W(h)ither China? "The End Of Extrapolation"

Tyler Durden's picture

On November 5, just as the 18th Chinese Congress was about to elect a leadership that would merely perpetuate the status quo, in "The Chinese Credit Bubble - Full Frontal" we presented a little known fact: namely that while China's sovereign debt is whatever the country wishes it to be (which due to the SOE basis of its banks is really a hybrid of sovereign and financial debt), one bubble that the country can not hide is that of its corporate debt level, which has hit the highest relative to GDP level in the enitre world.

Ten days later Businessweek followed up with "Corporate China's Black Hole of Debt", which contained the following replica chart:

And so the cat of China's real debt bubble is out of the bag and out for general consumption. Yet as promptly as it appeared, it was forgotten, as a desperate for any favorable economic news punditry has ignored the fact that economic data coming out of China is merely for propaganda purposes and consumption by the gullible (not our words, they belong to China's current Vice Premier and the man who will soon take the post of Premier, Li Keqiang, who 5 years ago said that "China's GDP figures are "man-made" and therefore unreliable...[most] figures, especially GDP statistics, are 'for reference only,' he said smiling."), and has latched on to the prior month of modestly more favorable, "rebounding" economic statistics.

As UBS George Magnus says, "Many people think the downswing has now ended, pointing to slightly feistier data in September and October for industrial production, fixed asset investment, retail sales, and exports, continued high levels of total social financing, and a renewed rise in corporate leverage." The trivial rebound will soon end but a far bigger problem will then reemerge: "the short-term outlook for growth pales into significance against the view that China will continue to grow at 7-8.5% for the foreseeable future."

And herein lies the rub: because while China is currently experiencing a brief dead cat bounce, a far greater question remains open: can China reverse its declining GDP growth rate and continue growing at what most realists now perceive as an unsustainable pace. Says Magnus in attempting to provide an answer: "This [...] rests on three critical but questionable propositions:
political will and capacity, the insensitivity of consumption to the
investment outlook, and the nature of rebalancing, itself."

Magnus then proceeds to share his vision of whether China can "rise above" the reality of an economy forced to transition from investment driven to one of consumption: a vision which is the topic of his latest paper titled "China: the end of extrapolation."

In short, his answer (which at 11 single-spaced pages is hardly short) is that the party in China has ended. Of course, he is far more diplomatic:

After a decade or more of turbo-charged growth, the economic model that drove it has led to deep imbalances, especially as regards the investment and consumption shares of GDP, significant increases in both the investment- and credit-intensity of GDP growth, and the distribution of income between profits and wages. A host of institutional, monetary, financial, tax and other fiscal arrangements has been developed to support this economic model. As we will explain below, changing this model has become of paramount importance if China is to avoid a disruptive bust in investment in the next 1-2 years, and lapse into a middle income trap in the medium-term. A change is all the more important as China’s competitive advantages in the global economy are slowly being chipped away by rising wage and labour cost pressures at home, and the development of cheap energy and new lower-cost, advanced manufacturing technologies in the US, South Korea and other OECD countries.

The biggest issue for a largely welfare safety-net free China has been balancing economic growth with broad prosperity. Focusing just on one, can and will promptly lead to social instability and "rising pressure":

Social pressures have continued to build with respect to income inequality, corruption, living and working conditions of migrant workers, miscarriages of justice and ‘land grabs’ by local government officials, and air and water quality and environmental degradation. According to one Chinese sociologist, the number of incidents of unrest may have been of the order of 180,000 in 2010.

So China has to keep growing at the required pace of 7%+ to keep the population mostly satisfied. But how, now that as noted above, the "turbo-charged" growth period is over. And how when the new Chinese Politburo leaders are even more conservative than the old ones, and even less willing to force the much required transition from an investment-driven to a consumption-led model.

The first proposition, following on from the political economy issues discussed above, is that the government has the political will and capacity to introduce reforms that lead to both a sharp fall in the investment share of GDP, and a roughly equivalent rise in the consumption share by strengthening or introducing important adjustment mechanisms discussed earlier. But we don’t know yet how strong the climate for reform in China is, even though there is a popular feeling that things can’t carry on as before. Some initiatives of political reform, aimed at restoring trust in the Party by curbing corruption and ‘purifying’ the Party so as to prevent the abuse of power for personal gain, certainly seem likely. More radical political reform, though, doesn’t look likely.




