#89: Chinese whispers


Which is the world’s largest economy? Converted at market exchange rates, China ($11tn) is smaller than the United States ($18tn) but, on the PPP (purchasing power parity) basis of conversion widely regarded as superior, China (at $21tn) now takes the top spot.

Be that as it may, there can be little doubt that the economy of China is second to none in terms of its importance to global growth. In local currency, Chinese GDP was RMB 68tn in 2015, four times larger in inflation-adjusted terms than it was in 2000. China has been the primary engine of world growth since the millennium, and most observers, it seems, expect it to remain so for the foreseeable future.

In short, if the Chinese economy were to catch a cold, the world economy would be in for a bout of influenza at best, and could well face the economic equivalent of pneumonia. This is as true of debt as it is of growth – wobbles in China would trigger shock-waves around the world.

There could not, then, be a more important subject than China for evaluation using the Surplus Energy Economics Data System (SEEDS).

Readers will find a downloadable PDF of SEEDS statistics for China at the end of this article.


For China’s army of Western admirers, the conclusions set out here are disturbing.

Most strikingly, Chinese economic growth has, over the last decade, become a hostage to borrowing on a gigantic scale. Though used primarily for capacity expansion rather than for fuelling consumption, this borrowing has had a hugely distorting effect on growth. Were China to cease borrowing about 20% of GDP annually, as she does at the moment, growth would fall back from 6.5% to a trend rate of 3.4%.

There must be limits to quite how long China can go on using borrowing to create growth. Based on reported GDP, debt already stands at 246% of reported GDP, up from 141% just seven years ago. When measured against an underlying GDP figure stripped of estimated debt-funded consumption, the ratio climbs to 384%. On this underlying basis of measurement, the ratio could hit 500% within just five years.

In short, the Chinese economy is following the tried-and-failed Western policy of using debt to manufacture “growth”.

There are clear limits to how much longer she can go on doing this.

GDP and debt

It must be understood from the outset that the reliability of much Chinese data seems questionable. At the simplest level, key metrics like growth and unemployment appear not only remarkably unvarying but are, equally remarkably, always exactly in line with official expectations. Some economic numbers seem hard to reconcile with non-financial, volume indicators.

There are also issues of discontinuity, where methods of calculation seem to change without the data for prior years being restated to match. It should also be understood that international data sources largely replicate these issues, since they are necessarily based on Chinese official statistics.

Let’s start with an indicator always regarded as pivotal in SEEDS analysis – the relationship between GDP and growth on the one hand and, on the other, debt and borrowing. The first chart compares GDP and debt in local currency at constant (2015) values. (Debt numbers used throughout this analysis exclude the inter-bank or “financial” sector which, were it included, would probably lift total debt from RMB 168tn to somewhere nearer RMB 200tn).

1. China: GDP and debt, 1995-2021F

China bespoke 1 GDP & debtjpg_Page1

As the chart shows, a remarkable divergence has emerged between debt and GDP in the years since the global financial crisis (GFC). Between 2007 and 2015, and expressed at constant 2015 values, debt increased by 228%, from RMB 51tn to RMB 169tn. This far outpaced expansion in output, where reported GDP grew by 154%, to RMB 68tn in 2015 from RMB 35tn in 2007.

Borrowing and growth

Of course, percentage changes are important, but what really matters is the relationship between borrowing and growth. This is summarised in the next chart, which shows annual borrowing and growth as percentages of GDP.

2. China – borrowing and growth, 2000-2021F

China bespoke 2 B & Gjpg_Page1

The picture that emerges is quite extraordinary. Over the ten years between 2005 and 2015, GDP grew at rates of between 9% and 14% annually, not even stumbling materially during the 2009 global downturn. But debt has grown by between 17% and 35% of GDP each year, with the exception of 2009, when debt increased by 47% of GDP.

What this means is that, over a period in which reported GDP increased by RMB 40tn, debt expanded by RMB 129tn. This is a borrowing-to-growth ratio of 3.2:1, still reasonably modest by Western standards, but a far cry from past Chinese practice – back in 2005, the trailing ten-year (T10Y) ratio was only 1.67:1.

