So what is everyone, including senior Chinese leaders, worried about? The concern comes from the realization that—assuming the debt level is manageable—fixing the problem will cause unrest within the country. Bad debts would presumably result in layoffs, primarily by the large SOEs that employ so many Chinese workers. The economic uncertainty that would result from widespread defaults in China would likely further encourage savings by Chinese consumers, further weakening the economy by curtailing consumer spending.
If one person’s debt is another one’s asset, the difference between the ultimate winners and losers may be vast. Officially, China’s bankruptcy laws became effective in 2007 and are very similar in structure to U.S. and European laws. In practice, the broad discretion afforded judges and the influence of the politically connected results in relatively few cases with largely uncertain outcomes. Combined with the questionable value of some underlying assets, the holders of Chinese debt could see a significant reduction in their assets.
The good news is that most of the impact of these changes would be felt within China. We believe that the government would intervene in a way that would limit global impact—not because the government is necessarily concerned about the damage done to foreign companies, but because it will make sure that basic Chinese needs are being met. For example, if China needs to import raw materials such as oil and coal to run its economy, it will do so. It may be a different SOE that is doing the purchasing, but the government will do what it can to maintain its economy. These imports have slowed down, and may continue to do so. But it is not Chinese debt levels that mandate the slowdown, it’s the realization that the Chinese economy no longer needs and cannot support such a high level of infrastructure investment. Debt is the symptom of China’s problems; it is not the root cause of them.
Conclusion
China remains a heavily indebted country, but one that owes most of the debt to itself. The political climate in China clearly shows a willingness to discuss Chinese debt, and that in and of itself is a significant development. Because China owes its debt to itself, the major impacts of China dealing with its debt problems will be felt within its borders. The timing is uncertain, however, and this process will be very painful for the Chinese people and for Chinese companies.
John Canally is chief economic strategist for LPL Financial.