Home > Uncategorized > How To Be A China Bull – Business Insider

How To Be A China Bull – Business Insider

The bull argument cannot ignore hidden bad debt

So to say that China has already set aside the resources to pay for the losses is, I think, meaningless, especially if it implies that somehow the impact of this wasted investment is in the past and not in the future. China has no more set aside the cost of the losses than Brazil had done so at the end of the 1970s, prior to its own lost decade. The losses are simply buried in the debt.

But an unrecognized past loss must be recognized at some point in the future, no matter how it is funded. On this point I think neither Hayek nor Keynes would disagree. In the end, the strongest indication about whether or not the current Chinese growth model is no longer providing sustainable growth is whether debt is rising faster than debt servicing capacity. This is where the debate must focus. Or to cite John Mills in his 1868 paper “On credit cycles and the origin of commercial panics”

Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.

If capital has been destroyed in the past, and that destruction is currently unrecognized, it must be recognized in the future, like it or not. This recognition can occur in the form of what Mills called a panic, and we would call a financial crisis, but given the stickiness of deposits in the Chinese banking system I don’t think this is likely to be the case in China. It can also occur in the form of many years of much slower growth in GDP, as those losses are ground away through excess debt repayment. But it will occur.

So if anyone wants to continue to be very bullish about Chinese growth prospects over the next decade, it seems to me that he must address and answer these three questions:

How much debt is there whose real cost exceeds the economic value created by the debt, which sector of the economy will pay for the excess, and what is the mechanism that will ensure the necessary wealth transfer?

What projects can we identify that will allow hundreds of billions of dollars, or even trillions of dollars, of investment whose wealth creation in the short and medium term will exceed the real cost of the debt, and what is the mechanism for ensuring that these investments will get made?

What mechanism can be implemented to increase the growth rate of household consumption?

via How To Be A China Bull – Business Insider.

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