The Chinese debt model

This pace of change in the trailing average means that the relationship between borrowing and growth merits close consideration. China retains comparatively low levels of household indebtedness, which stood at 39% of GDP in 2015, compared with 79% in the United States, 87% in the United Kingdom and 104% in the Euro area. Households accounted for a modest 18% of all net borrowing in China between 2005 and 2015. Government debt, too, remains low by world standards, at 44% of GDP. Neither households nor the state, then, are bingeing on borrowed money.

But the biggest share of Chinese borrowing by a wide margin is the PNFC (private non-financial corporate) sector, which borrowed RMB 83tn in the decade to 2015, or 64% of all borrowing. This increased total PNFC debt to RMB 112bn in 2015, from about RMB 29tn in 2005, an increase so huge that readers should be reminded that these are constant numbers, adjusted to exclude inflation.

Unlike the Western economies, whose vice-of-choice is to use debt to fund consumption and inflate property markets, the Chinese bias is towards using debt for investment in capacity. In theory, capacity investment should be “self-liquidating”, because capacity increases should increase income, and thus fund the paying off of the initial debt. (This is contradistinction to consumer borrowing, which is “non-self-liquidating”).

But the self-liquidating characteristic of business investment depends on capacity expanding without depressing margins, something which happens when expansion creates major capacity surpluses. It is abundantly clear that Chinese PNFC borrowing has followed the course of excess, depressing returns in the process.

As a result, much of the Chinese business sector earns returns which appear to be well below the cost of debt capital. In this situation, an obvious remedy is to convert debt into equity. This, however, seems to have been tried, and failed, because it showed clear tendencies to crash the equity market.

Of course, PNFC borrowing differs from consumer borrowing, but it nevertheless finds its way into consumption and economic activity. If a business invests in new capacity, much of that investment finds its way into the pockets of households, either directly, through employment, or via suppliers. High investment helps diminish unemployment but, where this investment is non-self-liquidating, the effect is “borrowing to employ”, and this has parallels with Western-style “borrowing to consume”.

The judgment call here is this – how much Chinese borrowing has inflated consumption (and broader activity) artificially, meaning that this activity would disappear were borrowing to cease? The calculation made by SEEDS ascribes only 16% of all borrowing between 2005 and 2015 to consumption, probably a conservative estimate of how much net new debt has been used to inflate activity. Even so, this amounts to RMB 20.8tn, equivalent to slightly more than half of all growth (of RMB 41tn) in GDP over that period.

If that estimate is correct, underlying growth in Chinese GDP over the last decade and more has been far lower than the reported numbers.

As the next chart shows, this calculation puts Chinese aggregate growth since 2000 at 160% (RMB 27tnb) – still impressive, but nowhere near the reported 295% (RMB 51tn). It indicates that underlying GDP in 2015 was around RMB 44tn, a very long way adrift of the reported RMB 68tn.

3. China – reported and underlying GDP, 1980 – 2030F

China bespoke 3 GDP % ULjpg_Page1

For how much longer?

The implications of this assessment are stark.

First, SEEDS estimates current trend growth at around 3.4%, far below official rates of 6.5%. It also trims per capita trend growth to 2.9% from 6.0%.

Of course, China can still record growth rates at or above 6% – but only if the country continues to borrow at recent levels. That would mean adding yet more surplus capacity, and depressing margins still further.

The final sting in the tail of this analysis is that, if underlying GDP is a lot lower when stripped of the borrowing effect, debt ratios are correspondingly higher. On the SEEDS basis of computation, aggregate debt already stands at 385% of GDP (rather than the reported 246%), and is growing a lot more quickly than publicly available numbers indicate, adding around 43% of GDP (rather than 20%) annually.

With the export-based model faltering, and with a great deal of economic activity dependent on borrowing, China may have ceased to be the powerful engine of growth that is so customarily assumed.

