"Fear
is running up the spines of many analysts - are we again facing a nasty surprise
that could trigger another crisis of catastrophic proportions? … It is now emerging
that local governments in China are laboring under excessive debts that may
reach 30 percent of China's GDP. … If the slowing of the Chinese economy is chaotic
and its municipal debt crisis becomes a horrible surprise, there goes the white
horse."
A Graphic showing which countries buy the most American debt. China, Japan, Britian, Brazil and Hong Kong lead the pack. But what would happen if China had its own debt crisis?
A
multi-decade credit binge has passed. Now on both sides of the Atlantic, there
is a hangover.
In the United States, the
crisis was born out of the over-indebtedness of American consumers during the
housing bubble years. On the other hand, the European crisis originated with
the over-indebtedness of peripheral E.U. countries during the early euphoria over
the euro - countries like Greece took advantage of low “German” interest rates to
take out loans left and right.
To complete the panic, it is now
emerging that local governments in China are laboring under excessive debts that
may reach 30 percent of the country's GDP. The Moody’s credit ratings agency
recently warned that Chinese banks are weighed down with debts they are unlikely
to collect on and which were underestimated in the official accounts. This
surge of lending followed official guidelines to accelerate infrastructure
projects after the 2008 financial crisis and to prevent the country from falling
into recession.
A Familiar Story
Fear is running up the spines
of many analysts - are we again facing a nasty surprise that could trigger
another crisis of catastrophic proportions?
In the U.S., a policy of low
interest rates and incentives for home buying encouraged consumers to take on
mortgages they couldn’t afford and banks to borrow (or leverage) to fatten
their profits.
The banks happily made loans
to people who had no jobs, income or assets. And those loans were securitized
into those collateralized debt
obligations.
With the wave of deregulation
that began in the 1990s, banks and other financial institutions lay down and frolicked
in the absence of rules.
Financial institutions sold sub-prime
mortgages to consumers who obviously couldn’t pay. But they didn’t care,
because they in turn sold these loans to banks that packaged them in the form
of mortgage-backed securities and passed them on. This was, of course, after
the ratings agencies had given AAA ratings to many of these securities, despite
the high probability of default. The banks then sold these securities to
investors, who as a guarantee held mortgages that had very little chance of
being paid - and that, eventually, ended in default.
Currently, the U.S. is going
through a process of deleveraging - or debt relief. Consumers are little-by-little
paying their debts, and for the most part, have stopped seeking new loans.
This, on top of the fact that the job market is slow, has created an atmosphere
in which consumers are unwilling to spend very much.
In an attempt to replace this
lost demand, the federal government entered the fray. Since Barack Obama became
president, the government has injected $1.2 trillion in fiscal stimulus, and the
FED has engaged in two rounds of “quantitative easing,” pumping $2.3 trillion
into the economy by buying up government bonds and mortgage-backed securities.
Now the U.S. finds itself at
odds with the numbers. The government will surpass the debt limit - $14.3
trillion - at the beginning of August. In Washington, the “don’t even think of
more taxes” Republicans and the “don’t cut social spending” Democrats are at a
stalemate and have been warned by Moody’s. If they don’t reach an agreement,
the U.S. will fail to honor some of its commitments, at least temporarily.
But
credit is also out of control in Europe.
However, there are nuances. In
Ireland, for example, the problem was an enormous housing bubble, which burst
and broke several banks along with it. In its mission to rescue the banks, the
government has quadrupled its debt.
Italy, now the eye of the
hurricane, has a very high public debt - 120 percent of GDP. But it has retained
its primary surplus all these years, even if it is less than it once was.
In
both cases, China saved their bacon.
In the U.S., China has been
the largest purchaser of debt for many years. In Europe, it has emerged as the bond
buyer of last resort for countries like Portugal and Greece that are virtually
broke.
If the slowing of the Chinese
economy is chaotic and its municipal debt crisis becomes a horrible surprise,
there goes the white horse.
Patricia Campos Mello is a reporter that writes about politics
and international economy for Folha. She was Washington correspondent for four years, during which she
covered the election of President Barack Obama, the financial crisis and the
war in Afghanistan, accompanying American forces. She has a Masters Degree in
Economics and Journalism from New York University and is author of the books,
O Mundo Tem Medo da China (The World is Afraid of China, Mostarda,
2005) and Índia - da Miséria à Potência (India - from Poverty to
Power, Planeta, 2008).
