What Record chinese indebtness tells us

Stumbled upon this FT-article yesterday, according to which China’s corporations have more debt outstanding than America’s corporates (whose debt levels also happen to be at record levels, see chart below). It says, that from now until 2018 china’s corporates are expected to borrow USD 20 tn, i.e. more than the size of US gdp (around USD 16 tn.). It is not clear how much of it is due to increased lending and how much is due to refinancing, anyway the number seems high.

This figure just confirms that China has been the largest money printer around and in largely responsible for inflated prices (assets, commodities) globally. Of course this whole monetary expansion is only made possible by record low rates on the USD, the world’s  reserve currency. China’s corporates are mainly bank financed (even most of its corporate bond issuance is held by banks). In a fractional reserve system increasing bank lending usually means creating deposits (i.e. money).

Contrary to what many  think, debt issuance per se is not inflationary. If you buy a bond out of your savings (forgone purchasing power) it is a perfectly fine transaction and NOT inflationary as the money supply stays constant. The story is different, however, if a bank grants loans by lowering its reserve ratio thereby increasing (sight) deposits (by getting a loan your deposit account is credited with the sum). Deposits are money substitutes, i.e. increasing them, increases the money supply. The increased supply of money can then be used to buy assets, commodities or consumer goods, thereby affecting different price aggregates depending on who gets the money first and depending on what he/she intends to do with it. Watching the CPI when most money nowadays is created by the commercial banking system or central bank repo (lending against collateral, i.e. assets) will only get you so far. This is different to some famous past episodes: historically most hyperinflation were characterized by money printing in order to finance government employees directly (Weimar republic, Yugoslavia, Zimbabwe a.s.o.) whose preference was to spend it on (imported) consumer goods, first. In the Weimar republic the striking coal workers got paid straight out of the printing press. Of course, once the inflation culture had taken hold, people started investing in assets in order to conserve their purchasing power (Mises’s “crack-up boom” comes to mind). In former Yugoslavia people started building houses like crazy, right u untill the beginning of the civil war…

Al the major monetary blocks have been expanding their money supply for decades, lately they have been joined and surpassed by the lunatics from Beijing. We live in exiting times…

Chart: the indebtedness of US corporations is not exactly small either – at least if we use history to guide us…

CorporateDebtLevels

Disclosure: short AUD, short CNY

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6 comments

  1. To be meaningful the net debt level needs to be split into fixed-rate and floating rate debt, and ideally visualised with its maturity profile. If corporates have issued long-term fixed rate debt, which has evidently also translated into larger cash balances, ie as yet unallocated capital, then future investment may occur at lower IRR thresholds.
    The technologies that could act as catalysts for an ‘investment boom’ are currently emerging and could be any of e-mobility, blockchain technology, robotics, nanotech, biotech /-engineering etc etc. None of these technologies are already breaking out in a game-changing way like personal computing or internet/email, but each has am equally disruptive potential (see John Mauldin’s newsletters). Nor do they enjoy particularly high probabilities of being the desired “Messiah” catalysts that the fraternity of central banks is praying for. However, for CBs banking on them delivering us from the evil of a destructive recession they are seemingly the best option, which is why QE is being used to buy more time. While this “Renaissance scenario” is improbable, it IS possible and surely the best scenario ideologically constrained institutions like CBs can attempt to steer their respective economies towards.
    The other scenarios all promise a mix of fire and brimstone, which intuitively hold less appeal to non-ultrarational Austrians.

    1. I am not sure whether fixed versus floating is a necessary distinction (although I agree that the information would be useful). Why? Even if you have secured fixed financing for, say, five years and rates go up tmrrw. you will still be percieved as distressed by the market, as it is easy to tell when you need refinancing and whether you can pay the new(higher) interest rates. The situation is different if you are able to repay the debt at maturity, of course. But the questio is: given the low capex levels, where is the additional cash flow goint to come from, with which to repay the debt – stock buybacks do not increase the debt service capacity of the firm.
      Also please do not forget that the aggregate figures (total debt, cash balances) hide a lot of important details: those companies with the highest cash balances (the Apples, Googles a.s.o.) are the ones with no net debt. They have never needed bond financing apart for tax-arbitrage or financial engeneering reasons. Yes, corporate cash levels are at an all time high, but those companies that have record debt are generally not the ones that have the cash…

      1. Your points are duly noted. The point I am making lies in the difference between liquidity and solvency – between financing corporate activities using Commercial Paper on a rolling basis or issuing a 10-year bond. The market has learned to differentiate between the two. Low capex has been due to the GFC hangover and a heightened perception of uncertainty due to macro-related themes. The reality in the USA is that capacity utilisation is steadily reducing and in industries that have growth potential capacity is tighter still. With a few more quarters of steady economic growth corporate capex will be well behind the investment curve in this cycle. Companies that have “pre-financed” investment at current low rates will be better placed to invest in the coming 1-3 years, where most likely interest rates will be several percentage points higher.

      2. In my understanding capex has been below average for the better part of the last 15 years, i.e. already pre-GFC. If there is any “heightened perception of uncertainty” I fail to see it: spreads at record lows (absolute yields do barely cover admistrative costs of a bank), stock market has not seen a 10 percent correction since 2011. Greece issues bonds below 5%, Cyprus the same, Greek banks trade above book value despite rising NPL… Given these facts, I am curious how our empirically-inclinded Keynesians are “measuring” (this is science after all) their “uncertainty”.
        The reality: companies do not invest because cost of doing so has been going up for years, notably taxes (comunal, income) and regulation (labour, environmental a.s.o.), whereas the CPI (price of goods to be sold) has not. The biggest cost factor however is invisible (unseen): due to low interest rates there is really no liquidation happening, liquidations would free scarce resources (land, skilled labour a.s.o) enabling (new) entrepreneurs to capitalize on opportunities – zombie companies keep surviving and draining resources – the biggest cost in my view.
        Mainstream economists cannot get this into their head: It is not absolute prices (CPI or PPI), but specific RELATIVE prices, that determine whether a company invests or not…

  2. I beg to differ – Capex has been disappointing since the GFC, not for “the last 15 years”. See http://www.economist.com/news/finance-and-economics/21606329-capital-expenditure-around-world-has-been-disappointing-if-they-build-it
    The uncertainty I refer to is less market volatility based and more linked to increasing regulatory red tape, media hysterisis about the “job-less” recovery and slack demand. This sets up the US to have a lack of capacity in industries that are poised for above-average growth. The result will be that these companies have pricing power and can pass through cost increases to their customers without compressing their margins.

    1. Cyprian,
      I was referring to capex in the US. With the rest I obviously agree, it is just when the Fed or Keynesians generally argue with “uncertainty” they can only mean market volatility (“speculators”), as they usually see nothing wrong with tose things that you and I think to matter (regulation, social security costs a.s.o.)

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