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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Dollarmedes's picture

There are lots of stats that are phony, but not all of them. Also, the Chinese government has a reputation for "fudging" the truth, which is why people go there to see things with their own eyes.

Were these observers imagining the mountains of ore and coal sitting outside the plants? Were they imagining the mostly-empty "ghost cities?" (or maybe they were paid shills of the NWO!)

Or do you think the Fed is responsible for not only pumping up the #1 world economy, but the #2 economy as well?

McMolotov's picture

It's the blobbing up of American Citizenism. Make me laugh.

24KGOLD FOIL HAT's picture

True, the old empire is much more debt laden than the past but The Matrix wants the US to dominate for a while.  Its military is useful to it.  Capital will flow to safety[mainly $ and US] from the BRICS in the next recession. 

A Chinese lady gave me the Chinese view: The US is the top of the pyramid militarily and financially.  China is farther down.  When US owes China $1trn, China is more vulnrable to US temp freezing of UST CUSIPS.  Not totally accurate but in the chess game arena, she has a point.

Did China conquer world manuf. markets or was it given them by the Matrix?  China exists as an export power at the pleasure of the Matrix.  Could China ebb as Japan did in 1990's?

I'm a Martin Armstrong fan.  [He did 9 years in the klink.  Means more than 2 days on the porch.]  He calls for hot money to slosh back to US Canada North Europe shortly. [2 or 3 yrs]

The Chinese even admit they are always behind the west.  They just started reducing the workload on the younger kids of the elite.  Mandatory 2 hours of play during the day, less of that robotic number crunching and memorization.  "You will be creative, princeling. [or else]

SheepDog-One's picture

But Tyler's, the bankster overlords promised they learned their lesson about derivatives and promised they'd never ever pinkie swear for reels they'd never mess us up with that again as long as the taxpayer pulls their nuts out of the fire.

cossack55's picture

Would love to see the "Minsky Moment" as a musical.

DavidC's picture

I don't know why (well, I probably do!), but that made me giggle. Very funny!


McMolotov's picture

Minsky Moment: "A young girl's strange, erotic journey from Milan to Minsky."

This is just one more item to file in the "alarming convergence of bad events" box. It's getting pretty full.

p.s. I can think of nothing more unfortunate than a kid growing up with the name Hyman. Mr. Minsky had some sadistic parents. No wonder Hyman Roth was such a bastard.

BigJim's picture

 Would love to see the "Minsky Moment" as a musical.

I, for one, think it would make an excellent name for a brand of after-dinner mints. 

LawsofPhysics's picture

It really isn't that complicated folks.  Let me be clear, NO FAITH=NO CREDIT

Tick tock motherfuckers...

Winston Churchill's picture

Coming soon to a theatre ,of war, near you.

fijisailor's picture

China is well known for taking decisive action.  Being the inventors of paper money and with a different philosophy on economics we can expect a response much different from what Japan or the West have done.  Something like line the fuckers up and shoot them all.

The Wisp's picture

Hey i Like the Line em Up and Shoot them Fix.. has a catchy, catch on kind of Ring..

narnia's picture

The extension of credit to no-collateral (state directed ghost cities & other projects that had no business being done) caused the problem.  The fact no lender will step up to the plate to help them refinance black holes is a consequence of that.

ebworthen's picture

Military expansion in the Pacific region fits in here somewhere...

Let them eat iPads's picture

Dr. Copper has declared China dead on arrival.

semperfi's picture

And this is how China brings down the Western financial system, well planned out, well timed.  When all the world's paper burns to ashes (including their own), the only thing left standing thru the ashes will be gold (and silver) - of which China and Russia will have the tallest pile.  And the West will be left with just a pile of ashes.  The new rulers of the world financial system will then be China & Russia.  Game over for USA, UK, EU.

LawsofPhysics's picture

And I will sell my farm produce to them in exchange for gold.  Sounds great!

Divided States of America's picture

You better make sure your farm is well fortified and you have people you can trust who will be protecting it. Otherwise, its just fair game and gonna get overrun.

When people are backed in a corner, (hungry, cold), they will risk their life for anything.

LawsofPhysics's picture

No shit sherlock, we are a sizable farming Co-op of mostly active duty soldiers and verterans.

