Chinese Debt Could Be the Biggest Cause of Market Volatility
Market volatility does not merely depend on monetary policy. Does the market have a chance to remain bullish? Perhaps. But, there are incendiaries already gathering and all they need is the right trigger to explode. Indeed, the strong stock market performance has swept any setbacks away from the horizon. Everything is going well. But the triggers for a financial catastrophe are there to see, for those willing to open their eyes. And the biggest trigger is debt. Chinese debt, to be precise.
Debt, as in all major crises, has not gone away. It’s merely been swept under the proverbial rug. U.S. debt is over 100% of gross domestic product (GDP). But U.S. consumer debt, from mortgages to auto loans, credit cards, and student loans, is surging. Debt has fueled the so-called recovery, and the rising interest rates—however, slow the pace of the increases is—will sooner or later reach a breaking point.
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It was rising interest rates in 2004-2007 that prompted many subprime mortgage holders to default. They borrowed at a low initial rate only to discover that they could not make the payments once rates increased. The U.S. debt crisis is but one of the triggers. Then, there’s the problem of China and its debt.
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China has been one of the greatest accumulators of debt over the past few years. China has bought U.S. Treasuries, helping to support the U.S. dollar. But how long it can keep going is anyone’s guess. The day of reckoning could come at any time. The Chinese economy is highly laden with private debt, estimated at 260% of GDP. Few countries have reached this level of indebtedness without cracking sooner or later.
For this reason, its highest authorities are constantly working to tighten financial conditions. But China has not learned any other way of financing growth other than debt. The moment it decides to change by stopping its reliance on debt, it would affect the U.S. economy as well.
All That Glitters Is Not Gold
The thriving growth of the Chinese economy and GDP, which have also suffered from recent slowdowns, conceal within them a huge danger that could become a systemic threat and risk to the global economy.
Most of China’s debt is public; it accounts for over half of the total. But the rest is what’s more troubling. Despite being a nominally Communist society, households, businesses, and the financial sector have accumulated an ever-growing amount of debt. Indeed, the Chinese economy depends on it. The economy cannot grow without it.
This has generated an explosion of risk that has already started to trigger many private defaults. But, the more debt grows, the less effective it remains as a tool for growth. That’s because while Chinese debt has been rising vertiginously, Chinese GDP has slowed down for the past three years in a row. This also means the Chinese economy is much less efficient.
Indeed, the time may have come when we should start to expect Chinese GDP to drop below six percent. In fact, this is already happening. Going somewhat further, let’s imagine China stops growing altogether. If that were to happen, it would cause a major dent in global growth, lowering average GDP levels to a level that many would consider a global recession.
China’s Economy Could Simply Stop Growing
It seems impossible to even ponder the question of whether it’s really possible that the Chinese economy might stop growing. But, in 2007, did it seem possible, except to a few insiders and the sharpest analysts, that the U.S. economy could grind to a halt and that such investment banks as Lehman Brothers Holdings, Inc. would collapse?
Such a prospect is hardly reassuring. There is a combination of China’s economy slowing down to a point where it might cause a global recession and the increasing risk of a major market crash on Wall Street. This is clearly an explosive mix that could make 1929 and 2008 look optimistic by comparison.
But, hidden from view, as the world focuses on Wall Street, the Chinese economy has grown to the tune of debt. When the financial crisis exploded in 2008, its debt ratio was relatively low, something like 170%-180%. That is high, but not as high as the current levels. Yet, many businesses in China are going to default, just like their counterparts in America or Europe.
Then there’s the way the debt has been spent. Much of public and private debt has fueled a giant real estate bubble in China. That is clearly one of the triggers of the implosion of the Chinese markets. The summer of 2015 and the early weeks of 2016 offered a glimpse of the Chinese market volatility and how it might react to an imploding bubble: not very well. Thus, when it does erupt, the Chinese real estate bubble will drag the rest of the Chinese economy along with it, starting from the financials. Then, there will be a sudden halt of consumption and investment.
But, a Chinese financial crisis would take mere moments to spread to other parts of the world. Inevitably, Wall Street would be affected. Direct consequences would be felt in the United States and Europe, not to mention the raw material suppliers of Russia, Canada, New Zealand, Australia, and Brazil.
Oil demand would collapse, dragging oil prices down to unsustainable levels, compromising the economic distribution systems in the Gulf petro-monarchies. That would result in a massive surge of political risk. In other words, China’s market volatility is today what America’s was in 2007. An implosion of its market will drag the world economy into crisis.
