The Private Debt Crisis


The Private Debt Crisis

There’s a Surplus of Worry About Debt


Last time when we read Montier’s report about macro myths, there is a great picture that shows that it is always the appearing of private sector deficit that got us in trouble.

And according to Noah smith’s newest bloomberg view, actually “there continues to be a steady drumbeat of editorials and essays warning about the danger of too much private debt. ” 

For example,


Richard Vague claims that “one of the key and largely overlooked reasons for this disappointing growth is the increasing global burden of private debt—the combination of business debt and household debt.”


Here, he want argue that “when too high, private debt becomes a drag on 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.

As soon as I saw these words, the lowest interest rate in the history jumped into my minds.

But obviously Vague did not dismiss that, “most middle- and lower-income households (which is where the highest rate of debt growth has been), as well as most small- and medium-size businesses, pay interest rates much higher than money market rates. And in addition to interest, all these borrowers have to pay down the principal balance of the loan. Moreover, though their rates may be lower, all of these borrowers are now in a world where increases in income and revenue are harder to come by.”

However, question still exists. China’s recent case shows debt concern make sense, but it looks like a reversing causality: it is the slowdown that draws concern on debt. So does Japan’s case.

Beside of growth,  just like we’ve mentioned, the biggest problem of private debt is “very rapid or “runaway” private debt growth often brings financial crises.”


Given to Vogue, that is because so much lending occurs that it results in overcapacity: “Far too much of something is built or produced—housing and office buildings are two examples—and too many bad loans are made.”

This makes sense if we think about China’s infra investments.

Vogue says “china’s skyrocketing private debt ratio brings a level of overcapacity that makes a continued slowdown in its growth inevitable in order for demand to catch up to a now-staggering oversupply of housing, commodities, and other items.”

And “China is compounding the problem by fully continuing to overlend and overproduce, albeit with diminishing returns. China’s nongovernment loans have grown almost a trillion dollars in the most recently reported period alone, and they are still producing 40 percent more steel than the world needs. In continuing this trend, the Chinese are taking a problem whose size and scope is unprecedented and making it all that much bigger.”

According to this, the world economy is doomed with low growth and deflation.


Japan maybe the future of China, which means a painful deleveraging in private sector balance sheet and a leveraging of government.. After all, governments can always resort to printing money, while households and businesses can’t.

The easiest and most direct way to solve the problem is to cut consumer debt and thus increase consumer spending (or demand) . And the easiest way to cut consumer debt is to lower the interest rate. China still has the potential to accomplish this target, though there are other problems remained in the supply and demand side.

However, Noah’s article doubted about the private debt story .

1.private debt has to be paid back at the individual level, but not in aggregate. Debts net out.

<- If I borrow $100 from my friend Jessica, Jessica borrows $100 from Michael, and Michael borrows $100 from me, none of us is going to have to suffer or cut back when all the debts get repaid.

This is point that Montier also mentioned. Private debt is not a generation problem.

2.In terms of telling when a recession is going to come, it’s likely that the quality of debt is more important than the quantity.

<- It’s indicators of bad debt, like term spreads and the percentage of high-yield debt that predicts.

However, about the debt problem in china, my favourite Chinese analyst Zhang Huaqiao has an idea that lots of debt in china are just failed government spending.

3.If a trend can more or less continue for three centuries, we should be a little wary about claiming that it’s going to end soon.

<- “How much debt is too much? Somehow, most countries have managed to keep their debt numbers growing overall since the dawn of the modern age. What looked like an unthinkably high debt level a century ago looks safely low in 2016. Will current ratios look similarly low to our great-grandchildren?”

4.Short-term debt trends are little changed or declining for most of the major economies




And one can easily get the following conclusion from this graph.

“China’s private debt levels, especially corporate debt, have increased extremely rapidly in recent years. More troubling, the quality of the credit seems to have deteriorated. That signals that a downturn may be in China’s near future.”

Maybe the graph about new economy in china can offer some relief.




Infrastructure investments in China


China infrastructure investment model under fire

Does infrastructure investment lead to economic growth or economic fragility? Evidence from China

About that China infrastructure paper that is making the rounds


A research at Oxford university finds:

More than half of Chinese infrastructure investments have “destroyed, not generated” economic value as the costs have been larger than the benefits

One argument has always been that infrastructure investment has been a major driver of Chinese economic growth over the past 35 years, 

especially given the fact that recently China relies on state enterprises as policy tool to stimulate economic but been seen as thwarts effort to boost efficiency [1]


The aim is surely to prevent a sharp slowdown.

This time differs from the stimulus launched in 2008, which focused on using credit expansion to fund construction of new factories -> that included an investment boom by private companies, which account for 88 per cent of all manufacturing investment.

By contrast, 72 per cent of infrastructure investment comes from SOEs.

And this is all because currency policy no longer works

see “They are turning Japanese”

But there are also some defenses:

“Strong state-led infrastructure investment does not aggravate overcapacity,” “By creating final demand, it helps digest the inventory of industrial goods, as well as buffering overall investment and GDP growth. “

while “sliding private and manufacturing investment suggests the country has been on the right track of cutting excess capacity”


Therefore a debate is needed over the viability of China’s infrastructure-led growth model. 

The favorite criticize for westerns has always been the debt:

China debt load reaches record high as risk to economy mounts


Although some still insist “At the current rate of expansion, it is only a matter of time before some banks find themselves unable to fund all their assets safely,”


But over long years many have given up an acute financial crisis, rather predict a chronic, Japan-style malaise in which growth slows for years or even decades. [2]


Case of Japan seems somehow convincible


“The most obvious example is Japan after 1990. It had too much debt, all of which was domestic, and as a consequence its growth collapsed.”

