Looking at credit charts makes you a China bear, and here is the one that usually scares people*.
It is a scary chart! Increases of private credit/GDP of this magnitude has generally meant trouble, EM or DM. An increase of 38.0% since the lows in November 2008 screams ‘crisis’, in fact, as it is hard to imagine that much credit expansion without over-leveraged balance sheets, non-productive investments, and a possible Minsky moment, by which one has to take on debt to cover interest rate expenditures [other credit charts of China are equally scary. Here are two from Goldman; here is one with EMs ranked, as always data is different from database to database!]
So are we going that way? My bet is no.
I wasn’t always this chipper about China. In fact go back six months and I thought the above mentioned chart spelled ‘doom’. I don’t anymore, and I can explain why with two charts.
First, as anyone who have studied the Asian Crash of 1997-8 will know, what made it close to inevitable was the combination of an overvalued currency (pegged) and huge borrowings in non-local currency denominated debt. Here is what I consider the best paper on that. This left the Tigers with the impossibility of remaining on pegged exchange rates, but if they devalued their corporate and banking systems would collapse (and they did). Can this happen in China, which also does some currency management? No.
While short-term external debt has risen in dollars, as a percentage of GDP it has not (red line). This means that it is a very different beast we’re dealing with, insofar as China does not have to decide on its exchange rate on the basis of its banking and corporate balance sheets. Credit is mostly Renminbi denominated. So far so good (and absolutely nothing new here.)
The second graph that has me re-thinking my view on China is the credit/deposit ratio.
While credit has expanded enormously since 2008, so has deposits. Why?
My theory (and I’d be very interested in opposite views) is that China’s credit story is different because of its closed capital account. China’s capital account is closed, and has arguably not been opened much since 2008. Here for example is a paper, “[studying] the renminbi (RMB) covered interest differential – an indicator of the effectiveness of capital controls. It is found that the differential is not shrinking over time and, in fact, appears larger after the global financial crisis than before. That is, capital controls in China are still substantial and effective.“
In other words This Time Is Different because credit has shown up as deposits elsewhere in the system. This is both good and bad. Good because China is still a, errr, relatively authoritarian country and if the Chinese government decide to pull the plug on credit expansion, the credit can be repaid with deposits elsewhere in the system. Simple bookkeeping and China controls all entries. Bad because, well, where is that money? Is it places like here? Is it with LGFVs, which have just said, “we have done stimulus,” and then just done nothing with the money except depositing them somewhere in the banking system? If that’s the case then credit expansion has probably meant less in real life, and more in debt statistics.
The crucial thing in my mind is just the fact that, because one cannot easily move money out of China, deposits actually have to show up somewhere when credit is created. This makes it (i) a whole new credit expansion story, and (ii) much more manageable.
This has policy implications, most notably that China should not move too fast liberalising their capital account, at least not before they are done tackling their credit situation. While money has stayed in China so far, it is not so certain that it would if China opened up. If money started to move out in spades, we could move closer to a ‘classic’ credit binge as the liability sides of balance sheets would have to be borrowed elsewhere. Nobody wants that.
[Update: I should add, as George Magnus made me aware, this does not mean that I think China will do great going forward. Their credit expansion will require a tightening cycle, and a big one, and growth will slow. I just think they have way more tools in the box than most any other countries before.]
* This theory is not at all original and you can find this kind of thinking elsewhere. This is just my write-up. Graphs are mine, though. Also again: data differs wildly in China so you can disagree with charts.