How Long Can China's Debt Continue To Grow Before A Systemic Crisis Strikes?

Tyler Durden's picture

Nearly three years ago, Morgan Stanley may have jumped the shark (a little) when its strategists Cyril Moulle-Berteaux and Sergei Parmenov declared that China's Minsky Moment has arrived. While that may have been partially true, the fact that China managed to incur an additional $12 trillion in total debt in the interim period, suggests that Beijing at least managed to postpone the inevitable.

And since in the 3 years since little has changed, questions about how much longer the Chinese debt-fueled growth "farce" can continue have once again emerged, in their latest incarnation courtesy of UBS, whose economist Tao Wang asks "How long can debt continue to grow before a Minsky moment or systemic debt crisis?"

Here is the proposed answer:

China's debt is set to rise further in the coming years, likely exceeding 300% of GDP within 2 years. As the government continues to rely on credit-fuelled investment growth to offset downward pressures within the domestic economy and from a subdued global environment, unless there is major debt restructuring, China's debt/GDP ratio is set to rise further. We don't think that there is a "magic"  level at which a debt crisis will take place. Many countries ran into debt crises at levels of debt significantly lower than China's current level, often because debt was financed by foreign resources due to low domestic savings, and/or because of duration mismatch (Figure 11).


Conversely, there are countries (e.g. Japan, Figure 2) where debt levels have risen ever higher without triggering any obvious financial sector distress.


Four factors make a typical systemic debt crisis unlikely for China. Typical debt crises are often liquidity crises of the financial system. In China,


1) over 95% of debt is domestic debt financed mainly via banks;

2) there is a very high domestic savings & under-developed capital markets, so saving largely exists as deposits or quasi-deposits in the banking system to finance debt (Figure 12);

3) capital controls still exist to keep liquidity at home; and

4) a high degree of government control over the financial sector and largest borrowers (SOEs) means that debt restructuring can take place gradually with government coordination rather than in a disorderly manner forced by the market. A central bank that always stands ready also helps to shore up depositor confidence in the banking system, helping to reduce the risk of liquidity events. This is why we still think that China's credit cycle may be a more drawn out process than one that is disrupted by a typical liquidity-related  debt crisis.


However, while a conventional debt crisis may be avoidable, UBS admits that ever-rising debt is problematic even if problems do not manifest themselves in a crisis.

The fact that debt is rising much faster than output year after year and an increasing share of debt is allocated in nonproductive or excess capacity sectors means misallocation of resources. Such systematic misallocation will depress long term productivity and economic growth, and wasted resources mean more potential bad debt will be created. While the aforementioned unique factors can allow China's credit cycle to last much longer than in other economies and with less volatility, this lack of a market-clearing mechanism could depress corporate profitability and investment, leading to lower or stagnant economic growth over a prolonged period of time. Eventually, the cost of accumulating so much bad debt will have to be borne by the financial sector and savers, asset prices will have to correct, and the ultimate cost of adjustment may be substantially larger.

How will this debt cycle play out and what to watch?

In the likely scenario that China's debt cycle is a drawn out process, the government would have to balance the need to stabilize growth and defuse debt problems by slowing credit expansion gradually, taking actions to gradually restructure the stock of debt (including by writing off bad debts, divesting some state assets and closing down "zombie" companies), and reform to encourage growth in less debt-dependent sectors. In any large credit event, banks and related financial institutions would likely be required by the government to bring some of the culprit debt on to their balance sheets, to gradually restructure its underlying assets to help the economy avoid a serious liquidity/credit crunch. If confidence in shadow bank channels drops, so long as the government retains control over the capital account, liquidity would most likely flow back to the banking system


Risk of a more disruptive break in the credit cycle has risen in recent years. The credit cycle could be more easily disrupted if 1) banks run out of "free" liquidity and have to rely on wholesale funding to finance balance sheet expansion, which provides less reliable funding. Banks may be forced to slow credit expansion sharply in the event of a market confidence collapse or asset price plunge; and 2) Large capital outflows persist for a prolonged period, with the resultant domestic liquidity tightening increasing banks' exposure to international market conditions. Indeed China is experiencing rising capital outflows as a result of the government's earlier push for capital account opening and the more recent weakening of market confidence (Figure 13).


The rapid shadow credit expansion is a risk. Shadow credit is less regulated and adds multiple layers of intermediation that increases risks and financing costs. More importantly, when multiple layers of shadow credit underpins the economy's overall funding structure, it becomes much harder for the government to quickly identify where funding problems may be or as they appear, compromising their ability to promptly oversee and manage any liquidity situation to prevent it from warping into a bigger systemic issue. As shadow credit becomes increasingly important, the government's ability to use banks to bailout the shadow banking sector will also be diminished.

