China isn't just contending with falling stocks, a plunging currency and a slowing economy.
It's got vampire trouble, too.
The Chinese economy is pock-marked with companies that can't pay their bills and survive only with government help. Jiangshi, the Chinese call them — "vampire companies." Or zombies.
These ghoulish companies and their debts are hindering the world's second-biggest economy and will likely do so for years. Companies that miss debt payments inflict losses on banks, which then find it hard to lend even to solid companies. By propping up vampire companies, the government can weaken the entire economic ecosystem.
All of which helps explain why the global economy is sputtering and why investors have been gripped by panic.
"It's undoubtedly a very serious problem," says Charles Collyns, chief economist at the Institute of International Finance. "The Chinese so far have been very reluctant to let market mechanisms work their way."
On Friday, as finance ministers and central bankers of the Group of 20 major economies began meeting in Shanghai, Zhou Xiaochuan, head of China's central bank, insisted that Chinese authorities closely monitor debt loads. Even so, he said he expects China's economy "to grow at a moderate-to-high pace."
The debt buildup is vast. Chinese corporations (excluding financial companies) had amassed $14.5 trillion in debt by mid-2015, up 4½-fold from eight years earlier, according to the McKinsey Global Institute.
That debt equaled 131 percent of China's gross domestic product, up from 76 percent in mid-2007. That's nearly double U.S. corporate debts' share of U.S. GDP, McKinsey says.
China's total debts — everything owed by corporations, households, government and financial firms — climbed from $6.6 trillion in mid-2007 to $31.9 trillion by mid-2015. It equals 290 percent of China's GDP, McKinsey says — astoundingly high for a still-developing economy.
When banks lend with a frenzy, they tend to make blunders as they shovel money to companies that can't repay. Buried in bad loans, banks tend to curtail the credit that's vital to growth.
IN MOST respects, double-digit growth is a relic of the past for China. In the third quarter the economy grew by just 6.9% year-on-year according to official data, and probably by a percentage point or two less in reality. Yet bank loans increased by 15.4% in the third quarter compared with the same period in 2014. Having released a torrent of credit to buoy the economy during the financial crisis, China was supposed to have started deleveraging by now. Instead, banks are continuing to pump debt into the economy, while the authorities, apparently worried about the damage a contraction in credit might do, coax them on.
Growth in credit has at least slowed in recent years. A broad measure is “total social financing” (TSF), which encompasses bank loans, corporate bonds and a range of shadowy loan-like products. TSF growth soared to 35% in 2009 when the government called on banks to open the taps and support the then-faltering economy. It has since decelerated: it rose by 13% in the third quarter from a year earlier. The problem, though, is that nominal GDP growth has fallen much lower, to 6.2%.
This means that China’s overall debt-to-GDP ratio is continuing its steady upward march (see chart). Debt was about 160% of annual output in 2007. Now, China’s debt ratio stands at more than 240%, or 161 trillion yuan ($25 trillion), according to calculations by The Economist. It has risen by nearly 50 percentage points over the past four years alone, with slowing growth only serving to magnify indebtedness.
A rapid increase in debt in a short space of time has historically been a good predictor of financial trouble, from Japan in the 1990s to southern Europe in the 2000s.
Remember the dire threat posed by our financial dependence on China? A few years ago it was all over the media, generally stated not as a hypothesis but as a fact. Obviously, terrible things would happen if China stopped buying our debt, or worse yet, started to sell off its holdings. Interest rates would soar and the U.S economy would plunge, right? Indeed, that great monetary expert Admiral Mullen was widely quoted as declaring that debt was our biggest security threat. Anyone who suggested that we didn’t actually need to worry about a China selloff was considered weird and irresponsible.
Well, don’t tell anyone, but the much-feared event is happening now. As China tries to prop up the yuan in the face of capital flight, it’s selling lots of U.S. debt; so are other emerging markets. And the effect on U.S. interest rates so far has been … nothing.
ON MAY 21st China’s finance ministry released details of a new scheme to allow ten wealthy localities in China—Shanghai, Beijing and Guangdong among them—to issue bonds directly for the first time in two decades. Although a small pilot scheme has allowed a few cities and provinces to issue bonds in the past, in practice the federal government issued them on their behalf. So the new scheme of municipal bonds is a radical departure.
The shift comes as China’s leaders increasingly fret about the mountains of local debt that have built up despite the restrictions put in place 20 years ago. Back then party leaders in Beijing were concerned about how recklessly municipal governments were borrowing. Local leaders had binged on bonds and bank lending to such an extent that a crisis loomed. Fed up with the resultant scandals and excesses, the federal government decided to solve the problem by banning local borrowing.
