Analyst Lays Out China's "Doomsday" Scenario

The first time we laid out the dire calculations about what is perhaps the biggest mystery inside China's financial system, namely the total amount of its non-performing loans, by former Fitch analyst Charlene Chu we called it a "neutron bomb" scenario, because unlike virtually every other rosy forecast the most dire of which topped out at around 8%, Chu argued that the amount of bad debt in China was no less than a whopping 21% of total loans.

Corporate investigator Violet Ho never put a lot of faith in the bad loan numbers reported by China’s banks: crisscrossing provinces from Shandong to Xinjiang, she’s seen too much - from the shell game of moving assets between affiliated companies to disguise the true state of their finances to cover-ups by bankers loath to admit that loans they made won’t be recovered. The amount of bad debt piling up in China is at the center of a debate about whether the country will continue as a locomotive of global growth or sink into decades of stagnation like Japan after its credit bubble burst. Bank of China Ltd. reported on Thursday its biggest quarterly bad-loan provisions since going public in 2006.


Charlene Chu, who made her name at Fitch Ratings making bearish assessments of the risks from China’s credit explosion since 2008, is among those crunching the numbers. While corporate investigator Ho relies on her observations from hitting the road, Chu and her colleagues at Autonomous Research in Hong Kong take a top-down approach. They estimate how much money is being wasted after the nation began getting smaller and smaller economic returns on its credit from 2008. Their assessment is informed by data from economies such as Japan that have gone though similar debt explosions.


While traditional bank loans are not Chu’s prime focus -- she looks at the wider picture, including shadow banking -- she says her work suggests that nonperforming loans may be at 20 percent to 21 percent, or even higher.

The chart below shows just how much of an outlier Chu's stark forecast was in comparison to her peers, and especially the grotesquely low and completely fabricated official number released by the banks and the government.

To be sure, it has always been in Beijing's best interest to keep true NPL data well-hidden by everyone from the lowliest bank teller to the Politburo, who all know that merely the recognition of the problem would be sufficient to spark if not a full-blown panic then certainly accelerate capital outflows form the nation to an unstoppable degree.

Another problem with making estimates of adequate collateral protection in China, one which makes such a venture more complicated than solving the proverbial riddle, wrapped in a mystery, inside an enigma, is that the very premise of collateralization in the world's most populous nation is nebulous. Recall that one of the biggest scandals in China in 2014 was the realization (as many had warned previously) that millions of tons of commodities were rehypothecated countless times, and thus "pledged" as collateral to numerous counterparties, and that as a result these same counterparties were unable to make sense of who owns what at one of China's largest ports, Qingdao. In this context, it is safe to assume that loss given default rates in China are if not 100% (or more, which is impossible in theoretical terms but in practice is quite possible, as another curious side effect of unlimited collateral rehypothecation), then as close to it as possible. In early June, Reuters published an expose on China's "Ghost Collateral" reminding China watchers that this most insidious phenomenon is anything but gone.

Since then, fears about both China total debt load and the size of its NPLs have only grown, and most recently came under the spotlight of the IMF itself, which two days ago issued a warning about Beijing’s reluctance to rein in “dangerous” levels of debt, blaming Beijing’s tolerance of high debt levels on its goal of doubling the size of the economy between 2010 and 2020.

“International experience suggests that China’s credit growth is on a dangerous trajectory, with increasing risks of a disruptive adjustment and/or a marked growth slowdown,” the IMF said. This statement is spot on, because as the IIF recently showed, total Chinese debt/GDP has now crossed above 300%, a level that in every historical instance, led to a financial crisis.

What was left unsaid is that it is only because China doubled its total debt load following the financial crisis that the world managed to avoid succumbing to an unprecedented depression in the years following the financial crisis. However, by engaging on this unprecedented debt rampage, China only delayed the inevitable.

The IMF tried to sound mutedly optimistic, adding that “the [Chinese] authorities will do what it takes to attain the 2020 GDP target,” however one look at the exponential rise in China's various credit product prompts substantial doubt how much longer Beijing can delay the inevitable.

