One of the greatest disservices you can do a man is to lend him money that he can't pay back.” - Jesse Holman Jons

Quite a lot of links about China this week and their tone is pretty dark. This won’t come as a surprise for regular readers, although this may also indicate that the China miracle is turning more rapidly than expected into a mirage. Steve Keen (a famous Australian economist) also published a very interesting video looking at credit growth and their impact on GDP growth. His findings are chilling, since using his tools reveals quite a number of countries that are currently considered as stable, including Canada, South Korea, or Finland.

In fact, the problem faced by China is a hyper version of the world’s greatest economic challenge: debt growing faster than GDP, and a GDP at least partly driven by debt. If debt growth stops, economic growth will decrease, stagnate or turn negative. If debt growth continues, misallocation will eventually create a debt domino that may paralyze countries. The question is not ‘if’ but ‘when’, and the costs grow exponentially as time goes on.

At some point, either the debtors or the creditors will have to pay, either through higher payments from debtors to creditors or from debt redemption of creditors to debtors. Both solutions carry different political and economic costs, and we would argue that a haircut for creditors would have a better social outcome, reducing inequalities and teaching creditors to make better lending decisions. Even though we need to also teach debtors not to take bad borrowing decisions, we would expect creditors to have higher levels of financial educations (and sometimes lower levels of lending ethics).

As the Great Financial Crisis showed, Western economies have become quite reliant on the financial sector and debt as companies and governments sought to sustain economic growth after the post-WWII expansion. Picketty’s book actually argues that economic growth is likely to remain low in the future, which has powerful implications for economic policies and politics in general, especially in the light of the growing debt load described above.

A transition to another economic and social system is needed, although no alternatives have been gathering enough support from politicians or citizens. Switzerland’s recent proposal to offer a basic income is actually a step in this direction, even though it may be too early as the country is growing faster than its neighbors and has a lower unemployment rate. Let us hope neighboring politicians will remember the idea behind this proposal rather than the result.

Science, General Knowledge & Environment

‘Unexplored’ China? Not for Long, the Way These Climbers Are Going – (Hat tip Lao Ho) – “One thing that stuck with me since that trip is how much of China, back then and still today, is unexplored. China may be the place that holds the biggest treasure trove of unexplored mountain territory in the world.

Finance & Economics

Zombie-to-Be Economies and the Walking Dead of Debt Include China, South Korea, Canada, Finland – [Video] – “He explains the workings of his economic model, which contrary to prevailing macroeconomic models, includes the role of banking and credit. He then identifies the conditions that lead to zombification: a rapid expansion of credit in an economy that already has a high debt load. He shows how merely stabilizing the level of debt to GDP leads to a serious economic contraction.

How Much Investment is Optimal – Michael Pettis, written in 2013 and still to the point – “If you believe, however, that China’s very low level of social capital has long ago made its investment strategy obsolete, the consequences and implications are radically different. It suggests that China has overinvested beyond its capacity to utilize these investments economically, and so there are hidden losses on bank balance sheets created by the failure to write down physical capital to its true value.

How big did you say China’s debt pile is? – Goldman Sachs “Compared to our previous estimates, the experience in 2015 suggests that the economy’s dependence on credit has deepened significantly and that it likely needs sizeable flow of credit on a persistent basis to maintain a stable level of growth.

Along the new Silk Road, a city built on sand is a monument to China’s problems – “The central government talks of reducing industrial overcapacity, cutting debt and transitioning to a new, innovation-driven economy, but provincial leaders, under pressure to meet economic targets, seem unable to abandon the old playbook.

Here is one export Germany should not be making – (Hat tip Lao Ho) – “About 60 per cent of the German current account surplus is with the US, the UK, France and Italy, which all have relatively high fiscal deficits. In short, Germany’s economy is supported by the demand management policies of countries that are heavily criticised by German academics and policymakers.

Financial Times Exposes McKinsey’s Secret, Conflict-Ridden In-House Hedge Fund – “Critically, the article was unable to parse how much of the total was unproblematic investments in other fund managers, versus direct investments or co-investments, which can represent conflicts of interest with McKinsey clients. Moreover, McKinsey asserts that the internal fund, called MIO for McKinsey Investment Office, is independent when it isn’t.

Picture of the day: World Ocean Day

Lionfish

About Carlito Riego

"Great perfection may appear imperfect, but its usefulness is inexhaustible. Great abundance may appear empty, but its usefulness cannot be exhausted. Great correctness may appear twisted, great skills appear crude, great eloquence appear awkward. Activity conquers cold; inactivity conquers heat. Clear serenity governs the world." - Lao Zi