Growth on Steroids: a Risk for China … and for France?
A number of international organisations, including the Bank for International Settlements (BIS), are expressing concern regarding the rise of the level of debt worldwide. In its September 2017 quarterly report, the BIS notifies that private sector – excluding banks – indebtedness (bank loans and market instruments) reached the all-time high level of USD 105.7 trillion, with a 8.4% raise over the past two years. Compared to the pre-crisis level, seen in retrospect as excessive, global private debt grew by 26.5%.
Should we be alarmed, as People’s Bank of China Governor Zhou Xiaochuan was in front of China’s 19th Communist Party Congress delegates, warning them against the risk of a “Minsky moment”?
Slow decline in rich countries, rapid growth in emerging ones
In fact, the evolution of private debt differs greatly according to regions, but aggregated numbers fail to display these discrepancies. Even though global private debt has indeed risen by 26.5% since mid-2008, it decreased by 2.4% in advanced countries, precisely where the excessive debt accumulation occurred, while it rose by 192% in emerging countries. This rebalancing mechanism is due to the dominant influence of the American monetary policy on all financial markets, and especially on those of emerging countries, as economist Hélène Rey perfectly described. When the Fed’s rates were high (5.25% in 2006-2007), access to credit was difficult for emerging countries. However, as soon as the Fed lowered its rate to 0.1% in December 2008, preserving it to this close-to-zero level until December 2015, the level of debt surged in emerging countries, while in developed countries, especially in the US and the EU, over-indebted households and companies reduced their pledges by all means, including bankruptcy. Unlike what central bankers had hoped for, zero interest rate and quantitative easing policies aiming to decrease long-term returns failed to trigger a fast reduction of over-indebtedness, probably because the equilibrium interest rate that would have allowed to restore balance sheets was excessively negative for central banks.
Hence this fundamental asymmetry between developed markets, where debt relief is awfully slow, and emerging markets, where indebtedness growth is far faster than fundamentals would suggest. Here again, aggregated numbers hide diverging dynamics.
Debt growth in emerging countries: China above all
The impressive rise in private debt, multiplied by almost three (+192%) since 2008 in emerging countries, is in fact predominantly driven by China, where private debt increased by 399% over the same period. In 2008, Chinese private debt amounted to 38% of that of all emerging countries. It amounts to 65% today, although economic growth, as tremendous as it was, did not differ greatly from other emerging countries’ growth such as India’s. Against this backdrop, Governor Zhou’s warning is more understandable.
The Chinese “Minsky” risk is asymmetrical
Paradoxically, Hélène Rey’s analysis, that highlights the importance of the monetary transmission channel between the US and third countries, that applies perfectly to Latin America, is not relevant to China, since the latter keeps a tight lid on capital flows through its borders. The explosion of private debt – and this term is not being used excessively – in China is way more endogenous. By adopting a model of development based on exports at the beginning of the 2000s, China exposed itself to a potential drop in world trade, which eventually occurred in 2008. In order to prevent an economic implosion, Chinese leaders launched an economic policy response through investments, financed by private or semi-public debt (the line between both is blurred in this country), to an extent that outshines Franklin Delano Roosevelt’s New Deal. Despite frequent calls by Chinese leaders to wean themselves from debt, that can become a drug, it keeps rising, admittedly at a slower pace, but still faster than the GDP’s. Its driver has become the property prices growth in big cities, due to China’s rapid urbanisation, a structural upheaval that will not come to an end anytime soon.
If the Chinese “Minsky” risk did occur, which is if the accumulation of doubtful receivables in the banking system were to lead to a series of bankruptcies, the authorities would immediately react. They would flood the banking system with cash to prevent a deflationary spiral, at the same time transferring part of the private debt in public debt, according to a common pattern. The main victim would be growth, and global trade growth as a side effect, since China has become its main fuel. The consequences of a financial crisis for the rest of the world would not be directly financial, as Chinese borders are immune to capital flows, but above all real, directly impacting emerging economies for which China is the main outlet, starting with South-East Asia. There would nevertheless be financial outcomes. Markets would have to adapt to a world with a sluggish Chinese growth, more or less temporarily. Subsequent correction of equity markets, with a risk of overreaction, and rebalancing of portfolios towards safe holdings such as sovereign debts - US treasury bonds above all - would thus be expected.
What about France?
A Chinese crisis would not have direct consequences on the French economy, but rather indirectly through global trade. Some of France’s trading partners, such as Germany, would be impacted more directly. It would however be mistaken to consider an excessive growth in debt as a solely Chinese problem. Indeed, according to BIS data, non-financial private sector debt (households and companies) in France grew from 156% of GDP before the crisis (September 2008) to 190% in March 2017.
Leverage – ratio of private debt on GDP for example – is higher in France than in its main developed partner countries. From this standpoint, our situation is closer to that of Korea (193% leverage) or China (210%) than that of the US (152%) or of the Eurozone (163%). Allegedly, this has something to do with the more favorable fiscal treatment granted to debt than to equity such as stocks. This was for example apparent in the 3% surcharge on dividends established at the beginning of the previous political term and recently dismissed by the French Constitutional Court. Should we therefore fear an excessive indebtedness to the extent of a French “Minsky moment”? Not from companies, which debt decreased by 4.7% compared to its pre-crisis level. Concern rather comes from households, which debtincreased very quickly, thanks to unusually encouraging credit terms, especially if borrowing rates are compared to wage progression, and because of the strong increase of property prices until recently. What would happen if housing prices were to decrease significantly, following an important change in asset taxation for example? Property assets being the ultimate collateral for real estate debts, the whole banking system would be impacted.
Outstanding credit to the private non-financial sector (core debt), % of GDP
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