4.China – debt/GDP ratios, 1995-2021F

China bespoke 4 debt ratiosjpg_Page1

China PDF

20 thoughts on “#89: Chinese whispers

  1. Pingback: Corruption and economic instability in the news | Peak Energy & Resources, Climate Change, and the Preservation of Knowledge

  2. Spot on.
    My calculation for current Debt to GDP was 355%.
    Great minds think alike!!!

  3. It’s just the standard neoliberal/contemporary corporate model of robber-baron capitalism – replacing the healthy version of genuine competition with government oversight only to reign in monopolistic behaviours & ensure basic services as well as national security. (So not selling off your essential infrastructure to the highest bidder for example) Obviously the historically ‘non-capitalist’ nations have now fully cottoned onto the scam of fiddling the figures so as to borrow as much as possible before anyone notices what you’re up to & by the time you’re rumbled, you have a competitive advantage as the incumbent.

    At the level of an individual, company or nation, once you’re borrowed up to the eyeballs, you can use this unearned money to buy things that are working well off genuine effort & the real economy, then profit off it as much as you can. So take a good viable business, buy it, asset strip it for immediate profit & you now have your own capital after paying off the debt – rinse & repeat with this formula & you’ll die rich. It’s easier & faster than real work & possible to do legally at an individual level, so why is anyone surprised that nation states are scaling up the same practice.

    When this becomes more obvious, it spreads organically & the average punter becomes demoralised, working only to earn what they need, having understood that it’s a mug’s game to work hard/honestly for a living. Cynicism breeds extremism, the vast majority of the population who’re essentially (morally) honest suss out that they’re the patsy at the poker table & give up, the social compact is broken & we have the 1930’s rewound, slide to the re-leveling via total war.

    • Yes, the bottom line is that it’s a con. Elites always end up doing this, and it has nothing to do with political philosophy. Think of the Soviet leaders with their dachas, or the Communist Party Shop – not much equality there.

      Sooner or later, the public get wise to this. First, they ask for reform. Second, if they don’t get given reform, they vote for it. Third……well, third is what happens if they don’t get reform by voting for it.

      Neoliberalism isn’t capitalism – it’s just a grubby heist by the establishment, and in that sense it’s not new, but “as old as the hills”.

    • The Beginning of the End

      JUNE 13, 2003 – There is increasing evidence that massive economic stimulus — monetary, courtesy of the Federal Reserve, and fiscal, thanks to the president and supply-side minded lawmakers — is taking hold. The magnitude of the policy turnaround, which caps a constructive, multi-year reflation process, should overwhelm the economic negatives — including the drag from expensive oil and poor finances at the state- and local-government levels.

      Expensive oil and its impact on other energy costs remains a concern.

      The current level of U.S. monetary stimulus is massive. Real interest rates have fallen 5.2 percent from December 2000 to March 2003, reaching -1.2 percent. A swing of this magnitude may be historical.

      Read more at: http://www.nationalreview.com/article/207227/reversal-fortune-david-malpass

      Around the same time we got this:

      According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices.

      Click to access high_oil04sum.pdf

      The price of oil was lifting off — destroying growth.

      The CBs responded to this growth destruction with massive stimulus programmes — slashing interest rates — pumping up housing bubbles….’whatever it takes’

      All in the name of offsetting growth destruction caused by higher priced oil.

      By 2007 the US and Europe were riddled with economic cancer due to these stimulus programmes — the world nearly collapsed — they were put on economic life support (QE ZIRP)

      And the baton was passed to China.

      If China does not do what is has been doing — we would not be here — we would be dead years ago.

      This has nothing whatsoever to do with elites enriching themselves.

      Think about it — if you are already an elite — then why destroy the system that is responsible for your exalted position?

      These are policies that we have never in the history of the world seen before —- there is no way in hell this does not end in total chaos.

      If I am one of the elite I am not ok with this — it is suicide.

      So why are they doing these things?

      Very obviously they have no choice. ‘

      We are out of cheap to extract oil — the economy cannot function on expensive oil.

