China's "Minsky Moment" Is Here, Morgan Stanley Finds

Tyler Durden's picture

From Morgan Stanley's Cyril Moulle-Berteaux and Sergei Parmenov, who pick up where our simple chart showing China's "debt nightmare" left off.

We have described in detail over the past two years how we believe China’s twin excesses (excessive investment funded by excessive debt) will inevitably unwind, causing a substantial slowdown in China’s economy, significantly below market expectations. In recent weeks, a trip to the region and further research into China’s shadow banking system have convinced us that China is approaching its “Minsky Moment,” (Display 1) which increases the chances of a disorderly unwind of China’s excesses. The efficiency with which credit generates economic activity is already deteriorating, as more investments are made in non-productive projects and more debt is being used to repay old debts.

Based on our analysis, our baseline case is that China may slow from the current level of 7.7% Gross Domestic Product (GDP) growth to 5.0% over the next two years. A disorderly unwind could take Chinese growth down to 4% in a shorter time frame with potentially disastrous consequences for levered Chinese assets (banks, property) and the entire commodity supply chain (commodity stocks, equipment stocks, commodity-sensitive countries and their currencies).

The consensus is more optimistic and expects China’s economy to grow by 7.4% in 2014 and 7.2% in 2015. Most market participants have concluded that the Chinese economy, despite its excesses, will slow only moderately as the government successfully manages to “soft-land” the credit and investment boom and that, as a result, the impact on global GDP growth could be moderate and is not likely to derail the global developed-market-led expansion. However, one of the more controversial conclusions of our analysis is that global economic growth could be impacted severely enough to cause a global earnings recession.


Hyman Minsky was a neo-Keynesian economist who developed a theory called the Financial Instability Hypothesis, similar to the Austrian school of thought, about the impact of credit cycles on the economy. In his 1993 paper entitled “The Financial Instability Hypothesis,” Minsky identified three financing regimes that economies can operate under: the first, which he called hedge finance, is a regime in which borrowers have sufficient cash flows to meet “their contractual obligations,” i.e. interest payments and principal repayment, usually by having a large equity component in their capital structure; the second, speculative finance, is a regime under which borrowers have cash flows that are sufficient to pay interest but not to repay principal, i.e. they must roll over their debts; the third, Ponzi finance, is a regime in which borrowers have insufficient cash flows to pay either principal or interest and therefore must either borrow or sell assets to make interest payments.

Minsky stated that “it can be shown that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system. In contrast, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a deviation amplifying system.” His paper draws the following two conclusions: 1) that “the economy has financing regimes under which it is stable, and financing regimes in which it is unstable” and 2) “that over periods of prolonged prosperity, the economy transits from financial relations that make for a stable system to financial relations that make for an unstable system.” In essence, the longer an economic expansion goes on, the greater the share of speculative and Ponzi finance, and the more unstable the economy becomes.

Our analysis indicates that China’s economy has arrived at that unstable state where speculative and Ponzi finance appear to dominate. From a macroeconomic perspective, very few economies have ever created as much debt as China has in the past five years. China’s private sector debt has increased from 115% of GDP in 2007 to 193% at the end of 2013.3 (Display 2) That 80% increase over five years compares to the U.S.’s 26% in 2000-2005. In recent years, only Spain and Ireland have achieved debt growth greater than China’s. Every year, China is now adding $2.5 trillion of private sector debt to a $9.7 trillion GDP.

There is evidence that this debt growth has become excessive and non-productive. It now takes 4 renminbi (RMB) of debt to create 1 renminbi of GDP growth from a nearly 1:1 ratio in the early and mid-2000s. After the massive stimulus and more than doubling of new bank loans in 2009, the government attempted to stabilize credit growth, but the growth of the shadow banking system exploded instead. Shadow banking now accounts for more than a fifth of total credit in China—or about 40% of GDP from a base of 12% just five years ago. The shadow banking system funnels credit to borrowers who can no longer get loans from the formal banking sector, such as Local Government Funding Vehicles, the property sector, and companies in sectors with massive overcapacity and low or negative profitability such as coal mining, steel, cement, shipbuilding, and solar. Work by Nomura’s Chief China Economist indicates that more than half of Local Government Funding Vehicles, which borrow money on behalf of local governments to invest in infrastructure, have insufficient cash flows to pay interest or principal; the exact manifestation of Minsky’s Ponzi finance regime. Total local government debt adds up to RMB17.9 trillion (nearly $3 trillion) according to the latest, likely understated, national audit. In addition, estimates show that up to one third of all new borrowings are currently being used to roll over existing debt, and that interest payments on debt represent nearly 17% of Chinese GDP—a staggeringly large number (which excludes principal repayments) and which is nearly double the level that the U.S. reached in 2007. (Display 3)

