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The writer, global chief strategist of Morgan Stanley Investment Management, is the author of “The Ten Rules of Successful Nations”
For much of this year, commentators have warned that falling yields suggest the bond market is increasingly irrational, disconnected from a rapid global recovery, and misled by massive central bank purchases or ebb and flow of the pandemic. Now, events in China suggest the bond markets are far from ignorant or crazy.
The world’s most indebted real estate developer, Evergrande, is on the verge of default. Its problems are rippling through the Chinese real estate sector and around the world, revealing a very rational reason why long-term interest rates wouldn’t rise too much: the global economy is heavily in debt and too financially fragile to handle conditions. more stringent credit. We are trapped in debt.
China is stuck at the bottom of this quagmire. As the 2008 global financial crisis approached, debt levels increased dramatically in the United States and in many European countries. Since then, China has led the debt frenzy: Private debt held by households and businesses increased by nearly 100 percentage points to reach 260% of China’s gross domestic product, accounting for almost two-thirds of the global increase.
In early 2016, China was on the brink of financial collapse. Default rates were increasing rapidly. Capital was rushing out of the country. To avoid another global financial crisis, the US Federal Reserve had to abandon its monetary tightening plans and the Chinese authorities had to inject massive sums into the financial system.
Over the next five years, China slowed down much less quickly than one might expect given the level of debt, thanks to the meteoric rise of its tech sector. The new economy, led by private sector digital technology companies, was virtually debt-free and experienced explosive growth. The technology sector now represents 40% of the Chinese economy, up from 20% in 2016.
In the background, however, the debt bomb was still in full swing. After 2016, private debt increased by more than 20 percentage points more as a percentage of GDP, as households took out mortgages at a record pace. Much of it went to further inflate the housing bubble. About 40 percent of the assets of the Chinese banking system are now linked to the real estate sector.
Evergrande’s outstanding debts of over $ 300 billion represent just 0.6% of total credit in China, but the worry in situations like this is always the contagion effect of any default. very publicized. Prior to 2008, the US subprime mortgage market peaked at just $ 600 billion before going bankrupt and threatening to bring down the global financial system.
Most financial analysts argue that China cannot afford to let Evergrande go bankrupt and risk further debt tightening. But this time, politics is in direct conflict with the economy.
Chinese President Xi Jinping is trying to revive a form of socialism reminiscent of the era of Mao Zedong. His government has started cracking down on the excesses of capitalism, including the wealth and power of tech moguls, as well as runaway speculation and rising debt in the real estate industry.
The problem: What happens in China no longer stays in China, which is the main engine of global growth. In many ways, China follows the same model of distorted capitalism as most Western countries, but more so, taking on more and more debt to generate less and less growth.
The result is growing financial fragility. Like its more advanced rivals the United States in Japan, China has created a financial system that is in constant need of government support and stimulus. Policymakers maintain economic growth at all costs and repeatedly forgo policy tightening at the slightest suspicion of economic or financial hardship. Whenever a business of any size runs into trouble, the authorities have stepped in with a bailout. This is especially true in China, where default rates have been well below very low global averages in recent years.
Conditioned to expect the government to step in in time to avoid any crisis, global investors have yet to withdraw money from China. But if Xi were to step away from the past, purging debts and allowing defaults to rise, it could trigger a nervous breakdown in the global financial system.
What we are likely to witness over the next few months is an epic clash between a ruler with supreme powers determined to change the course of his nation and the economic constraints imposed by gargantuan debts. For now, markets are still betting that the stakes are too high, even for a leader as powerful as Xi, to suddenly wean China from a form of debt-fueled capitalism the world has practiced for years.
Letters in response to this article:
China courts uncertain future for its economy/From Professor Louis Brennan, Trinity Business School, Trinity College Dublin, Ireland
The world should stop getting into debt / By Guy Wroble, Denver, CO, US