Will $9 Trillion of Losing Bets by the CCP Cause an Asian Financial Crisis 2.0?

A Chinese bank worker prepares to count U.S. dollar bills and a stack of 100 yuan notes at a bank in Hefei, Anhui Province, China, on March 9, 2010. STR/AFP via Getty Images

Commentary

The Chinese Communist Party (CCP) is in dire straits. Economically, China looks like a basket case after having its growth directed for decades by an ideology of victimhood opposed to the most basic principles of market economics.

The growth was based on trillions of dollars of debt that can’t be paid back and could cause China’s financial system to collapse, affecting most countries in Asia. An Asian Financial Crisis (AFC) 2.0, starting in China instead of Thailand this time, could be coming.

Like the AFC 1.0, which began in Thailand in 1997, China now has a devaluing currency relative to the U.S. dollar and a weakness in its equity and property markets. If its foreign reserves run low, it could have a balance of payments problem and a banking crisis.

According to Beijing’s self-reported data, which, in the case of unemployment and corporate due diligence, it’s hiding, we aren’t there yet. However, international investors are already acting upon the increased risk of China’s contagion effects.

On Aug. 24, Morgan Stanley cut its price targets for the MSCI China stock index by 14 percent based on lower earnings and valuation expectations. On the same day, Goldman Sachs warned of a “spillover” to other countries in Asia (except Japan), “slashing” price targets for Asia’s MSCI (ex-Japan). That included Australia, Malaysia, and Hong Kong, all of which are correlated with China.

Except for a slight uptick in China’s consumer sentiment that didn’t even reach the low bump of April and surprisingly good net income reported by China’s electric vehicle maker, BYD, the economic news from China, including deflation and slumping international trade, has been doom and gloom. The worst, however, are indicators that trillions worth of local government shadow bonds could become nonperforming.

Since the financial crisis of 2008, the CCP has allowed city and provincial governments to take $9 trillion worth of off-balance-sheet debt to build bridges, roads, water plants, and flashy high-speed rails that drove eye-popping growth. That drew CCP bragging rights, international applause, major investment to China, and the export of the model internationally under the Belt and Road Initiative.

An elderly man making his way home after buying some vegetables from a market in Beijing on Sept. 7, 2012. Wang Zhao/AFP/Getty Images

The CCP presented itself globally as a miracle-maker that raised 800 million people out of poverty. Many around the world bought the talking point hook, line, and sinker and are still repeating it to this day.

Yet in China, seniors receive pensions of only $25 to $410 per month.

“Public health care covers less than half of people’s costs,” Keith Bradsher wrote in The New York Times. “Unemployment insurance provides around $220 a month; the U.S. average is nearly $1,700.”

This lack of a social safety net weighs on the Chinese consumer’s confidence.

The problem with China’s shadow poverty and shadow debt is in the opacity of the regime and China’s so-called economic growth, which, in the case of local government infrastructure projects, is largely funded by off-balance-sheet debt taken by local government finance vehicles (LGFVs). These projects rarely turned a profit but did allegedly provide local officials with plenty of bribes.

The CCP nevertheless allowed local shadow debt to increase for years, which caused no crisis as long as the property market was gangbusters and local government taxes could be used to pay the interest.

With Beijing’s attempt to limit local shadow debt in 2020, however, China’s property market slumped, and major developers went into crisis. Evergrande is filing for bankruptcy in the United States, and Country Gardens is near default on its first bond of as much as $2.9 billion of note obligations for the rest of this year.

Local governments lost revenue from land and home sales, which, combined with unexpected pandemic expenses, made paying LGFV interest difficult. Bond payments are still being made, but cracks are starting to show in the servicing of shorter-term debt. Last year, about half of the cities in China were making interest payments only with difficulty.

If LGFVs default on their bonds, the first to feel the pain will be investors in China.

“All types of financial institutions have exposure to them: commercial banks via their wealth management units, insurers, mutual funds, securities companies and hedge funds,” Bloomberg reported. “The overwhelming majority of their investors are local, as foreigners consider LGFVs to be opaque and hard to analyze.”

But as noted by Goldman Sachs, international investors also have worries, especially those in Asia whose economies are closely tied to China. According to Bloomberg on Aug. 23, “any default on LGFVs $2 trillion of bonds—which account for nearly half the country’s onshore corporate debt market—would destabilize China’s $60 trillion financial system, producing global shockwaves.”

Thai economists are warning that the Evergrande collapse alone is hitting Thailand’s construction material exports and tourism revenues hard. Thailand’s biggest export market and source of tourists is China.

Beijing has responded by allowing provinces to adopt some of the debt onto their balance sheets. That could provide solace to markets by decreasing the risk of shadow defaults and contagion.

Some investors, including internationally, are calling for more government stimulus. They threaten to not return to China if the government doesn’t cough up more subsidies. However, subsidies that failed because they didn’t follow market principles were the cause of China’s economic problems in the first place.

These investors want short-term profit. They don’t care about China’s long-term economic strength, which can be based only on increased political and market freedoms rather than more communist-directed subsidies.

In the long run, freedom, rather than dictatorship, slavery, communism, taxes, and subsidies, will create international trade and strong economics to boost the shockingly low standards of living in China. The tangible benefits of freedom are the lessons that the thriving economies of the United States, Europe, Japan, South Korea, Taiwan, and a free Hong Kong (may it rest in peace) have for China. With freedom comes prosperity.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.