The zombie apocalypse is near, as China's debt is approaching $30 trillion.
While China has $3.22 trillion sitting in foreign-exchange reserves, it is the credit binge of State Owned Enterprises (SOE) in the property, industrial and commodity sectors that need to be feared. Earlier this month Moody's warned that the SOEs have racked up debts of 115% of GDP, and that 20% may require restructuring.
The SOEs were able to borrow copious amounts, as lenders (incorrectly) thought they had a sovereign guarantee. The mountain of debt is estimated to be twice as extreme as Japan's Nikkei bubble in 1990. Since 2007, the debt is estimated to be greater than the combined outstanding liabilities of the US, Japanese, German, and Indian commercial banking systems.
The Walking Dead
Copious amounts of debt and loss making operations usually kill companies; but not in China. Zombie companies walk mindlessly through the economy.
Over the last few years, the Chinese Government led a valiant effort to reduce excesses, and reform a number of sectors – especially where the SOEs were involved. Local governments had to abandon the job creation initiatives which were often at the heart of these inefficient companies.
No more empty cities, no more excess steel production, no more roads to nowhere. Zombies be gone.
As part of a credibility measure, the Chinese Government lobbied for the Yuan to be included in the World Bank’s Special Drawing Rights basket. This too was part of the broader step to free markets... but there was a catch. They had to de-peg the Yuan. In August 2015, the People’s Bank of China made a clunky step toward a market based mechanism for the Yuan. Stocks fell, and money started leaving the country en masse. SOEs came under even greater pressure as their debt was USD denominated, and rising in costs.
Early this year, some zombies gave up the ghost, and defaulted on bonds.
Since August, the Chinese Government has loosened financial conditions. They’ve cut interest rates, defended the selling pressure on the Yuan, and expanded fiscal policy. This has increased money supply by 22%, the fastest pace since the GFC/Lehman.
With money swishing around in the system, Societe Generale estimate that since the start of this year, total loans rose by $1.15 trillion, equivalent to 46% of quarterly GDP. House sales rose 60% in April, new housing starts +26%, and home prices leapt 63% in Shenzhen alone.
The zombies have had their way to date, but as one commentator puts it “the rot in the country's $7.7 trillion bond markets is metastasizing”. More than 100 firms have cancelled or delayed bond issues in April, and most notable being the AA+ rated China Railways Materials.
Slaying the zombies won’t be as simple as knocking off heads. There’ll be greater risks of contagion into the banking sector and broader economy. Fear the walking dead.