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The China Bad Debt Daisy Chain is Starting to Unravel

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The coming credit crisis in China is no secret. China has $1 trillion or more in bad debts waiting to explode. These bad debts permeate the economy.

Some are incurred by Chinese Provincial authorities trying to get around spending limitations imposed by Beijing. Some are straight commercial loans on bank balance sheets. Some are external dollar-denominated debts owed to foreign creditors.

The most dangerous type of debt involves a daisy chain of insolvent corporations buying debt from each other. A single cash advance of $100 million can be passed from corporation to corporation in exchange for a new promissory note, used to extinguish an old unpayable promissory note. Repeated enough times, the $100 million can be used as window dressing to prop up $1 billion or even $2 billion of bad debts.

These kinds of accounting tricks will land you in jail in the U.S., but it’s accepted practice in China as long as the corporate CEO is a “Princeling” (a politically connected Communist Party insider descended from the old guard), or an oligarch willing to pay bribes.

This state of affairs has existed for years. The question investors keep asking is, “How long can this last?” How long can the daisy chain keep operating to gloss over a sea of bad debt and give the Chinese economy an appearance of good health?

 This article suggests the answer is the ponzi will not last much longer. The article reports that even compliant Chinese regulators are starting to blow the whistle on bad loans and the banks that cover them up. So, the good news is that China is starting to address the problem.

The bad news is that if China gets serious about cleaning up bad debts, their growth will slow significantly, and so will world economic growth. That’s bad news for global stock markets.

 

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