      The CBs are juggling a number of balls here…

      – they are playing Goldilocks with the price of oil — not too low so as to bankrupt the industry — not too high so as to collapse the economy

      – even with oil at 50 bucks that is a drag on growth so they need to keep on pouring stimulus into the mix

      – the oil industry is insolvent at 50 bucks — so they have to make sure they can tap ZIRP cash to remain in business

      The rest of the world is on life support — China is going to join them soon enough — when that happens the growth story is over — there will be a deflationary death spiral.

      And we will be dead.

      Of course in the meantime we may get the deflationary death spiral sooner than later — GDP in the US is dropping fast…

      And there are plenty of other potential black swans out there — Japan … the EU…

      We are on the edge of very tall cliff… the CBs are literally fighting for our lives… the Chinese are doing ‘whatever it takes’ to keep the system from imploding..

      It will implode. ‘What cannot go on forever – will stop’

  4. Maybe I missed it first reading, but where or who does China borrow from? Who knows? They don’t seem to be borrowing from outside China [Very Wise!] so the money must be coming from the government itself.
    As anyone who has a handle on the actual mechanics of macroeconomics today knows. any Monetary Sovereign nation can get all the money it needs by buying whatever that nation has for sale, the limit being having stuff for sale and keeping the economy from excessive inflation.

    It does not require a supplier for the money except the government itself and it certainly gets it interest free as well as debt free.
    China’s Communist party knows its legitimacy rests on improving the lives of its citizens, and it has spent big to achieve that, although not always wisely. There is little to stop it from continuing to spend big except eventually the resources themselves may force a stop.

    So it’s conceivable China could demolish all those empty cities and then rebuild them. Wasreful, certainly, but if the Party’s survival is on the line, it will be done.

    • Not much help, unfortunately. All the articles, even this one assume the debt is already created. However as we know the money to pay comes from thin air – IOW “free” but at a cost, such as resources. So when the central bank says to regional banks they can lend “x” amount, the banks simply take up debts [mortgages etc.] to match that amount. So like any MS nation all its money comes from thin air. China’s problem is simply its debts in US dollars. It has to buy them but it can create the payments just like all the rest.

    • I think it’s helpful to remind ourselves periodically that money has no intrinsic worth – it is simply a “claim” on economic output. This is why I emphasise that there are “two economies” – a “financial” economy of money and credit, and a “real” economy of goods and services, labour, energy and resources.

      This much is obvious. But the monetary system determines the allocation, not just of output but also of wealth (real “wealth” being everything from properties and businesses to yachts, but not money, except as a claim). Tinkering with money does not add to output or wealth, but does affect allocation. If someone uses debt to buy something, then evades repaying his debt, that is fraudulent allocation. Like a shell-game, it’s sleight-of-hand – and the bottom line is: in whose hands does the property, business or yacht end up?

      Think of a system (and they still exist) where workers have to spend their wages in a company shop. Irrespective of how correctly they are remunerated in the first place, the “company store” distorts the monetary allocation, to the detriment of the worker.

      Imagine A borrows $1m from B. A uses this $1m to buy a yacht. Then A defaults – and this needn’t simply be a case of A not repaying B. B could be repaid, but in money which has lost its value through inflation. That’s simple “soft” (as opposed to “hard”) default. But there are other variants, too. Interest rates below inflation filch value from B to the benefit of A. Bail-ins can operate in the same way (B may have a “credit” in his bank account, but a bail-in confiscates this to bail out borrowers, i.e. A). Bottom line, though, after the dust has settled, is that A gets to keep the yacht, and B is out of pocket.

    • You are discussing intra personal borrowing. I am talking about monetary sovereign governments. It’s totally different. Buying a yacht just brings it into a bankruptcy event if the buyer defaults. That’s not going to work with a mass default. The Chinese government is not a household operation. You haven’t explained it’s debt problem in your post well yet.