This raises questions about the wider significance of rebalancing, which means reforms that would abandon the key drivers of the ‘old model’, including wage rises significantly below productivity growth, repressed interest rates, a managed exchange rate, and other subdued factor prices, that is, of land, water, energy, and importantly, of capital. There is little question that, over a decade and more, a correction of repressed factor prices, money and capital especially, would help to generate the resource shift needed to drive a more household- and private enterprise-oriented economy, and strengthen resource allocation, efficiency, innovation and total factor productivity. We can be hopeful that China’s new leaders will reform gradually in this direction. But intent will count for little in the face of inertia or a concerted push-back or resistance from others in the Party and the state apparatus, and it may be prudent to remain cautious. Remember that fundamental economic reforms are all about politics that are highly controversial and could, in some respects perhaps, prove to be of existential significance to the Party.

So while politics is certainly the primary consideration for what is still largely a centrally-planned economy, an even bigger concern may be simple math.

The maths are problematic. If investment is 50% of GDP and the growth rate falls from 15% to say, 5% per annum, consumption growth has to accelerate from about 8% to an unprecedented 12% per annum or so if the underlying GDP growth rate is to stay at 7.5%. You can do the maths of alternative scenarios at leisure, but the bottom line is that rebalancing requires investment to grow more slowly than GDP, and consumption significantly faster over an extended period of time. Otherwise the model isn’t changing.


The more structural reason is that the mechanisms that would allow consumer spending to strengthen further don’t yet exist, and would, in any event, compromise the legacy sources of economic growth that have generated structural imbalances in the first place. For example, higher wages dent corporate profits and investment; higher interest rates and a stronger exchange rate help consumers, but to the disadvantage of companies, whose debt-servicing capacity would be compromised; pro-household tax, income and social security reforms have to be financed, one way or another, by companies, or the government.


The issue, specifically in China, is more about the speed of capital accumulation, and misallocation of capital, given that, uniquely, the investment share of GDP has been in a range of 40-50% for about a decade now. Roughly two-thirds of the stock of capital has been built in the last decade, and half of infrastructure investment since 2000, for example, has been in transportation projects, many of which serve the same objectives, and must, for a while at least, be redundant or not viable commercially.15 And while total factor productivity growth, which is a  measure of the efficiency of capital and labour utilisation, did rise strongly during the 2000s to about 4% per annum as the pre-imbalances  apex boom gathered momentum, it has fallen back to around 2% per annum since.

But perhaps the biggest concern is the one that needs no introduction on this website, and is always summarized simply in what is the real four letter word: debt.

It is well known that China has experienced strong credit expansion. The growth in regular RMB loans by banks may have slowed down from about 35% in 2009, to a more modest 15% since the middle of 2011, but these loans capture only half of China’s credit creation. Total social financing includes also a number of informal financing arrangements, including commercial bills, trust and entrusted loans, other trust assets and corporate bonds not held by banks. The last item, in particular has been growing rapidly, reaching a record RMB 300bn in October 2012. The different definitions of credit creation are shown in the following chart, which comes from a research note by UBS China economist, Tao Wang.


The chart differentiates between regular bank loans, the total of bank credit and off-balance sheet credit, and total credit in the economy. As  hown, the broadest credit share of GDP has grown from about 150% in 2007 to around 200% in the last 5 years, quite unprecedented for a country of China’s size.


The rising credit intensity in the economy is also evident in the changes in the relationship between total social financing and GDP. Between 2002 when the former data start and 2007, credit outstanding grew by RMB17 trillion, compared with a rise in GDP of RMB14.5 trillion, a ratio of 1.2, but since then, credit has soared by nearly RMB61 trillion, compared to a rise in GDP of RMB25.5 trillion, or a ratio of 2..


The biggest expansion in debt financing has occurred in the corporate sector. Chinese companies’ debt ratios have risen to join some of the most indebted corporate sectors in major countries, according to Li Yang, vice-president of the Chinese Academy of Social Sciences.19 At 107%, the ratio is right up there with those of the US, Canada, France and the Eurozone, though the standardised OECD ratios may not accord to Li Yang’s definition. But he noted the recent BIS warning that corporate debt levels over 90% of GDP make companies increasingly sensitive to changes in income and interest rates, financial fragility and default risk. These things are liable to weigh on SOEs and other companies, as GDP growth slows, profits and cash flows weaken and in the wake of expected financial liberalisation. And, inevitably, tougher times for  orrowers mean tougher times for banks. Most people doubt the officially estimated 0.97% is a realistic number, and higher loan losses are inevitable. China is better equipped financially than most to deal with banking sector loan loss or recapitalisation issues. The point, though, is that someone has to pay: the cost is almost bound to fall on the household sector, one way or another, and so where does that leave rebalancing?

