While worries about a U.S. debt default in the future are increasing, the Chinese are engaged in massive defaults today. This article reports that Chinese defaults are accelerating.

These defaults are coming from the corporate sector and include both dollar-denominated and local currency bonds. As large as these defaults are, they are just the tip of the iceberg in relation to what’s coming.

China’s debt situation is structured as a massive Ponzi, where one company issues debt and then lends the money to another affiliated company, which lends the money to another affiliated company and so on in a daisy chain of related company debt. This means that if any single company in the chain defaults, the entire group will default because the affiliates will be unable to pay back their loans to the parent company at the top of the food chain. China is between a rock and a hard place.

On the one hand, China has to tighten monetary policy and restrict lending to avoid letting asset bubbles and potential debt defaults get out of control. On the other hand, China needs new debt to roll over old debt and to prop up asset values that depend on leverage.

If China tightens too much, it will cause a wave of defaults. But if China does not tighten enough, it will let the asset bubbles in stocks and real estate expand to the point that market collapses are inevitable.

China’s central bank may have enough assets to bail out the commercial bank lenders, but that bailout will severely deplete China’s hard currency reserves, leaving little to defend the yuan cross-rate to the dollar. China is heading for a crisis in debt, market values or the foreign exchange markets  perhaps all three at once.

Given the size of the Chinese economy (second largest in the world, with about 15% of global GDP), a disaster in China will inevitably ripple around the world in a new global financial crisis. Based on current headlines, this crisis may be much closer than many believe.

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