And then there is, of course, the biggest wildcard: how much of China's debt is already impaired, i.e., bad.

* * *

Fast forward to today, when Charlene Chu, described by the FT as "one of the most influential analysts of China’s financial system" is back with a revised estimate that the bad debt in China has now reached a stunning $6.8 trillion above official figures and warns that the government’s ability to enforce stability has allowed underlying problems to go unchecked.

Charlene Chu built her reputation as China banking analyst at credit rating agency Fitch, where she was among the earliest to warn of risks from rising debt, especially in the country’s shadow banking system. Today many of her original views — such as concern about Chinese banks concealing risky credit in off balance sheet vehicles — have become consensus among analysts.

The story repeated with grim determination by Charlene Chu, who left Fitch in 2014 to launch the Asia operation for Autonomous Research, is a familiar one: "everyone knows there’s a credit problem in China, but I find that people often forget about the scale. It’s important in global terms,” Chu told the FT in an interview.

So if Chu held the wildly outlier view nearly two years ago that China's NPLs amount to 21% of total, what is her latest estimate? The number is a doozy: in her latest report, Chu estimates that bad debt in China’s financial system will reach as much as Rmb51 trillion , or $7.6 trillion, by the end of this year, more than five times the value of bank loans officially classified as either non-performing or one notch above." That estimate implies a bad-debt ratio of 34%, orders of magnitude above the official 5.3% ratio for those two categories at the end of June.

Needless to say, there is a solid pushback against Chu's conclusion, and especially those who are currently invested in Chinese financial assets are doing everything in their power to prevent her opinion from becoming gospel.

Chu is among the most bearish observers of China, and some analysts question her methodology. In particular, her estimate of Rmb51tn in bad debt is based on average credit losses across other 11 other economies that previously experienced rapid debt increases comparable to China, including Japan in 1985-97 and the US in 2000-07.


But Chen Long, China economist at Gavekal Dragonomics in Beijing, said this methodology implicitly assumes that an economic crash will eventually occur in China.


Mr Chen argues that credit losses are highly correlated with economic performance: bad loans rise when growth slows. If China can prevent a sharp downturn, credit losses will be much smaller, despite the extraordinary increase in leverage.

Chen's conclusion is delightfully and perversely reflexive: as long as China can avoid a crash, it will avoid a crash: “If there’s an economic collapse, of course there will be massive credit losses. No one disagrees about that. But the issue is whether the collapse will actually happen. She takes that as a given,” he said, adding that Chu failed to consider examples such as Korea in the 2000s or Japan after 1997, when debt rose strongly without harming growth. Which is true, but what Chen forgot to note is that globalsince both of those examples has risen to never before seen levels, in the process making the recurrence of such one-time "success stories" impossible.

Clearly Chen sees a far happier, non "crash landing" ending for the country with the 300% debt/GDP.

As for Chu, she acknowledges that an acute crisis does not appear imminent as the government suffocating influence over both borrowers and lenders has allowed Beijing to delay problems much longer than would be possible in a more market-driven system. One factor that has foiled countless shorts over the years is that Beijing can simply order state-owned banks to keep lending to a lossmaking zombie company or to a smaller lender that relies on short-term interbank funding to stay liquid, and that's precisely what has been happening, when looking at the various non-conventional credit pathways in China in recent years, which include Wealth Management Products, Bank Loans to Non-Bank Institutions, Shadow Banking, Repos and Certificates of Deposit.

But Chu said the ability to avoid recognizing losses only delays the inevitable day of reckoning as problems fester for longer, and grow larger than in an economy where actors respond purely to market incentives. That said, the recent spike in corporate bankruptcies indicates that even Beijing is slowly shifting to a more "market" driven stance.

“What I’ve gotten a greater appreciation for is how everything is so orchestrated by the authorities,” she said. “The upside is that it creates stability. The downside is that it can create a problem of proportions that people would think is never possible. We’re moving into that territory.”