Most ominously, however, is the realization that China too is now engaging in the developed world's favorite pastime, simply known as "kicking the can".

Unfortunately, it isn’t really possible for us, or more to the point, China’s government, to know precisely where the country stands in this  process, any more than people were able to gauge where the West was in 2006, for example. A Chinese Minsky Moment, to coin another phrase, may not be imminent. In a highly managed economy with dominant state industrial and banking sectors, the state can deploy policies, and sources of finance to minimise cyclical fluctuations (as now), helping to sustain the status quo and lowering perceptions of risk. But this is the equivalent of ‘kicking the can’ at the risk of a harsher and more disruptive adjustment later

Finally, Magnus on what happens if instead of the hoped for 8% trendline growth, China can at best muster half of the previous 10% growth rate:

The incremental changes in economic rebalancing, and gradual deceleration in investment spending, which are implicit in the extrapolations of 7-8% GDP growth, don’t stack up for this scribe. A more significant fall to 5% over the coming decade – to pick a number – need not be the cataclysm that springs to mind, unless you’re a dyed-in-the-wool industrial commodities and commodity currency bull.... A halving of China’s superlative growth rate would still see GDP double by 2027, and continue to converge on the US. And since we can imagine China’s citizens care more about living standards than GDP, a change in the economic model and in its incentive systems need not be threatening, if the process is managed well and in a timely fashion. But there’s an unfortunate truth about changing your development model, which is that when you get to the point of having to do so, sustainable and stable growth and prosperity are about politics, institutions and legitimacy. You have reached the end of extrapolation.

Much more in the full paper below, which is a perceptive analysis to be sure, but really one which puts into words what the simple chart at the very top of this article succinctly summarizes without a single word: that the age of credit-driven expansion is over, in the entire developed world, as well as in China, as China too succumbs to the tractor beam of peak consolidated (or is that fungible?) leverage. Because without the ability to create any more debt, and thus money, out of thin air without the threat of an ensuing debt delinquency, discharge and default avalanche, there is no more growth.

Full George Magnus paper on China:


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magpie's picture

What do you want to know ?
That despite all of the Myanmar dazzle last week O'Barry effectively conceded ?

element115's picture

OT: But I am writing this from a 45 minute line to pay at Victorias Secret, Bellevue Square, outside of Seattle, WA. About 5% of the shoppers are white, 80% Asian, and 15% Arab. Most people have one or two items in their hands. Hollister was a zoo, 50% off the entire store. Almost everyone in line has an iPhone 5. I'm jealous!

WSP's picture

Somebody forgot to tell these guys that analyzing numbers means nothing---the criminal "printers" decide what numbers to post, and even when the numbers are bad (mostly revisions to make future corruption easier), the MSM has their talking points.

Everything is positive, bad news is good news, good news is great news, the government is good, MSM is honest, etc-----move on, just go buy shit to make the job of the liars easier.

luckylongshot's picture

This article manages to totally miss the crucial point in this entire situation, which is that since China owns its own central bank it can create the funds it needs to produce goods and services whenever it wants to. This means there is no chance of a hard landing. Recessions only occur when private bankers control the issuance of a nations currency and get greedy. China's mistake has been to open up some of its markets to international finance, something it actually has no need of and can fix overnight.

falak pema's picture

you don't get the essential of the NWO construct : China joins the "club" on our terms!

WHich meant :

1° producing our designed products ; Nike period. 1991---

2° exporting to our markets hi-volume; lo-cost, with big margins for our corporates; Walmart period. 1996---

3° Making more hi-tech and becoming our outsourced world factory ; WITHIN WTO rules. Current 2001-2012 period; best example Apple-Foxconn deal. But this created a MASSIVE transfer of wealth. And although the Yuan is undervalued, the whole China soup depends on Western markets staying open (WTO sword), and obligation for western or local banksta oligarchy web surrogates (Taiwan, HK, Singapore) to invest in the world inc. Factory located in China.

So China cannot just walk away from this deal. It means it will lose access to western markets. And we don't know if the Eastern alliance can replace Western markets. If you see the Nippo-Sino stand-off the answer has got to be NO!

China is not ready to assume leadership on its own two feet and those of surrogate local family. IMO. But it will now try, if the USD/EURO combine shit hits the fan big time. 

These OLigarchs, like in Europe 1914, were all friends when the colonial cake was growing and at each other's throats when its markets froze under Anglo-French "no vacancy" signs, that riled Germany looking for lebensraum. 

