasn’t taken steps to address its debt troubles. Every time the country’s economy slows down, the government opens up lending. It’s already in so much debt that new loans are covering old ones instead of paying for new projects. Because of this, the country is getting less growth from its loans than it was in the past.

China is currently running its economy like a Ponzi scheme. The Washington Post reports that China’s inclination to borrow excessively from shadow banks like trading firms is making the situation appear better today at tomorrow’s expense.

China’s Solution to Growing Debt and a Slowing Economy

At this point, the only way for the country to fix its debt problem is to enact deep pro-market reform. Instead of spouting rhetoric that they don’t intend to implement, officials must make a major shift toward full labor mobility. China needs to do this to offset a workforce that’s shrinking due to an aging population. The country is sinking under its financial obligations. To learn more about China’s solution to its debt, visit the Personal Money Store.

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