We’ve written numerous times about the likelihood of a Chinese credit crisis and the risks of contagion from such a crisis in China and the global economy. Despite long-standing concerns, this is an issue that simply won’t go away. China has repeatedly turned to more debt, lower interest rates, currency devaluation and other cheap tricks of economic stimulation (really pulling demand forward without solving problems) to boost its economic output one more time.
The problem is that such tricks are subject to what economists and statisticians call “diminishing marginal returns.” This means that stimulus can have some temporary benefits when first used or if used in a recession. But over time, the stimulus effect grows smaller and smaller.
Eventually the gimmicks result in “negative marginal returns” where the debt trick not only does not provide stimulus but reduces growth. What you are left with are no stimulus and more debt, followed by a debt death spiral, which leads to default, confiscation or hyperinflation.
Now China seems to be at the end of this road, as explained in this article. The Chinese economy had grown at an annual rate of over 10% from the 1980s until a few years ago. Now annual growth is 6.4% and promises to drop even lower. Even those figures are overstated because China ignores wasted investment included in the government figures. Some analysts put actual Chinese annual growth in the 3% range.
When the crisis emerges and China suddenly has to correct its economy, a currency devaluation of 30% or more and massive write-downs are the best outcome. The worst outcome is something more closely resembling the Great Depression on a global basis.
It’s almost too late for China to correct this path because of the inflexibility of political and civic institutions and intolerance for dissent. It may be too late for the Chinese to change the outcome, but it’s not too late for individual investors to pivot away from exposure to China.
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