We remain long sharecropping and physical assets of all kinds.

Divided States of America's picture

Hey Laws, I agree with you but you seem to be a bit cranky today. Is it because J-bitch Yellen is testifying today?

centerline's picture

Cool stuff LOP.  Have to say I wish I was in such a position.

Historically, those who leave the big cities did the best in face of collapse (social, economic, war, etc.).  Have a feeling we are going to repeat this on a scale never before seen.

Of course, real skills and adaptability are the key.

Carl Popper's picture

I will trade my medical skills for your gold and produce lol.  I got plenty of guns and bullets but will also accept bullets, young women, and other forms of payment. 

ebworthen's picture

And China and Russia will also have the functioning factories and workers.

jackstraw001's picture

Game isn't over until all the ammo is spent, missiles have been fired and the bombs dropped.  And we have a shit load of all of them.  We've started shooting wars for lesser reasons than this.

24KGOLD FOIL HAT's picture

Romes colonies broke away before the city fell.  The BRICS will hit recession before the US.  Capital flows to US "safety".

youngman's picture

The Chinese guy that will win this game is the guy that can find a tenant for all his vacant he owns...

GrinandBearit's picture

Don't worry... I'm sure this (in some way, shape or form) will be bullish for the US markets.

24KGOLD FOIL HAT's picture

10-4 Grin.  Who gots da best military?  Flow the money there for a while when BRICS have a correction.  US is cleanest dirty shirt.

bvrulez's picture

How is it possible that debt is a problem, when every debt dollar is someone else's asset? may zerohedge please explain this.

The Most Interesting Frog in the World's picture

Under "normal" conditions, it's only a problem to the degree the assets become worthless and security interest must be liquidated.  It's a natural phase of any business cycle.  This is heads you win, tails you lose.

Unfortunatly, under the current heads you win, tails you win, world we live in - nobody in the world knows exactly what "risk" is.  To GS it means they temporarily lose value until the federal government and Fed bail them out.  In China, they have been bailing out investors as well.  These bailouts have caused a huge amount of speculation and increased credit - with no risk of loss why not lend - to anyone???.  The "moral hazard" of not letting the natural process work...

If China, as they have recently done, no longer backstops the loans, credit expansion will and should stop dead in it's tracks.  Fear of loss and long lost rationality will return.  Absent massive currency printing, this resultant credit decline would be massively deflationary...  cash is king... and everything else DOWN...

Mike in GA's picture

The "asset" side is a promise to repay.  What if the promise is not honored?  What if the value of the repayment is not equal to the value at time of "asset creation"?  All a debt holder has is a promise and maybe some non-performing collateral.  (if it were performing there would be no prob with repayment)

What if your government borrows 40% of every dollar they spend?  What if the debt service alone consumes evermore every year of the people's tribute?  What if every government around the world is so indebted and creditworthiness declines raise interest rates to the point that even without a single dollar more being spent the debt service increases?  What happens to the last guy that buys the last bond sold by an about-to-default government?

iLiquid's picture

The problem lies in the mismatch of assets and liabilities, not the debt per se.

When Lehman was finally liquidated there was a residual of 5b (if memory serves) in net assets.  The company failed not because its debt outweighed assets.  It failed because the assets couldn't match the liabilities in duration and liquidity.  Hence disorderly liquidation ensued.

Adding to China's problem is the currency mismatch by ponzi borrowers.

BigJim's picture

 How is it possible that debt is a problem, when every debt dollar is someone else's asset?

Every 'debt dollar' gets extinguished on repayment, remember. But the chief problem is that every debt dollar has to be 'rented', via interest payments to the creditor. If those 'debt dollars' were borrowed to finance poor investments, then the interest cannot be paid.... hence default. And as debt is now repackaged and used as collateral for more debt creation, if you start getting people unable to pay their debts, you start a cascade of default throughout the banking system.

This is why 'deflation' is so systemically dangerous in our present system; not price deflation, but monetary deflation, as an economy finds it harder and harder to meet debt repayments if the amount of money in an economy starts shrinking. By definition, too, as our economies' money is all debt, the only way to stop GDP falling is either by the creation of more debt, or an increase in the velocity of money.... and in a recession/depression, people cut spending, so there goes the velocity.

