Can the world’s biggest economies — USA and China — keep living on credit?
Since the dollar is cheapening in world markets, we hear forecasts about a soon collapse of the US financial system — the world’s biggest economy — again. The second economy in the person of China is solving its problems — the necessity of decelerating the loan growth and accelerating the rise in the population’s well-being. Both economies have one characteristic in common — bigger debts that total about $30 trillion in each. The public debt compared to the US’s GDP is about 108%, China demonstrates 66,8%. The pandemic year forced to open the wallets bigger, the economies were supported thanks to new loans. Realnoe Vremya’s columnist, economist with long-term banking experience Artur Safiulin offers to find out how justified the pessimistic outlooks are.
China is trying to have it both ways
For the first time in history, China has faced an extraordinary growth of the country’s total debt — public and corporate. Judge yourself, the total debt against GDP in the first third quarter of 2020 was 190% (about $40 trillion). Corporate debts that accumulated because the government eased the conditions to take out pandemic-related (preferential) loans for companies account for a significant part. Now, after realising the risks, the Chinese government is convulsively trying to cool the overheated lending market down (reducing the growth of loans from 13,3% in 2020 to 10-10,5$ in 2021) by tightening rules but no raising the key rate because this measure impedes the government’s plan for doubling the per capita income b 2035. As we understand, these two measures have diametrically opposite vectors. And China, in fact, is trying to have it both ways.
But as many experts note, the Chinese economy suffered from the pandemic the least. It is a more industry-oriented economy than the USA where the services sphere reigns, demand for service is much more volatile. China’s costs on economic recovery didn’t turn out phenomenally high like in the USA. The budget deficit in particular rose just by 0,9% in 2020 and totalled 3,7% of GDP. In fact, it is a step back to the numbers of 2016-2017, moreover, the deficit in 2018 was higher, 4,2%.
Problems of corporate debts in China aren’t solved by means of public money. It is a rule that is rigorously followed even in the case of public companies. As a consequence, possible defaults of companies won’t influence the amount of the country’s public debt. China isn’t going to increase its debts more than it has done in the last three years and will concentrate on the acceleration of the growth pace of the economy, which is obviously illustrated by the key rate that hasn’t been raised since April 2020 and even the possible fall by late 2021 to support small and midsized businesses.
This is why the risk of a financial crisis whose scale is comparable to that of 2008 is quite real. Look, in the next two years, Chinese companies will have to repay or refinance $2,14 trillion of debts, which is 60% more than in the last two years. Investors who are always sure that public companies will be rescued in any case faced delayed payments for bonds have now started to sell them out. It feels like a credit crisis is looming. A conglomerate belonging to the government is a good example. As one of the most successful Chinese issuers, it didn’t manage to sell a single dollar bond in 17 months (as of July 2021). In the absence of public support, the rule “too big to go bankrupt” doesn’t seem to work in China anymore. The government says such an approach comes from the necessity of educating corporate discipline and transforming the national loan market $17 trillion in size. I will not surprise if they manage to avoid this crisis too: this country has been operating with big numbers and projects for long.
US authorities might announce default in October
The USA lives in a completely different situation but with a bigger debt both in absolute terms and compared to GDP. Approximately once in two years, Congress approves the so-called agreement to suspend the debt ceiling: in fact, this allows increasing loans without limit. The current agreement terminated on 31 July 2021, and by its termination, the debt amounted to $22 trillion. Less than a month later, the digit already is $28,5 trillion.
If Congress doesn’t permit borrowings again, the US authorities might formally announce default in October. It will be a catastrophic event for the world financial and economic system in general, that’s why it didn’t expect the events to develop this way. For reference, Congress has raised the debt ceiling 80 times in the last 70 years. So the USA will carry on raising public expenses by trillions of dollars through Treasury bonds to back the pandemic-affected economy up.
The budget deficit rose to 14,9% of GDP in 2020. To compare, in 2019, this indicator was 4,6%. Whereas the ratio of public debt to GDP reached 108%. The debt growth dynamics that are not as fast as in China save the situation. From 2016 to 2020, the indicator grew from 105,3% to 107,6%. Moreover, the number of 2020 was registered amid a fall in GDP with a sudden ramp-up in borrowings to support the economy. Given the qualitative growth of GDP in 2021 (only the second quarter showed 6,5% growth), the ratio can go down.
The comparison of the profitability of 10-year-old Treasury bonds with inflation is another way of verifying the country’s ability to attract and sell cheap. In particular, the yield of US bonds is now 1,3% (reaching 1,9% at the peak of the alarming 2020), while inflation is 5,4%. To put it simply, the Treasury takes out at 1,3% a year and grants them devaluated at 5,4% a year. In fact, the state remains profitable — it is brought money asking to accept it as a debt. It is a paradoxical situation. We should remind you that such a bond rate is linked with a very low key rate of 0,25%, which will stay at this level until 2023. The holiday of cheap loans goes on, and seemingly, the end is not seen. It is good to be an issuer of the world’s key currency when you can afford to raise the debt ceiling without risk of defaults.
In conclusion, I would like to note that the first and second economies of the world with similar debt sizes in fact have very different situations. China is dealing with corporate debt and doesn’t intend to save its conglomerates, which threatens it with a potential crisis in financial markets. On the other hand, if a fire of corporate defaults starts and it is necessary to inject it with money, China will easily increase its public debt as its GDP grows, the ratio of the total debt to GDP isn’t critical (especially compared to the USA). As it has been said above, the Chinese government decided to put its financial markets in order. It will be interesting to see how things will unfold.
While the USA has been partying to the full with borrowed money, moreover, for many years. And one can see no end to it, nor there will be any. As an issuer of the global currency, the American government will be pleased to issue new bonds to cover the budget deficit, while the world will bring the hard-earned money by simultaneously changing them for dollars (thus, supporting the dollar as a currency too) asking to use them in work at 1,3% a year and receive them in a year with gratitude with 5,4% inflation. A lucrative business, isn’t it?
The author’s opinion doesn’t necessarily coincide with the position of Realnoe Vremya’s editorial.