Bloomberg View editorialist Mark Whitehouse wonders whether China will produce “the next global financial disaster.” The numbers are certainly ominous: According to a new report published by the (London-based) Centre for Economic Policy Research and the (Geneva-based) International Center for Monetary and Banking Studies, the size of China’s combined public and private debt (not counting financial-sector debt) as a portion of Chinese GDP increased by 72 percentage points between 2008 and 2013, to reach 217 percent overall. The report’s authors — economists Luigi Buttiglione, Philip Lane, Lucrezia Reichlin, and Vincent Reinhart — believe that China’s current debt burden “makes it one of the candidates for the next episode of the debt crises that have plagued the world since the early 1990s.”
It’s important to remember that private debt is often a bigger concern than public debt. Indeed, after surveying the history of financial crises from the 19th century onward, investor Richard Vague and other analysts noticed a recurring pattern: “A major financial crisis is preceded by a run-up in private debt relative to GDP. In fact, there seems to be only one other ingredient required for a crisis: that the absolute level of private debt is high to begin with. We found that almost all instances of rapid debt growth coupled with high overall levels of private debt have led to crises.” With that in mind, writes Vague, China’s ongoing debt buildup should be setting off alarm bells. “Applying our private-debt early-warning criteria to China, we can see that its economy is at risk of a major financial crisis in the near future.”
Recognizing the dangers of private-debt growth is one thing. But what if the global economy has become dependent on credit bubbles in order to achieve adequate levels of demand? Financial Times columnist Martin Wolf fears that may be the case:
“Huge expansions in credit followed by crises and attempts to manage the aftermath have become a feature of the world economy. Today the US and UK may be escaping from the crises that hit seven years ago. But the eurozone is mired in post-crisis stagnation and China is struggling with the debt it built up in its attempt to offset the loss of export earnings after the crisis hit in 2008.
“Without an unsustainable credit boom somewhere, the world economy seems incapable of generating growth in demand sufficient to absorb potential supply. It looks like a law of the conservation of credit booms. Consider the past quarter century: a credit boom in Japan that collapsed after 1990; a credit boom in Asian emerging economies that collapsed in 1997; a credit boom in the north Atlantic economies that collapsed after 2007; and finally in China. Each is greeted as a new era of prosperity, to collapse into crisis and post-crisis malaise. . . .
“[T]he biggest lesson of these crises is not to let debt run ahead of the long-term capacity of an economy to support it in the first place. The hope is that macroprudential policy will achieve this outcome. Well, one can always hope.
“These credit booms did not come out of nowhere. They are the outcome of the policies adopted to sustain demand as previous bubbles collapsed, usually elsewhere in the world economy. That is what has happened to China. We need to escape from this grim and apparently relentless cycle. But for now, we have made a Faustian bargain with private sector-driven credit booms. A great deal more trouble surely lies ahead.”