So while on net UBS is not yet sounding the alarm on the imminent bursting of the world's biggest debt bubble, here are the four warning signs investors should watch for when it comes to China: 

  1. Liquidity (LDR) in the broad banking system after adjusting for shadow credit;
  2. change in profit margins and/or return on assets in the corporate sector;
  3. size of shadow credit relative to traditional banking; and
  4. net capital outflows – persistent large outflows will erode China's domestic liquidity buffer.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
dogismycopilot's picture

Longer than you can sit in a bunker. 

luckylongshot's picture

Because China has a public banking system debt can be written off or made interest free with no threat to the economy. However because the west has a Rothschild controlled  fraudulent ponzi scheme, debt does not get written off even though money is invented into existance and collapse is guaranteed. Rather than looking at China, how about looking where there is a real danger of collapse.

JamesBond's picture

Longer than their citizens can stay solvent....



roddy6667's picture

Ssome societies can deal with debt better. Look at Japan. High standard of living, happy and healthy people, almost no political unrest. Much better than a lot of countries that look better on paper.

Grandad Grumps's picture

Japan has traditionally been a cohesive society. The US may have been on the path to developing a peaceful cohesive society, but the Fed changed that.

Scrubbing Bubblez's picture
Scrubbing Bubblez (not verified) Grandad Grumps Jan 30, 2017 4:09 AM

Japan is mostly a single race country. Back when whites were 90% of the population, it ran well, too. Niggers and spicks turn everything they touch into a 3rd world shithole!

old naughty's picture

not to worry,

they're still waiting...

for the other bubbles to burst first.

Arnold's picture

This is my thought too.

The cards are delt,

time to up the bet and we'll see who folds.

Grandad Grumps's picture

If Trump wants the US to survive, he not only needs to expose the work of both Soros and the neocons, but should align not only with Russia and Britain, but China as well.

For the time being, the EU and Japan are unimportant, except that they have their own problems with corrupt power. And, Israel will likely show its teeth if it's plans are disrupted and it has to come out of the shadows.

Great theater, no? Definitely worth the "E" ticket.

Mahatma Coat's picture

Look at that. Only 5 posts into to an article on Chinese debt and already we have Joos and Soros and Israel to blame.

Fuck me.  Whatever happened to intelligent discussion here?

cwsuisse's picture

The death by missallocation is slow and painful. The symptom is lack of real growth. China is not different from the US or Japan or the EU: the destruction of the pricing mechanism by the central banks is blowing bubbles and preventing real growth and real wealth. In the US the bubblemeter are the Fangs and their overblown valuation which is neither backed by revenues nor profits. 

Five Star's picture

As long as everyone elses debt bubbles?


Batman11's picture

I have just found the first mention of the “wealth effect” in “Fault Lines” by R.G. Rajan, it was used by the BoJ in the late 1980s.

Under U.S. pressure, Japan signed the Plaza Accord in 1985, this made the Yen appreciate and exports came under pressure. The BoJ cut interest rates sharply to boost both the stock and property markets. The “wealth effect” would then feed out into the general economy.

In 1989, the bubble burst and Japan has never recovered.

The Central Banker’s took no notice and still saw the “wealth effect” as a useful tool.

After the crash the ECB and FED use the “wealth effect” tool in their Central Banker’s tool boxes.

The FED blows up a US housing bubble that bursts leading to 2008.

The ECB blows up housing bubbles in Spain, Ireland, Greece and Holland. They burst later and trash their respective economies (Holland’s bubble is still inflated).

The Central Banker’s take no notice and still see the “wealth effect” as a useful tool.

After the 2008 crash all the Central Banks use the “wealth effect” tool in their Central Banker’s tool boxes.

What could possibly go wrong?

Invest with caution.

Batman11's picture

Australia, Canada, Sweden and Norway, too late, it’s already gone wrong.

Your housing bubbles will burst and trash your economies.

In a globalised world you really need to pay a bit more attention to what is going on in the world around you.

new game's picture

answer:king dolla goes to war!

Citizen_x's picture


"How long can debt continue to grow"


China should consult with the high priests of debt monetization, Greenspan and Bernake.

GRDguy's picture

Debt continues to grow as long as the banksters please.

Collapse happens because the banksters have decided it's time.

Kinda like certain men deciding when to start shearing the sheep.

