Who does China owe money to?

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We all know that the U.S. owes billions of dollars to China – but China is also taking on a debt burden that may prove to be its undoing

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It’s a funny world we live in.  Yes, technically the United States “owes” China billions of dollars since China has bought billions of dollars worth of U.S. treasury bills as an investment for the huge trade surplus it has developed over the years.  China is the largest exporter to the U.S.

Is this something the United States should be worrying about?  Yes, but more because of the debt the country is piling on and not because of who Americans owe it to.  Treasury bills, after all, are unsecured loans and China can do nothing to call them in if the U.S. government chooses not to pay up. 

Meanwhile, China has been amassing an enormous debt burden of its own.  It doesn’t owe this money to a foreign country but to itself.  China’s government debt totals apprixmately US$ 4.3 trillion and the creditors are mainly Chinese households. 

What’s up with China’s insatiable hunger for credit?  It’s mainly driven toward ambitious infrastructure projects – think the Three Gorges Dam but also numerous schemes of more dubious value, plus ghost cities.  As described in a Barrons article by Jonathan R. Laing,

. . . mountain ranges of empty apartment buildings that rim Chinese cities large and small, a giant gold-colored statue of Mao, replicas of Beijing Olympic stadiums in third- and fourth-tier cities, bullet trains and toll roads far too expensive for the average citizen to afford, redundant international airports and deepwater ports with little or no business, opulent high-tech centers with no tenants, and exposition centers in improbable locations that sit largely empty throughout the year.

Is there anything necessarily wrong with this credit-fueled explosion of growth in infrastructure?  Won’t it all just even out in the long run as China’s standard of living rises.  Won’t the impoverished in the countryside gradually get wealthy and move into these empty townhouses?  That’s obviously Beijing’s idea but the complicating factor is entrenched corruption and skewed incentives in China’s society, which is dead set on piling on debt with little regard for the inherent risk.  As Laing writes,

In the dog-eat-dog economy, rent-seeking by insiders trumps the public interest. Moral hazard lies at the heart of the system, allowing those with political clout to take risks with the conviction that the state—and ultimately the general public—will always bail them out.

Whether China’s government has a handle on this growing problem and whether it will spill out of China and affect other countries is debateable.  On the one hand, the same Chinese households, developers and home buyers who are the creditors for the government’s debt burden are also amassing debt of their own in order to further inflate China’s property bubble.  From Laing,

Indeed, prices have become untethered from local incomes or even any basic need for shelter. Typical investors regard town houses and apartments as pure financial investments and often buy multiple units they don’t bother to live in or even rent out. The latter is deemed to only diminish eventual resale value. The homes are merely stockpiled by investors, whether citizens, [state-owned enterprises] SOEs, or banks, in the conviction that growing urbanization will bail them out.

In a manner reminiscent of the collapse of 2008 in the Western world, the imminent collapse of China’s property bubble could spell doom for China’s broader economy.  Laing predicts,

Any major collapse in this most speculative market would have a major impact on the Chinese financial system. Credit directly tied to housing sits at about a third of GDP. Much household wealth would be vaporized.

And because foreign direct investment by Chinese companies now exceeds FDI coming into China, there are concerns that evaporating wealth in China will adversely affect the economies of other countries.

Other analysts, like Chi Lo, also in an article for Barrons, are less pessismistic about the likelihood of China’s debt problem developing into a full-blown global crisis.  Lo argues that because China’s banking system relies on household and private corporate creditors as opposed to the wholesale fund market and since these creditors are backed by the government through implicit guarantees, there’s little risk in the near future of a loss of public confidence leading to crisis.  The government also has “ample financial resources” and “little foreign debt” – all of which buys the government time to make the structural reforms necessary to avert a crisis. 

In any case, debt-addicted America as a counterpoint to frugal China is no longer valid.  China has enthusiastically joined the Western world in its reliance on credit-fueled growth.

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One thought on “Who does China owe money to?

  1. This is very interesting. Having covered two major financial crises in the US (1988 savings & loan collapse for UPI and the 2008 collapse of the subprime mortgage instrument for BNA) this gives me a chill of recognition. When any market sector is riding on air expect a crash. Yet this one is strange. It’s almost a case of too much real property in too few hands rather than too little value in too many underfunded hands. So if a collapse comes it will be a case of too much property chasing too few buyers and a resultant collapse. In a controlled economy the fall could be cushioned to some extent but the middle-class investor could still suffer devastating losses.

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