by John Rubino
The business cycle has its stages, and they’re usually both predictable and logical. For example, governments tend to generate a lot of tax revenue late in an expansion as more people get jobs and start paying income taxes and rising stock prices generate big capital gains. Meanwhile, less has to be spent on social safety net programs because everyone is working. Combine higher tax revenues and lower spending and you get shrinking deficits.
But not this time. Government borrowing soared around the world in 2018, even as economic growth, employment and stock prices peaked. Why the change? Well, apparently governments have decided – for the first time since the inception of the business cycle – to preemptively attack the next recession.
The US, as everyone by now knows, has returned to crisis-era trillion dollar deficits even as the unemployment rate hovers around 4% and stock prices hit records. That’s historically unusual to put it mildly. But it pales next to what’s happening in China. From Doug Noland’s Credit Bubble Bulletin:
January 15 – Bloomberg: “China’s credit growth exceeded expectations in December, with the second acceleration in a row indicating the government and central bank’s efforts to spur lending are having an effect. Aggregate financing was 1.59 trillion ($235 billion) in December, the People’s Bank of China said on Tuesday. That compares with an estimated 1.3 trillion yuan in a Bloomberg survey.”
January 15 – South China Morning Post (Amanda Lee): “China’s banks extended a record 16.17 trillion yuan (US$2.4 trillion) in net new loans last year…, as policymakers pushed lenders to fund cash-strapped firms to prop up the slowing economy. The new figure, well above the previous record of 13.53 trillion yuan in 2017, is an indication that the bank has been moderately aggressive in using monetary policy to stimulate the economy, which slowed sharply as a result of the trade war with the US. Outstanding yuan loans were up 13.5% at the end of 2018 from a year earlier… In addition, debt issued by private enterprises increased by 70% year-on-year from November to December last year, indicating that the central bank’s efforts to support the private sector are working.”
There’s a strong consensus view that Beijing has things under control. Reality: China in 2019 faces a ticking Credit time bomb. Bank loans were up 13.5% over the past year and were 28% higher over two years, a precarious late-cycle inflation of Bank Credit. Ominously paralleling late-cycle U.S. mortgage finance Bubble excess, China’s Consumer Loans expanded 18.2% over the past year, 44% in two years, 77% in three years and 141% in five years. China’s industrial sector has slowed, while inflated consumer spending is indicating initial signs of an overdue pullback. Calamitous woes commence with the bursting of China’s historic housing/apartment Bubble.
Typically – and as experienced in the U.S. with problems erupting in subprime – nervous lenders and a tightening of mortgage Credit mark an inflection point followed by self-reinforcing downturns in housing prices, transactions and mortgage Credit. Yet there is nothing remotely typical when it comes to China’s Bubble. Instead of caution, lenders have looked to residential lending as a preferred (versus business) means of achieving government-dictated lending targets. Failing to learn from the dreadful U.S. experience, Beijing has used an inflating housing Bubble to compensate for structural economic shortcomings (i.e. manufacturing over-capacity). This is precariously prolonging “Terminal Phase” excess.
To sum up, China built way too many factories and now has decided to pay for the related costs by inflating a housing bubble. That doesn’t sound very smart.
But China’s screw-up is just one in a very big crowd. Noland points out that the other emerging market economies are doing something similar:
January 16 – Financial Times (Jonathan Wheatley): “Emerging-market companies have gorged on debt. Slower global growth and higher funding costs will make servicing that debt harder, just as the amount coming due this year reaches a record high. The result? Less investment for growth and yet more borrowing. These are some of the concerns raised by the Institute of International Finance… as it published its quarterly Global Debt Monitor… The world is ‘pushing at the boundaries of comfortably sustainable debt,’ says Sonja Gibbs, managing director at the IIF. ‘Higher debt levels [in emerging markets] really divert resources from more productive areas. This increasingly worries us.’ Of particular concern is the non-financial corporate sector in emerging markets (EMs), where debts are equal to 93.6% of GDP. That is more than among the same group in developed markets, at 91.1% of GDP.”
January 16 – Barron’s (Reshma Kapadia): “A record $3.9 trillion of emerging market bonds and syndicated loans comes due through the end of 2020. Most of the redemptions in 2019 will be outside of the financial sector, mainly from large corporate borrowers in China, Turkey, and South Africa. The question will be if they can refinance the debt…”
So here we are, ten years into an expansion (which is four years longer than the average one) and governments are not only taking on massive new debts themselves but tricking/cajoling their companies and consumers into doing the same. This will (if cause and effect still matter) do several things:
1) It will make year-ahead growth higher than it would otherwise have been, and combine with the probable resolution of the US/China trade war to give the expansion a brief second wind.
2) It will further tighten labor markets, raising wages and pushing overall inflation up a point or two, which in turn will boost/support interest rates.
3) Higher-than-otherwise interest rates (or simple debt-related exhaustion) will bring the long-awaited recession. And societies around the world will realize they’ve already borrowed all that anyone will lend them, leaving them with very few remaining weapons to fight a deflationary crash.
In other words, the current debt binge is the culmination of a decade of can-kicking in which new credit has filled the gaps created by past mistakes. There’s a limit to how far this can go, and the recession of 2020 might reveal it.