Thus, many are now concerned that China’s debt could lead to a so-called balance-sheet recession — a term coined by Richard Koo of Nomura to describe Japan’s stagnation in the 1990s and 2000s.

When corporate debt reaches very high levels, conventional monetary policy loses its effectiveness because companies focus on paying down debt and refuse to borrow even at rock-bottom interest rates.


Let’s turn back to the paper

The core of the paper is an examination of the performance of individual infrastructure projects in China, which the authors compare to projects undertaken in other countries.

They find that infrastructure projects in China often cost more and take longer to complete than expected, and that planners often do not accurately forecast demand for the completed projects.



The basic ideas are:

“Far from being an engine of economic growth, the typical infrastructure investment fails to deliver a positive risk-adjusted return”

Hypothesis 1. Due to a propensity to cost overruns and benefit shortfalls, the typical infrastructure investment destroys economic value.

“Poorly managed infrastructure investments are a main explanation of surfacing economic and financial problems in China. We predict that, unless China shifts to a lower level of higher-quality infrastructure investments, the country is headed for an infrastructure-led national financial and economic crisis.” 

“It is a myth that China grew thanks largely to heavy infrastructure investment. It grew due to bold economic liberalisation and institutional reforms, and this growth is now threatened by over-investment in low-grade infrastructure” [3]

Three quarters of all projects suffered a cost overrun, which has exacerbated the debt problem



They estimate three quarters of all projects suffered a cost overrun, which has exacerbated the debt problem ->  a third of China’s $28.2tn debt load is attributable to such overruns.


“China’s relatively low official government debt-to-GDP ratio understates the actual debt burden the government carries for the following two reasons: corporate borrowing (125 per cent of China’s GDP) and financial institution borrowing (65 per cent of China’s GDP) are dominated by state-owned or state-controlled entities. The liabilities of these state-linked entities are ultimately governmental in nature if a liquidity crisis were to manifest.”

Ok no more debt, let’s check the infra itself

“The study is based on a sample of 95 road and rail infrastructure projects in China between 1984 and 2008. “


Here’s a big but basic problem that one could dissent: they are roads and rails!

“Even if an infrastructure project does not directly generate enough cash flow to cover its financing costs, they argue, positive externalities can spur enough economic activity that makes the project worthwhile.

“For most of the past few decades, the bulk of Chinese infrastructure investment has served the overall economy reasonably well. If you compare China with most other developing countries, they would love to be in China’s shoes in terms of having all that infrastructure”

But one can still accuse for diminishing returns from additional infrastructure, as well as problems with excessive and wasteful infrastructure investment, 

though a crisis looks less likely

“The authors’ data on individual infrastructure projects tell us that China is basically no worse and no better than the rest of the world in terms of managing infrastructure projects — just like everywhere else, they often run behind schedule and over budget”


And we actually have more attacks to this paper from economists:

“if China is no better and no worse than the rest of the world at planning and executing infrastructure projects, it is hard to see how this would lead it into an infrastructure-driven financial crisis. The problem must therefore surely be that China is spending far too much on infrastructure”

“But they don’t. In fact they present absolutely no statistical information about the level or growth rate of infrastructure spending in China. Instead they present the usual numbers about the rapid growth of total investment and debt in China, such as the figures on gross fixed capital formation in the national accounts. It should hardly need pointing out that gross fixed capital formation is not the same thing as infrastructure spending; infrastructure is only one component of gross fixed capital formation, most of which is housing and business capital expenditure.” [4]

Rather, a real issue should be:

Chinese infrastructure projects generate low financial returns, but have to repay debts at interest rates that are far too high. 

the average return on assets of state-owned enterprises in infrastructure sectors is around 2%
the average interest rate that state-owned enterprises pay on their debt is around 5%.
the magnitude is sizable: 6-7 trillion yuan a year


By channeling a lot of essentially public-sector borrowing through financing channels normally used by private companies, China has created a large financial problem.

-> if the government does not want the projects to default then it needs to restructure the debt into lower-cost government obligations [5]



Many analysts now believe the best hope for dealing with inefficient SOEs is not to change them from the inside but to shrink their relative share of the economy. That means opening up protected industries to competition from private business and reducing the many advantages SOEs enjoy, especially access to finance.

“I don’t think SOEs can be ‘reformed’. They can only be downsized,” “Within China’s system of state capitalism, you can have less ‘state’ and more ‘capitalism’.”


They believe the People’s Bank of China will retain its ability to ward off crisis. By flooding the banking system with cash, the PBoC can ensure that banks remain liquid, even if non-performing loans rise sharply.

The greater risk from excess debt, they argue, is the Japan scenario: a “lost decade” of slow growth and deflation.


This is [a] ‘China myth’—that the country grew thanks largely to its heavy investment in infrastructure.

<- In the 1980s, China had poor infrastructure but turned in a superb economic performance. China built its infrastructure after—rather than before— many years of economic growth and accumulation of financial resources. The ‘China miracle’ happened not because it had glittering skyscrapers and modern highways but because bold economic liberalization and institutional reforms— especially agricultural reforms in the early 1980s—created competition and nurtured private entrepreneurship.


According to estimates by the former OECD economist Richard Herd, government and infrastructure sectors have usually accounted for 20-30% of gross fixed capital formation over the past couple of decades.


since infrastructure investment is still growing by around 20% annually, and returns on infrastructure investment could plausibly fall even further (capacity utilization at thermal power plants is already at a 20-year low due to excess capacity)