Edit: I forgot to add that as the debt gets repaid, the pool of currency with which to pay the inetrest shrinks; this is another reason why declining velocity is so disastrous in a debt based monetary system - when a lender lends $100 at (say) 10% interest, only $100 has been created, but more than $100 is required to pay it off. This extra currency 'exists' only in the sense that interest payments get recycled through the bank back out into the economy, and, hopefully, back to the debtor so s/he can pay interest. Declining velocity? Inability to pay interest = more defaults.

centerline's picture

Thanks for the link Seer.  Bookmarked that site.  Will check it out later today.

ThroxxOfVron's picture

"How is it possible that debt is a problem, when every debt dollar is someone else's asset? may zerohedge please explain this."


Imagine that each person in the system believes that a distinct, unique and indentifiable debt/asset belongs soley and wholly to them; but, there is only enough real assets or cash money to pay a small fraction of the outstanding debt assets.


Some debts are uncollectable, unenforceable; -bad debts.

One day only a small number of debt payments in a great many can be made.  

Much debt is in danger of being defaulted as the underlying collateral/property/cash/guarantee does not exist or cannot be procurred or cannot be acted upon for whatever reason(s).  -Many debt assets are discovered to be worthless.  

Only priviledged and politically connected persons can trade their debt assets for new money or are allowed to sell the assets at any justifieble price or have them guaranteed for payment by captured central banks/governments.  

Systemic crisis: collapse.  

Just because a debt asset/bond/IOU exists does not mean that it can be called or collected on or sold for any amount approaching anything resembling par either in the immediate or ever...

Charles Wilson's picture

"This could lead to a credit crunch where credit to the economy is choked off for all but the safest borrowers..."

(The above should not be considered a solicitation or invitation to contribute to any Ponzi-Nomics Scheme in China or any area controlled by Communist Party Apparatchiks...)


The Ghost Cities, "Malinvestment" of Chinese Assets, etc., were all funded for "The Safest Borrowers".  That was the Point!  This tells me that what is happening now is not the finished product.  There is still blood to suck out of any given set of Proles and the only people who should really worry are those who stole massive amounts and now run the risk of getting caught.

"...But I was on the Chairman's Good Side...I coulda' been a contender...I coulda' been somebody..."

"Off to the Slag Heaps, criminal...". 

"Say, comrade, those slag heaps give me an idea.  If we could get the Party to fund this idea, we could make a fortune..."



Squids_In's picture

All of this means ... more QE ... so ... BTFNH !!!

deepsouthdoug's picture

That's a big frickin Minsky Moment!

kristian01's picture

This report is at least a month old ( ...It would be great if ZH could give some indication about the timeliness of their 'breaking news' alerts...

roadhazard's picture

Any more current links from you would be appreciated.

besnook's picture

the chinese is the perfect fiat ponzi. the pboc is a black hole of credit. it can give as much credit as it wants to while absorbing as much bad debt as it needs to keep the whole thing afloat. the chinese were smart enough to structure their "capitalism" model so the money is owed to themselves and not a private parasite central other words, who cares if i owe myself a trillion dollars?

besides the chinese economy still has a several hundred million person cushion to absorb all the moneyflow on the street level and a lot of gold to back it up in the case of a dollar collapse, which will happen first for minsky reasons.

Byte Me's picture

Good job the armed forces of the PRC have about 5 million inductees, they may soon really need theem.

falak pema's picture

Cyril Moule that belgian or is it french fries?

As for Parmigiano cheese I feel like saying "smile" when the bulb lights up.

The Minsky moment, as anybody who has ever been to Minsk knows, is when the furry brown mink from the north pole meets head on with  russian white sable.

Belarussian mink is better than anything that Peking can imagine in false shadowbanked fable.  

Never buy chinese fable when you can buy Minsky mink or russian sable stamped genuine by Putin himself as if made in Gorky park.

Some moments are eternal. "Parce que vous le valez bien". 

Quinvarius's picture

But the Yuan is the reserve currency for 25% of the world's poplulation, because that is how big China's population is.  Therefore, according to American MSM logic, it is impossible for anything to happen but growth and skittles for everyone.