It is clear to us that speculative and Ponzi finance dominate China’s economy at this stage. The question is when and how the system’s current instability resolves itself. The Minsky Moment refers to the moment at which a credit boom driven by speculative and Ponzi borrowers begins to unwind. It is the point at which Ponzi and speculative borrowers are no longer able to roll over their debts or borrow additional capital to make interest payments. Minsky states this usually occurs when monetary authorities, in order to control inflationary impulses in the economy, begin to tighten monetary policy. We would add that this monetary tightening often begins to occur at the time when the size of speculative and Ponzi borrowings have become so large that the demand for additional capital to keep these borrowers afloat becomes greater than the supply of such capital. We believe that China finds itself today at exactly this juncture.

The People’s Bank of China (PBOC) has been slowly tightening credit for nine months. This can be seen in the steady uptrend in interbank financing costs (the one-month Shanghai Interbank Offered Rate, or SHIBOR, is up 220 basis points since last May). The PBOC’s latest Q4 Monetary Policy Report indicates it intends to continue to tighten liquidity in order to control the excessively fast growth of shadow banking credit.

Of the $1.8 trillion in Trust Loans provided by the shadow banking sector, nearly $600bn, or RMB 3.6 trillion will come due in 2014. (Display 4 shows maturities for a sample of half of collective trust loans, which represent one quarter of total trust loans)

Defaults or near-defaults have begun to occur with regularity over the past three months and are likely to pick up in quantity significantly over the next year. As it is becoming more clear that investors may not get all of their money back, interest rates on trust products, wealth management products (WMPs), corporate bonds, and bank loans have risen by roughly 200 basis points in the last year. (Display 5)

So at the same time that large amounts of debt come due and borrowers are increasingly stretched, growth is slowing, monetary policy is being tightened, and market rates are beginning to rise, making new borrowings even more expensive and difficult. The combination of these factors indicates to us that China’s Minsky Moment is approaching.

The unwind of this credit boom is likely in progress, and we expect it to pick up speed over the coming months and quarters. It will likely involve a steady drip of defaults and near-defaults as insolvent borrowers finally become illiquid. Market rates for all assets except central government bonds and central bank bills will likely continue to rise, reflecting increasing market fears of default by shaky borrowers. Asset values will likely begin to deteriorate as stressed borrowers attempt to sell assets to stay afloat. As a result, banks and other financial entities could begin to increase provisioning for bad debts and to reduce credit availability by gradually tightening credit standards. This could lead to a credit crunch where credit to the economy is choked off for all but the safest borrowers.

This rise in defaults, non-performing assets, and credit standards could exacerbate a significant slowdown in economic activity concentrated in the areas most dependent on debt, such as local government infrastructure spending and the sectors with the greatest overcapacity mentioned above.

The impact would therefore be most visible in the fixed investment side of the economy, particularly in infrastructure, real estate construction and related industries (cement, steel, machinery, etc.).

In time, the slowdown in growth and the increase in defaults could become significant enough that the government would intervene and ease policy to moderate the downturn. This policy easing would likely involve a combination of monetary easing and extraordinary liquidity by the PBOC and possibly, some fiscal stimulus. But until then, the impact on assets that are dependent on China’s debt growth and investment spending growth could be severe.