    • My point here isn’t solely inter-personal. Rather, the authorities, faced with an unsustainable debt burden, have several options, most obviously:

      1. “Hard” default – renege on debts – seldom ever preferred

      2. “Soft” default – destroy the value of outstanding debts using inflation – the commonest solution, but not always feasible

      3. “Net off” – use “bail-ins” to transfer value from creditors to debtors

      Mentioning yachts etc., intended to be illustrative, was too flip. But the principle is evasion of liabilities by borrowers, by one of the three above routes.

    • It will be debt jubilee time I think. The Fed can “buy” all the debts, mortgages etc or it can wipe them out. It has unlimited scope under the Constitution. Banks will lose their mortgage documents. Mortgagees will keep their houses. Steve Keen says the Fed can pay to those without a mortgage burden an equivalent stipend, so they don’t lose out. All the insurance deals between banks like CDO’s will be made to disappear as with all financial intra bank deals. They are of no value to the economy so they will not be missed, except by a few bankers. People like with the yacht deal you mentioned will still have to be sorted between individuals. It depends on whether we are in the 8 meal window or not.

    • “any Monetary Sovereign nation can get all the money it needs by buying whatever that nation has for sale, the limit being having stuff for sale and keeping the economy from excessive inflation..”

      The limit is energy stocks. If you print currency without an increase in energy stocks … you are purely devaluing it.

    • who is printing currency without an increase in energy stocks now? no one.
      In the end the planet is a zero-sum equation, but that is some way off into the future and will be the terminal game. In the meantime we can right some wrongs and improve our lot.

  5. “This pace of change in the trailing average means that the relationship between borrowing and growth merits close consideration. China retains comparatively low levels of household indebtedness, which stood at 39% of GDP in 2015, compared with 79% in the United States, 87% in the United Kingdom and 104% in the Euro area. Households accounted for a modest 18% of all net borrowing in China between 2005 and 2015. Government debt, too, remains low by world standards, at 44% of GDP. Neither households nor the state, then, are bingeing on borrowed money.

    But the biggest share of Chinese borrowing by a wide margin is the PNFC (private non-financial corporate) sector, which borrowed RMB 83tn in the decade to 2015, or 64% of all borrowing. This increased total PNFC debt to RMB 112bn in 2015, from about RMB 29tn in 2005, an increase so huge that readers should be reminded that these are constant numbers, adjusted to exclude inflation.”

    How can household debt be 18%, govt 44%, and PNFC 64%? =126%?
    And presumably ‘from RMB 29tn to RMB112bn’ is a typo.

    • I think you may be confusing debt-to-GDP ratios with share of aggregate borrowing?

      At the end of 2015, total debt was RMB 168 tn, or 246% of GDP. Within that 246%, government was 44% of GDP, households 39% and PNFCs 164%, adding up to 247% (small rounding error).

      Between 2005 and 2015, total borrowing at constant values was RMB 129tn. Within that, government borrowed RMB 23tn, households RMB 24tn and PNFCs RMB 83tn, adding up to the RMB 129tn borrowed. Of the amount borrowed, government was 17%, households 18% and PNFCs 64%, adding up to 100%.

      Perhaps I should have made this clearer.

  6. Doc, thank you for providing excellent info about whats going on. Your cold hard numbers confirm my thoughts. Maybe not THAT hard, but hard enough to see savers pulling at the short end.

  7. A strange air of normality. When I read the newspapers business sections – the stock markets are at a record high – I then turn to oil and websites that say that there is enough to economically recover until 2050 although it probably never will be because as it gets more expensive other energy sources will become economic.

    There’s mergers going on – car production seems sound – Trumps is going to massively expand his spending on the military – and yet……we seem to be sitting on a time bomb which is about to go off.

    Are our governments paying the media to portray an air of normality to avoid mass panic?

    Apart from the posts on here – which I have taken careful note of – the other site which highlights our predicament is ‘The cubic mile of oil’ – which states how difficult it will be to replace the energy produced by oil.

    Now should I live the dream – so to speak – and keep on living as I am or go to my local store and buy some carrot seed.

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