January 11, 2016
Has the world run out of credit boom and credit busts?
The reason I ask this question today is because China is having its own bust. The culprits are the same as usual: too much lending; too much borrowing; too much optimism and too little foresight. As Led Zeppelin might say, the song remains the same – we’ve all seen this before, we know the chorus and we know how the song ends.
The great Chinese credit boom of 2008 to 2015 was the fifth major global credit boom/bust episode of the past 25 years. It is now over, with dramatic consequences. It’s worth looking back at recent history to see how we never, ever learn.
The first major splurge was the Japanese boom/bust of the late 1980s – leading to a ten-year recession in the land of the Rising Sun. This was followed or coincident with the American “saving and loans” boom/bust disaster of the early 1990s. Did we learn? Not on your nellie. We simply changed direction.
The next great credit crisis came in Asia in 1997, but it was building from almost the day the American savings and loans banks collapsed. The Asian credit boom lasted from 1992 to 1997. Then it imploded.
This was followed by the dotcom 1998-2002 boom/bust, which wasn’t so much a credit boom as a stock market jamboree financed by other people’s money which ultimately went sour.
In 2002, we saw the beginning of the mother of all boom/busts when America, Britain, Europe and, of course, Ireland, decided that borrowing was the road to riches. This sorry cycle collapsed in 2008 – and we all know the story.
In 2008, the only country with no debt was China. However, terrified that the rest of the world wouldn’t buy its exports, the Chinese started their own credit extravaganza.
In late 2008, after the collapse of Lehmans, when the world economy went into spasm, no country was more potentially exposed than China, despite having no internal debt.
The reason for this is political. For the Communist Party to survive, it had to ensure no social tensions – the type of social tensions that come with recessions.
Beijing was determined not to make Moscow’s mistakes of the 1980s. Therefore, control of the economy was paramount. It couldn’t allow the Chinese economy to be dragged down with the Americans and Europeans.
Unlike most countries, China had money in 2008. While countries like Ireland needed other people’s money to survive, China had the cash. Having spent 20 years exporting to the world and building up massive foreign reserves, the Chinese government had money to spend. And they spent it.
After the global financial crisis, China pumped four trillion yuan ($586 billion in 2008 US dollars) into its economy to protect it from the global fallout.
The story of what happened next will be familiar to everyone in Ireland. The double-digit growth attracted foreign investment and as all this cash came in it drove up prices. Everything looked brilliant.
China has experienced the triumvirate that Ireland knows too well – (1) easy money, (2) easy lending leading to (3) easy growth.
The result tends to be too much investment, too much optimism and then too much extra borrowing. Again, think of the dynamic in boom-time Ireland.
With everything going up and everything looking rosy, all sorts of investments looked attractive and the sky was the limit. Easy money begat yet more easy money. Chinese companies borrowed from “everywhere”; and “everywhere” was prepared to lend to Chinese companies. The whole world was beguiled by the “Made in China” idea. This is now coming to a shuddering end.
But the Chinese boom of 2008-2015 has changed the world, because during this period the traditional moniker to describe the Asian giant has changed. Now it’s much more accurate to describe the relationship between China and the world not so much “Made in China” but “Sold to China”.
After ten years of hyper growth fuelled by borrowing, China is the world’s largest consumer of copper, steel, iron ore, cars, aluminum, mobile phones, nickel, rice, cigarettes, meat, Swiss watches, television, rubber, potash, energy, robots, beer, red wine, machine tools, dried milk, wheat, rare earths and coal, as well as many of the luxury goods that we associate with Europe and the US.
Because of China’s seemingly endless demand for everything, many companies – and entire countries – have tried to build their business and economic strategies around selling to China.
Over the past few years, China’s borrowing has exploded. Today there is a huge $28 trillion of debt in China. This is the problem now. China is deeply in debt. Even though the debt is largely internal, it still has to be paid.
When the economy is growing at 8 per cent per annum, debts don’t matter so much. But when the economy slows quickly, debts become not only material, but hugely and horribly significant.
Now the process of too much debt, leading to bankruptcy, leading to more panic will take hold – as it did in Ireland. Good companies with too many debts will become bad companies with too much debt overnight. The money that flowed into China will flow out and the growth rate will fall. The problem for China is that after years of 7 per cent growth, a 4 per cent growth rate will feel like a recession.
We know in Ireland what happens to human nature when things suddenly turn for the worse. The Chinese are no different. Years of ridiculous optimism are followed by a bout of irrational pessimism. We are seeing this now in the Chinese stock market, with greed rapidly giving way to fear. This torpor will spread to the real economy too, as it did in Ireland.
We’ve seen the story before. We know how it ends. Is it any wonder that financial markets are in spasm?