We recognize that it is extremely likely that the Chinese government will attempt to stave off the unwind or at least keep it orderly in an effort to achieve the ever-elusive soft landing. One way that the government could attempt this would be by stepping in to bail out borrowers on the verge of default. A version of this occurred in January, when the well-publicized default of a RMB3 billion China Credit Trust product was averted when an unknown entity stepped in to pay the principal due to investors, though not the remaining interest due (worth approximately 7% of principal). The unknown entity is likely to have been either the local government of Shanxi, home of the coal mining company that defaulted on the underlying trust loan, or the Ping An insurance company, parent of China Credit Trust. The benefit of the government or other entities stepping in to bail out borrowers is that it helps prevent investors from losing money, maintaining their faith in the financial system and ensuring they continue to buy trust products offering rates five times above deposit rates. The drawback is that credit continues to be extended to weak or insolvent borrowers, potentially leading to an even higher level of bad debts in the future. The problem is not eliminated, it is simply postponed. Interestingly, growth is likely to be negatively impacted whether or not the government steps in frequently to prevent borrowers from defaulting. First, scarce capital is being provided to prevent default by insolvent borrowers (“zombies”) rather than being channeled toward productive investments. Second, in order to limit the cumulative size of the bailouts, the government is likely to continue to restrict the growth of shadow banking and lending to these uncreditworthy borrowers. Lastly, market rates are likely to continue to rise, reflecting increasing market unease with the growing number of near-defaults.

Most other analyses we have seen conclude that China could slow more than currently expected by the consensus, but that the global economy is well-positioned to withstand such a slowdown. Our conclusion is a bit more pessimistic. We have found that every 1% of Chinese GDP deceleration could reduce global economic growth by 60 basis points. On a current dollar basis (i.e., not purchasing power parity, or PPP), the global economy is expected to grow about 3% in 2014 and 2015. (Display 6)

Therefore, if the Chinese economy were to slow by 200 basis points to 5.4%, from current expectations of 7.4% for 2014,13 (Display 7) global economic growth would slow to 1.8%, substantially below potential of 2.8%. This could have a significant impact on global equities, as our analysis shows that the global economy needs to grow at least 2.5% for global corporate profits to grow. Thus, a 1.8% pace for global GDP growth would result in earnings down roughly 13%, a huge miss compared to current expectations of 11% earnings growth. At this point, this is not our base case but a risk scenario we are closely monitoring.

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So Close's picture

What?  No Ctrl-P?

Evil Peanut's picture

Surprised the Chinese haven't taken a page from the FED's playbook and pull numbers out of thin air

TruthInSunshine's picture

typing this from tiny smart shitty phone - trust me, China has been pulling numbers out of its collective asshole in a quantity and of a margin of misrepresentation that would make anyone at the Fed, Treasury, CBO or BLS positively blush... is coincidental I had a long meeting this morning where there were 5 Chinese citizens here on business and that I was able to discuss this general topic with them and they are in open acknowledgment that China is completely screwed, and that without using the expression of the Minsky Moment, they would agree that everything described therein is precisely what's happening in China j. Real time.

Just wait until this thing gets a full head of steam.

Ban KKiller's picture

Long crooked accountants? 

Short MSG? No, make that long MSG as they need something to make the rice noodles taste good. 


macholatte's picture



but does THIS guy care?

This is what a $2 million puppy looks like


now those gotta be some really big turds.

semperfi's picture

may we live in interesting times !

maskone909's picture

So this is what is refered to as a Minskey Black Hole . Its a debt singularity in which countries collapse under the weight of its own debt.

StupidEarthlings's picture

In any normal universe I would agree.. but these are different times..

I'm wondering if countries even CAN collapse anymore..lorde knows theres sev6that should have by now.   :/

maskone909's picture

Like japan! Exactly!

In the above video around 20 mins or so steve keen breaks down what he refers to as the perpetuall event horizon that japan seems to be stuck on
Oh yeah and lauren lister is in the vid too lol mmmmm

Watch the whole vid to get a concept of the minksy singularity concept with alot of good background info

disabledvet's picture

Japan does not have nuclear weapons or a "PLA."
And...Lake Wobegon!..."borders are being rearranged."

on the one hand you have historical animosities and grudges, on the other hand you have people trying to create these things "where none exists to begin with."

overlay with "internet" and presto! "instawar!"
so no...unfortunately this is not like Japan but it sure looks...a lot like Europe 2008-2012!

TruthInSunshine's picture

I would like everyone to notice how the financial MSM talks about the 100 trillion in global gov't debt & the Chinese RE/debt crisis in the following days, weeks as if these things are a nasty surprise of some kind (when ZH and others have been stressing how unsustainable they were as long as a year or more ago).

Some surprise, riiight...Chinese defaults are going to take the Chinese economy down with a resounding sonic boom, as there is no way the authorities can balance their massive bad debt liquidation, interest rates & inflation inputs in any orderly way.

