I’ve noted in the past that I believe that the Bank of Japan, and specifically the reversal of the yen carry trade, could spark a credit event.
Maybe it’s going to be China after all.
China’s debt levels have been surging at an alarming rate. The country’s total household, business and government debt is estimated to be about 282% of its annual economic output. This is a cause for concern, as high debt levels could potentially trigger a financial crisis.
The property sector has been a significant contributor to the country’s debt problem. Over the past decade, China has experienced a property boom, characterized by soaring property prices and overbuilding. This has resulted in a glut of unsold properties and a mountain of debt.
The property market plays a crucial role in China’s economy, accounting for about one-fifth of its GDP. However, the sector has been under immense pressure in recent years. Sales of flats have been plummeting, and developers are grappling with high debt levels. The recent financial troubles at Country Garden (OTCMKTS:CTRYF), China’s biggest developer by sales, and Evergrande (OTCMKTS:EGRNF), another real estate giant, have exacerbated concerns about the health of the property market.
A downturn in the property market could have severe ripple effects on the broader economy. It could lead to higher unemployment rates, decreased consumer spending and lower GDP growth. This could potentially trigger a credit event, leading to a financial crisis.
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Is a Stock Market Crash Brewing?
China is currently grappling with the possibility of entrenched deflation, which is now forcing the People’s Bank of China’s hands as evidenced through its recent surprise rate cut. Deflation is a situation where the price of goods and services is falling. This presents a unique challenge for the country’s monetary authorities.
Unlike inflation, which can be managed through policy tightening, deflation is harder to combat. Deflation increases the real value of debt, making it more burdensome for borrowers to repay. This could potentially lead to a surge in defaults, exacerbating the debt problem. Deflation also discourages consumer spending, as people tend to delay purchases in anticipation of further price decreases.
There is a very real risk of “Japanification” for China’s economy. This refers to the prolonged period of economic stagnation that Japan experienced in the 1990s, characterized by low growth, low inflation and high public debt. China’s current economic conditions exhibit some similarities with Japan’s economic situation in the 1990s. Declining growth rates, high levels of debt, deflationary pressures and demographic challenges are all reminiscent of Japan’s “lost decade.”
The Bottom Line
Bottom line? I argued a few months back that I expect China to stimulate the economy and that could be a bullish catalyst, but the more I look at the underlying data, the more worried I am getting.
China’s economic challenges are complex and interlinked. The country is at a critical juncture, and the decisions made by policymakers today will have far-reaching implications for the future of China’s economy. To ensure sustainable economic growth, China needs to shift its growth model from an investment-driven one to a consumption-driven one. Policymakers also need to tackle the debt problem, reform the property market, and address the demographic challenges.
When the tinder is dry, anything can start the fire. China may be yet another catalyst that breaks global markets.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