Best recent illustration was the collapse of Soviet Union and the creation of their oligarchs.

peterk's picture

Economics is useless in  all this.

The unconcious mind of CROWDS  controls Bubbles, and CHINA is a BUBBLE.

Crowds seek no  LOGIC, so bubbles can exceed all human reason, hence  economics and all of its schools are useless. Show me someone who makes money in markets using economics?.. NAUGHT!.. no even schiff. an i like Austrians. But thats seperate to making money in markets.

The answer to  when will the crowds change their minds is in this question:

What controls CROWDS?


Arnold's picture



A classic, I still have my copy, I think I bought it in the seventies.


"The obnoxious hat was often snatched from his head and thrown into the gutter by some practical joker, and then raised, covered with mud, upon the end of a stick, for the admiration of the spectators, who held their sides with laughter, and exclaimed, in the pauses of their mirth, “Oh, what a shocking bad hat!” “What a shocking bad hat!

Let it Go's picture

Recently China has been on a tear to add liquidity to its flagging financial system. What it is failing to do is reform. A combination of corruption, to much debt, and policies that misallocates capital will come back to haunt them.

Expect the debate to continue as to whether China has turned the corner, however, one thing is clear and that is money flowing out of the country continues to distort markets across the world. More on this subject in the article below.

MaxThrust's picture

I believe China's rulers will continue to pump credit into the economy until an external black swan occurs . They need political cover from an external shock to burst this bubble. Until then expect the rulling elite's continued government bailout of the over-leveraged chinese economy.

Dragon HAwk's picture

We're all going to be Millionaires I tell you., it's a great world, print print print..    /s

Iconoclast's picture

China = the next big short, assuming they don't bring the global system down to such a level that no one gets paid out and digi currency and enslavement is all that's left in the rubble...

Ever since the Chinese finally woke up to how fractional reserve banking can 'work' and how bringing into existence fiat as debt was so easy it was child's play, they've been on full tilt creating money out of thin air to pollute the already engorged global system. Debt to GDP at circa 300%, personal debt rising by circa 500% over the past decade. China could crash the western banking and global monetary system and they wouldn't give a flying fukc as previous generations are hardened to having nothing.

They've been busily shopping in London over recent years, buying up property with yuan, making Harrods their second home, generally taking the piss out of the former western banking system, who'd have thought it was this easy? Create trillions, convert it to pounds, euro's and dollars, whilst exporting the white folk trillions worth of shite, then infect their system (with worthless yuan) after pwning it. Nicely done.

OCnStiggs's picture

Looks to me like they are getting ready to short the West. They run up a huge debt tab and then convert to the gold-backed currency, the Gold Yuan. We are left scrambling while their market takes off.

Ban KKiller's picture

I know, I know! Just hire more enron accountants? 

orangegeek's picture

China will do what Russia did - it's taking longer because of China's output.


When Chinese imports to the US tank, the Juan will get dumped.


Chinese currency ( remember all those assholes who said juan should be a global currency ) will consolidate, something like 10:1, as did the Ruble, and China's loud mouth will get pretty quiet after that.


And those 1.2B people over there will die very quickly.

ThrowAwayYourTV's picture

The cheap china is coming to an end quickly. Chinese workers are demanding better pay, working conditions and living standards.

To do that the chinese goobermint must create at least 10 million high paying jobs each year. To do that, and since the snowflakes are getting tired of buying electronic toys made in china, the only way will be to create jobs for the military and grow the military. Round and round we go, where we stop nobody knows.

DaBears's picture

China will print as much Yuan as they can as long they have a pegged system with a foreign reserve. Hyperinflation of Yuan is in their futures. 

all-priced-in's picture

You beat me to the same thought.



all-priced-in's picture

There has to be an impact on FX - the impact on FX has to also impact the Chinese economy.


Why is China just printing Yuan to create liquidity any different than Venezuela printing bolívar?


IMHO - The difference is the confidence level of the market. Loss of confidence will happen - and the end result when confidence is lost is always the same.  


The Yuan peg to the dollar can no way be maintained - something has to break.


To believe otherwise would be accepting a country can just print currency out of thin air for ever without any consequences.  





radbug's picture

Actually, Orangegeek, they're all dying more slowly than ever! It has been said that PRC demographics are 20 years behind Japan's and Japan's TOTAL population turned down in 2000. This development has been somewhat obscured by lengthening lifspans. Japan & the PRC, same population dynamics, same Banzainomics. Ergo, look to Japan to foresee China's future.