Finally, putting it all in context is the following chart showing the total size of China's financial sector, which as of the latest quarter has grown to $35 trillion, double the size of the US.

If Chu is right, and local savers and investors certainly know best, it would explain why when looking at SAFE data showing "onshore FX settlement" and "cross-border RMB flows”, and which reveals that net flow of RMB from onshore to offshore was another $13.8billion in July , contrary to PBOC reports Chinese outflows have not ceasued since the summer of 2015...

... as a third of Chinese bank assets being "bad" would be nothing short of a "doomsday" scenario for China's financial system and also explains the relentless attempts by local to park their money offshore before the system one day "unexpectedly" crashes.


Justin Case Thu, 08/17/2017 - 12:43 Permalink

Following moves by China and Japan to regulate digital currencies, Australia is attempting to crackdown on money laundering and terrorism financing with plans to regulate bitcoin exchanges.

"The threat of serious financial crime is constantly evolving, as new technologies emerge and criminals seek to nefariously exploit them. These measures ensure there is nowhere for criminals to hide," said Australia's Minister for Justice Michael Keenan in a press release.

The Australian government proposed a set of reforms on Thursday which will close a gap in regulation and bring digital currency exchange providers under the remit of the Australian Transactions and Reporting Analysis Centre (AUSTRAC).…

Swampster (not verified) Justin Case Thu, 08/17/2017 - 12:46 Permalink

"THE DESTRUCTION OF WHITE COUNTRIES WAS PLANNED LONG AGOThe socialist jew run banking cartel needs a bigger flock of sheeple to shear, as their American flock is getting poorer and poorer. The world is now their Oyster.And what can't the greedy socialist jew FEDERAL RESERVE BANKING CARTEL buy with the SEVEN TRILLION DOLLARS they printed for themselves under Obama? It's buying the destruction of White Countries before our eyes.WHAAAAAT????? You mean the greedy lying socialist jew media never explained to you that QUANTITATIVE EASING WAS SOCIALIST JEW BANKERS PRINTING THEMSELVES MONEY?The average American stupe probably has never even heard of Q,E., but it's what made your grocery bills double under Obama!White Culture, White History, White Family, "White Religion", and White Work Ethic have all been attacked since the 1960's. Diversity = The War on Whites Christians and Heterosexuals. Multiculturalism destroys countries, while uni-culturalism holds them together.Political Correctness, Multi-Culturalism, Diversity,....all designed to destroy the foundations America was built on,. It's all part of the Jew World Order, which is WHY SOROS IS SPENDING hundreds of MILLIONS bankrolling MUSLIM REFUGEES IN EUROPE, and why Obama has opened our Southern Borders and is bankrupting America. It's no coincidence that America and Europe are being over run with non-white, uneducated, illiterate criminals, terrorists, and rapists at the same time.China and Russia are being taken down too, by economic warfare and proxy wars, with a real war coming. i.e. with "War Protesters", a Nightly "Body Count" on the Jew run media, and a parade of outraged liberals screaming at the tops of their lungs....and yes it will happen under the next "Republican" President, keeping the current jew run media "Republicans are Warmongers" meme's Divide and Conquer, and White people also have a long history of fighting back against Kings and Tyrants. Now you know why White countries are being destroyed, what are you going to do about it?Only one thing works, and we all know what it is. We should all now see why the Founding Fathers were smart enough to include the 2nd amendment in the United States Constitution. It now seems that the Jew World Order cannot flourish unless all white countries perish.And to think our forefathers once overthrew a corrupt Government over the price of some stinking Tea!!!How far we have fallen.

In reply to by Justin Case

Kayman Swampster (not verified) Thu, 08/17/2017 - 13:33 Permalink

17 week TrollWithout "White" countries, which I assume you mean Western countries, the people of Jewish ancestry, secular or practicing, would not survive. While I agree those of Jewish persuasion dominate much of the conjuring in finance, real wealth comes, not from paper but from your mind and hands. Your religion or politics is just so much baggage.