We look like heading there again.



falak pema's picture

Debt is money and the present elite lives off the future generations like a bunch of economic pedophiles on the loose.

That was the whole premise of this perverted capitalist model of Reaganomics fame : debt leveraging in FIRE construct to ensure a better future for themselves, the 1%, and we are there big time.

The truth is : the biggest leveraging of UNSUSTAINABLE debt is on the private OLIGARCHY side, and its worldwide. Thank you Maggie and Ronny for having started this suppy side gravy train, without the slightest government due diligence and without local union protest; as they had been destroyed in the initial phases of big-bang construct.

The current mechanism for Oligarchy sleight of hand is to further socialise the PRIVATE debt by putting it onto the public ledger via CB shenanigans. Who print money out of thin air to compensate their acceptance of fake assets sold to them by the corporates, in exchange for new money, and who THEN tax the hell out of their citizens to compensate for the increased public debt. While the Oligarchs stash their money in Off shore Caymanista land. That's what Draghi and BEn are currently doing in front of our eyes, and we see the results on the streets of Athens; all to save the private banksta cabal! 

Net result: the private pump gets "profitised", admittedly in fake money and commodities, and the public sector gets "sodomised" in fake asset accumulation, in more debt acceptance and resulting higher taxation for the current salary and retirement earners.

We are all heading to Greek status in this corrupt world as the ever growing fiat fake money generated just runs after less and less real assets; all held by the Oligarchs, witness Glencore-Xstrata merger. Overbloated bonuses for criminal commodity manipulation.

Its a self fulfilling and suicidal global strategy. Soon they will be no other issue possible to these incestuous Oligarchs but to ramp up their local wars, and create a state of permanent instability to ensure inevitable herd thinning. Think of GOMA in Congo, think of GAza in ME.

What a corrupt world construct this Pax Americana and surrogate BRIC construct has now become.

When Clinton and GWB gave the factory keys of first world to China, they truly ensured, along with G-S revoke, and derivative duck soup, the end of representative democracy. 

Viva NWO-Reaganomics! 

Never One Roach's picture

Asia's Hot Spot for Bank Jobs Cools Down

One of the key destinations for financial jobs, Singapore is fast losing its lure as bank layoffs threaten the once robust job market in this Southeast Asian city state.

"The [job] cuts have been ongoing for about the last 12 months within the major investment banks," Adam Faulkner, manager at recruitment firm Michael Page in Singapore said. "The cuts have been surprisingly protracted. It's been going on longer than most people expected."


SWIFT 760's picture

Solly, no sa-peak Engwich.

Chinky gvt can do whatever, whenever.

Currency wars lead to trade wars and then, usually, military wars. Especially when a country has oil. However, the 900 lb gorilla in the room wrote the book "Art of War". Chinks already 3 moves ahead.

WhiteNight123129's picture

Debt is not an issue as long as you write it off and purge it. You have bankruptcies here and there and so what? You are too late to short China party, you should have covered your shorts already.

WhiteNight123129's picture

Ok middle income trap, fine.  How about ponzi high consumer and gov leverage income countries?


~A change is all the more important as China’s competitive advantages in the global economy are slowly being chipped away by rising wage and labour cost pressures at home, and the development of cheap energy and new lower-cost, advanced manufacturing technologies in the US, South Korea and other OECD countries. ~

Well the rate of technology progress is much faster in China than in the US at this point. I am not saying that China has superior technology than the US, in a few areas they are quite good (perfect black object, a device that traps lights)


Now China Produces 700,000 engineers a year versus 70,000 for hte US, when you compare their budget for renewables it is much much higher than the US. When people scoff at renewal energy, Malaysia (Petronas) and Bao STeel (China) work actively on deploying the process of Lanzatech, a company which basically use microbes to transform toxic gas like CO into ethanol. Instead of Sugar-Yiest- Ethanol, the microbres use CO as food.

I am not convinced at all that the pace of technological progress is faster in the US than in China, the level might be different, but the catch up is absolutely undeniable, unless you call LinkedIN a technology company..



Errol's picture

White Night,

Right here in the US I happen to have some high-tech machines that convert CO2 into useful hydrocarbons.  On top of that, these machines are self-replicating!  I call them "trees".

As it happens, if you wish to convert a waste product such as COs back into the lower-entropy substance you started with, you have to re-imput the energy you got out when you burned the hydrocarbon in the first place.  Solar energy (sunlight) works well for this, but happens to have a low energy density per square foot, and is only available during the periods we call "daylight".