Now that equity suckers are lined up in their pens, with as many of the sheeple as their ever would be buying the "market," the'financial MSM is going to open up some taps of truth, and leak some disturbing facts, and yell

Westerners shouldn't gloat b/c there is literally tens of trillions of western investment in the form of factories, plants,'R&D centers, etc., that are now "hostages" to the Chinese crisis.

p.s. I loathe Wall Street, including its two bit criminals which include the likes of Margin Stanley, but this analysis (which was probably written many months ago and is purposefully just now being released) does a great job of explaining the daunting rock-meet-hard-place predicament the Chinese Authorities find themselves in.

maskone909's picture

Our first clue that the patient is terminal is when the parisites start fleeing the host(chinese purchase tons of RE everywhere but china ect)
They will have to cntrl-p like a motherfucker or attack the dollar ORRRR invade japan? Its anyones guess

Oracle 911's picture

China will attack the dollar, it is the easiest thing because Russia is on the board and Iran is on the board, not to mention the pissed Saudis.

old naughty's picture

That's the general consensus?

after all, a chimera is a beast with two-heads and one ass.

Key is in the USD holdings. Who's going to btfd, on the way down?

I'd look for an alternative scenario...May be ZH101 had a point?

centerline's picture

There has been alot of "truthiness" lately.  Hard not to notice.

BandGap's picture

All I have to do is wonder why Chinese are not buying Chinese real estate. They know the fucking place is going to blow and they want out.  Chinese society has little pity for those who steal from them, and if inflation ever kicks in the cities will be filled with many hungry peasents.

Go on take the money and run.

thestarl's picture

You know TIS has no one learned from history its a command economy run by some of the most corrupt cunts on the planet this was never gunna end well man.

thestarl's picture

Also when you watch this check out the smog/pollution this is a fucking disaster  financially enviromentally and then think to yourself this: 

1.Oil 100usd/barrel

2.China net energy importer

3.Average Chinese fucking wage(how on fucking earth i ask can the fucking Chinese flip the swith to consumerism when they can't afford to buy property and secondly spend in excess of half their wages on food and rent ).

4.Water scarcity

5.Top 1% control i'm guessing over 50% of the wealth

6.When its in TPTB over there vested interests to maintain the status quo

When you try to explain to the sheeple the scene over there the response is well India will be the next powerhouse at which point i start laughing uncontrollably 


Stuck on Zero's picture

Can you spell: re - hi - paw - the - kaya - shun?


disabledvet's picture

that's easy.

of course "what happens when that doesn't work" means you're still not asking the right question.

google "Hyman Rickover" instead of Hyman Minsky.

booboo's picture

Anyone named Hymen can't be wrong.

rqb1's picture

Almost anything published by ms for public view is worthless.

DavidC's picture

What about the USA?


Tyler Durden's picture

US is bad from a "stock" perspective, courtesy of those several hundred trillion in derivatives, which however need modest credit creation (at least from a China perspective) to be kept afloat. China, however, is much, much worse from a flow standpoint.

So Close's picture

Tyler.. Can you point us at articles discussing, defing, etc. "Flow."

Tyler Durden's picture

This article, written long before QEternity was announced, is a good start.

This may also help: Fed purchases of government debt: Flow-share versus stock-share, bu then again it was written by the Fed at a time before the Fed realized it was all about the flow.

old naughty's picture

Thanks for that, TD...

finally got back on the human touch.

Kirk2NCC1701's picture

Tyler, I'm amused that your IT guy(s) have you as "new".

Wait... what happened?  It was fixed after I posted this.  WTF?

maskone909's picture

New is akin to new post not new membership. Wait did i just get "/sarc'd" again?!? Damnit

centerline's picture

Is like a highly leveraged business... all that matters is flow.  And when it dips below a critical threshold, shit gets funny really quick.

Considering that actual collateral is so far removed (in most cases terminally seperated from actual financial instruments), all that remains in most of the global economy is flow... even if it is at the barrel of gun.  The spice must flow.

disabledvet's picture

so the "flow" into Ukraine or North Africa is not a surprise at all then.

Why is the media changing the subject again?

gjp's picture

There's a lot more people consuming a lot more and producing a lot less in America than in China.  Surely that requires more new credit flow?  I don't believe any macro stats anyway, the biggest bubble is in the tottering overfed and complacent old empire, not the new upstart.  It's common sense.