In reply to by Swampster (not verified)

Peacefulwarrior Thu, 08/17/2017 - 12:49 Permalink

China has had deflationary numbers for years. Maybe if interest rates spike sharply and they can't borrow they have a problem. However, nothing a major War can't solve.

debtor of last… Michigander Thu, 08/17/2017 - 14:48 Permalink

Yep. Its a way to stash a small part of your wealth. In this case however i think its a gambling circus. And i think a major crackdown by some government is on its way. Erdogan did shut down twitter. Another one will shut down exchanges. But hey, gold can be confiscated too.

Did you notice China articles keep coming back on a regular basis? Written and/or edited by zh? They know... China is a financial neutron bomb.

In reply to by Michigander

HRH Feant2 (not verified) Thu, 08/17/2017 - 13:00 Permalink

So this is a race to see which country implodes, financially, first, China or the USSA.

LawsofPhysics Thu, 08/17/2017 - 13:15 Permalink

LMFAO!! So fucking what? China is in fact a single-party TOTALITARIAN society!!!!!They will make all that bad debt fucking dissapear and give their PEOPLE (not corporations) FIAT to BUY ALL OUR REAL ASSETS WITH!!!!FYI, anyone who doesn't go along with the plan will also dissappear, but either way they end up owning and ruling the world. How's your mandarin?

Dragon HAwk Thu, 08/17/2017 - 13:23 Permalink

So they print all the money they want, lend it out to anybody they want, and the only  person who doesn't get paid back is the Government? sounds like a win to me.. I read the entire article and nowhere did it say who was not going to get paid, or who would be hurt.

Batman11 Thu, 08/17/2017 - 13:26 Permalink

Everything is going so well, I can’t see a problem.The US: and 2008 stick out like sore thumbs; bank credit going into financial speculation and stocks (1929) or real estate (2008).Leveraged financial speculation with bank credit.The UK: and real estate speculation.China:I don’t have the graph, but expect something similar.The global gold standard for economics, neoclassical economics, doesn’t look at private debt. Steve Keen is the source of the first two graphs; he saw 2008 coming in 2005 by looking at the first graph.He thinks China is in trouble too, along with Hong Kong, Norway, Sweden, Belgium, Australia, Canada and South Korea.

Ghost who Walks Batman11 Thu, 08/17/2017 - 21:37 Permalink

Not in your commentary but essential to get a grip on the nature of the problem is Steve Keen's second derivative of credit growth. He often makes the point that once the rate of growth of credit goes negative then the economic problems happen.The Chinese problem is that eventually the rate of growth of credit must go negative even if total credit is still growing. As others have pointed out China is a command economy and they may be able to finesse their way through the credit crisis. Banks don't have the same leverage in China that they do in the West.China will have to deal with non-performing loans issue sooner rather than later. Another of Keen's ideas is the requirement for regular debt Jubilees where debt is forgiven, so that an economy can move on unencumbered.It's this concept which may be the most powerful solution to the NPL problem. It is not canavassed in the West due to to the probable losers (Banks) having political power and having set the broader population up to make them whole when the crisis come to pass.Japan has lost the two decades of growth because the bank losses where not recognised in a timely fashion. It may be that the great recession since 2008 is also a manisfestation in western economies of the same underlying problem of Western Banks being under-capitalised and hiding bad loans. Italy comes to mind, but I'm sure that the UK, France, Spain and Germany all have similar problems that are hidden due to the political problems of cross-border losses being borne by other countries and their taxpayers.Iceland and the collapse of their banking system and the pressure that the UK in particular applied to protect Brit depositors comes to mind.

In reply to by Batman11

PGR88 Thu, 08/17/2017 - 13:31 Permalink

China will have NO "doomsday scenario."Sure they have a lot of debt, but they also have this thing called the COMMUNIST PARTY, which controls every large company, every bank and every financial entity in China.   China doesn't allow people like George Soros to play in their country, and they don't allow companies like Google to spy on them. If things get dicey, they will shoot one or two "corrupt speculators" to make an example, and the people will cheer.   They also have a massive army which will not be intimidated by the USA.  There will be no 'Arab Spring' and there will be no rush for the exits.

