Is No One Safe???

Considering that it has a reputation for being the ultimate creditor (it holds about 1.2 trillion USD of U.S. debt), it’s hard to believe that China is a big-time borrower itself.

China claims that its debt-to-GDP ratio is at 17%, but like many, I’m not buying this figure. Estimates from several independent analysts say that if we were to consider China’s enormous local government debt, its ratio would actually reach the 80% range. That basically puts it in the same ballpark as Portugal (83%) and the U.S. (79%), and we all know those two countries are neck-deep in debt doo-doo!

Et tu, China?

Even large credit rating agencies are feeling more and more iffy about Chinese debt. Just this week, Fitch sounded the alarm on China’s debt rating. After revising its outlook on China’s debt from “stable” to “negative” in April, it warned that it may also downgrade its AA- status.

Adding to that, Moody’s says that China’s local government debt may be underestimated by as much as 530 billion USD, and that 8% to 12% of the total may prove to be uncollectible. You don’t have to be a genius to figure out that loaning money to people who can’t pay is bad for business, or in this case, the economy.

How did China rack up so much debt in the first place? To answer that, we’ll have to go back in time to 2008, the start of the global financial crisis. To the DeLorean, Marty McFly!

Like most major economies, China tried to stave off a huge economic slowdown with a huge stimulus package and easy money. It basically tried to spend its way through the crisis, and to a certain extent, we can say that China succeeded. After all, it led the way for global growth during the crisis and managed to expand by over 9% annually from 2008 to 2010. But its growth came at a price.

With loose credit conditions came heavy borrowing. Local governments basically went crazy for loans. However, the money that was borrowed wasn’t always spent wisely. Rather than being spent on education and health programs, most of the easy money went to infrastructure. You only need to google “China’s ghost cities” to see that many of those investments turned out to be total duds. Consequently, many debts went bad and are now uncollectible.

So in not so many words, China boosted its GDP by making money cheap and increasing spending, but it also racked up truckloads of debt and made bad investment decisions in the process.

As a result, concerns about a Chinese default have been on the rise. But let’s be real, the chances of that happening are very slim. What we should be worried about is that there will come a point in time when China will HAVE to face and wrestle its mountain of debt.

It can’t just let its bad debts keep growing. It will have to act in one way or another, and its actions could result in a major economic slowdown, as many have already anticipated. It may decide to temper spending or perhaps tighten credit further. Whatever the case may be, it could have bone-chilling repercussions on economic growth.

Its expansion was ridiculously strong over the past three years. Heck, it was during this period that it overtook Japan to officially become the world’s second largest economy. But the question that begs to be asked now is, “Should we expect an equally strong crash?” Let’s hope for the global economy’s sake that the answer is “No.”