Will Chinese Private Debt Trigger the Next Great Crash?

Private (non-government) debt of six nations as a percentage of GDP from 1952 (source; click to enlarge).

by Gaius Publius

A quick-hits piece, just to put the idea on your radar. I've been reading for months about brewing trouble in the Chinese economy due to any number of factors, and have been meaning to write this up, since if it comes, the "next great crash" may well have a Chinese trigger that starts it and world-wide private debt that fuels it (click the link above to see why).

The following seems the easiest-to-grasp way to present the idea. It's from a piece that appeared at Naked Capitalism, written by Richard Vague, managing partner of Gabriel Investments. The piece was originally published at Democracy Journal.

Before you read, note the chart at the top. The Y-axis shows private debt (debt held by persons and non-government entities, like businesses) by six nations as a percentage of each nation's GDP. Note the spike in Chinese private debt to 225% of its GDP, up from less than 75% in the late 1980s. Chinese private debt (a) far outstrips the others on the chart at the present time, and (b) has the kind of shape and spike associated with a coming crash, as discussed below.

For comparison, now look at the spikes in Japanese private debt coming into the 1990s, and the similar spike in U.S. private debt in the run-up to 2008.

The piece is long and well worth a read. I'm going to quote just a bit of it, just to make this a clean idea to grasp. Richard Vague writes (my emphasis):

Private debt is a beneficial and essential part of any economy. However, as it increases, it can bring two problems. The first is dramatic. Very rapid or “runaway” private debt growth often brings financial crises. Runaway private debt growth brought the 2008 crisis in the United States, the 1991 crisis in Japan, and the 1997 crisis across Asia, to name just three. And just as runaway debt for a country as a whole is predictive of calamity for that country, runaway debt for a subcategory of debt, such as oil and gas or commercial real estate, is predictive of problems within that subcategory.

The second problem it brings is much more subtle and insidious: When too high, private debt becomes a drag on economic growth. It chips away at the margin of growth trends. Though different researchers cite different levels, a growing body of research suggests that when private debt enters the range of 100 to 150 percent of GDP, it impedes economic growth.

When private debt is high, consumers and businesses have to divert an increased portion of their income to paying interest and principal on that debt—and they spend and invest less as a result. That’s a very real part of what’s weighing on economic growth. After private debt reaches these high levels, it suppresses demand.

Except for Germany, private debt is above 150% for all countries included in the chart, and year-over-year GDP growth, the usual measure, is low (again my emphasis):

The United States is the world’s largest economy. Yet, in the last two decades, like in the case of many other developed nations, its growth rates have been decreasing. If in the 50’s and 60’s the average growth rate was above 4 percent, in the 70’s and 80’s dropped to around 3 percent. In the last ten years, the average rate has been below 2 percent and since the second quarter of 2000 has never reached the 5 percent level.

To put Mr. Vague's point more simply — and more politically — if every banker and corporate creditor must be made whole, with no debt ever forgiven or discharged and each debt paid in full, as the highest priority of U.S. economic policy, our economy — and the world's — will grind to a standstill, a condition of "running in place," since for most of us, the lower 80%, only necessities can be bought while crushing personal debt is serviced yet never discharged. 

Which sets us all up nicely for the "next great crash." Trigger warning: watch China.  

GP