Kayman PGR88 Thu, 08/17/2017 - 13:52 Permalink

"they also have this thing called the COMMUNIST PARTY,"Yeah, that Communist Party sure made China a wonder of the world for the first 50 years.  Without American capital and technology, China would still be starving.  Now they are choking on pollution in their air and water.And they badly need that massive army; not for external enemies.

In reply to by PGR88

scraping_by Thu, 08/17/2017 - 13:35 Permalink

The only question about bad debt is when the default happens and everyone moves on with their lives. The only question about default is who gets burned. The Chinese Central Bank? Print more money. The private banks? Too big to fail, print more money. The government oligarchs who stole public money? They can be wiped out and nary a ripple. Average people? Few have any real savings, mostly debts for real estate.Default would slow things down, but only crash things if the government decided to keep the wealthy wealthy.

bankbob Thu, 08/17/2017 - 13:49 Permalink

The 19th People's Congress is scheduled for this Fall.  Look for Xi to announce another Great Leap Forward that involves banks closing their loan windows and the government implementing very harsh new crackdowns on Western Behavior.  Remember this is the guy who has already publicly executed 70 major party members for corruption.For China to survive the coming crash as an intact country - a major crackdown will be necessary.

truthalwayswinsout Thu, 08/17/2017 - 13:49 Permalink

There are 30,000 BMB explosions about to take place in China. (Bernie Madoff Bombs).The greatest depressions ever were from Tulips and the Louisanna Land scams. This one will set a record that will last a 1000 years.

DEMIZEN Thu, 08/17/2017 - 14:47 Permalink

what if we put this analysis in another time perspective. what was a  similar US bank analysis made in 1988 worth after the eastern block implosion? Chinese make their bets taking into account western contraction in the near future. core GDP is likely off anyway. time will tell

Dammit Walter Thu, 08/17/2017 - 16:10 Permalink

What we have learned from Japan is that when the Bernie Madoff ponzi schemes of a Banking and Market system eventually starts to implode, the .gov can print and devalue to delay the funeral Weekend At Bernie's style for several decades.  People have been calling for Japan's collapse for how long now?

InnVestuhrr Thu, 08/17/2017 - 18:54 Permalink

NONSENSE cuz the Communist Party controls everything in the CLOSED SYSTEM that is China - all they have to do is have their central bank buy bad debt, erase bad debt from books, etc. VERY LITTLE Chinese debt is held outside China - who is going to complain ?????Actually quite trivial and routine for a system that has been operating with completely fictitious economic data since inception.

francis scott … Thu, 08/17/2017 - 19:07 Permalink

Come on, Charlene, is it really worse than our National Debt of over $20 trillion when the Fed has to print interest payments for the principal every month.Get a grip, girl.

ds Fri, 08/18/2017 - 02:50 Permalink

The flows in the global financial economy is much larger than any individual country including China. Japan's real economy limped along because the Japan has all along been attached to the global financial economy and BOJ worked in coordination and not in defiance of the Fed and the then US hegemony. Hence the Yen did not tank although its value is not reflective of Japan;s real economy.China is in a different category. The globalists hate nationalistic economies. The globalists will see to it that China will not be latched to the global financial economy. The globalists will encourage the market predators who smell blood to attack and muzzle co-operation from major central banks like Fed to provide the stability and credibility that PBOC needs for the real economy of China. Putting US real economy into the matrix is almost done. Now the game is to challenge China's hegemonic ambition as all nationalistic hegemonies have to fold into the Matrix. Xi has underestimated the Globalists and the Chinese People are deluded to think that it is US Nation who is underming them. US is just the apparatus of the Globalists, not the enemy.China can do nothing and at best limp along through lost decades when the RMB is being priced by Globalists. All the shifting of assets within china's real economy are kool aids to ensure no revolts.