Love how MS identifies China's Minsky moment, but not a peep from any of these sage and very well-rewarded economists about the utter rot at home ...

ebworthen's picture

Margin Stanley does not have any rotting skeletons in their closets, promise.

They are all in China (*cough*).

LawsofPhysics's picture

Yes, but compare the population density of asian cities with that of american cities.  I bet it would look a lot like Tyler's chart.  In addition, the Chinese has passed americans in terms of the consumption of many things already, so be very careful what you wish for.

gjp's picture

Undoubtedly they've got their problems too, in spades, but we depend on the bubble far far more than they do.  Their elite may fall, but their populations are used to harder times, not endless bread and circuses.  The reckoning / come-down figures to be worst where the denial is greatest: at the heart of the empire.

LawsofPhysics's picture

Bullshit.  A day of reckoning is akin to shutting off the power/energy supplies.  Doing so in an American city will be no different than doing so in an asian city.  Please. Pull your head out of your ass and get out of the basement.

no man is an island (in america or china).

I have been long sharecropping and a dependable tribe for quite some time now.  I suggest you do the same.

gjp's picture

um, ok, i think we're on the same page here, regardless of your confrontational approach and whatever personal strategies we've employed

agreed it all comes down to energy and that picture is bleak for China

but it ain't too pretty for the US either regardless of the lies spewed about energy abundance - and we've been paying for energy imports with funny money, while China at least has paid for them with value-added manufactured goods.  Who's energy situation is going to be messier when the status quo keels over?

LawsofPhysics's picture

"Who's energy situation is going to be messier when the status quo keels over?" - You seem to be ignoring the massive amount of energy that is required to simply feed 7+ billion people (much less manufacture anything).

The answer to your question is NO ONE.

At least no one within driving distance of a major city.

hedge accordingly.

Bioscale's picture

I think gjp is right, there is a big difference between an american city and a chinese one. Chinese don't have guns and militarized police with drones.

LawsofPhysics's picture

Yes, Chinese history is very clear on that and the "regime du jour" in China has committed genocide numoerous times before.  They do not have an armed populace, but they do very much have "militarized police with drones".

Are you another fool willing to turn in you weapons for "security"?

Good luck with that.

TruthInSunshine's picture

If any American thinks our government is oppressive (and I'd agree it is growing more so even if I'm using that term on a VERY relative basis)they don't have the first clue as to how cheaply Asian countries, and in particular, ones like China, view human life.

Chinese Officials view their citizens' lives as LITERALLY disposable - as in the equivalency of stray dogs.

I'm not big on defending the creeping police state that the USA increasingly
infringing on Americans' RIGHTS under what is supposed to be a government restrained - not ENABLED - by a Constitution, but even today, Chinese have literally no safeguards against complete abuse whatsoever, and when viewed by that relative metric, Americans still have much hope.

BandGap's picture

Guns? they don't need guns. Just ask the 30 or so people on the wrong end of the blade in China a few weeks ago.

As far as drones, when you have a police force that takes their tactics from swarming ants and could give two shits about your Miranda Rights, I think that's a wash, too.

Apostate2's picture

Sorry sport. They have both. 

FreeMktFisherMN's picture

the effects of the malinvestment there will be felt for sure, but they are used to frugality and saving, and foregoing consumption. And they don't have a policy of promoting multicultural PC like the Western states do, so there is more cohesion. Them letting the bad businesses go bankrupt is capitalist and better in the long run.

Dollarmedes's picture

1) China has 4x the population of the US. What is lacking in quality is made up for by quantity.

2) The biggest bubbles happen where there is the largest/most rapid growth. That isn't the US, it's China.

3) The Fed created $4 trillion in 5 years. The PBoC created $15 trillion in 5 years. Then, there's all the shadow banking credit...

Dollarmedes's picture

Regarding point #2: I think the S&P 500 (including dividends) was up 32.39% last year. Of course, I don't really count the stock market as "the US," but the same logic applies there. Hmmm...there might be a correction in the future.

gjp's picture

But they consume less than a quarter per capita than what Americans do.

you want to believe all the banking stats spewed out by our lords and masters?  Not for me.  Most of that Chinese credit stats is probably a byproduct of all the bullshit USD washing up on their shores.  Wonder what Belgium's credit stats look like now that they are the biggest buyer of treasuries of late ... it's all bullshit and it's all USD-basd.

We have a massive trade deficit three decades running that we pay for with credit.  China, not so much ...