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Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

China's debt binge, Goldman Sachs says, may be far worse than people imagine. As Tracy Alloway of Bloomberg News notes, the investment bank's proprietary metric puts credit creation last year at 24.6 trillion yuan ($3.7 trillion), far ahead of both new money supply and total social financing.

This is the amount that households and companies channeled into non-government debt over the course of 2015, according to Goldman's calculations. Part of it came from money deposited with banks, while another part skipped the deposit route altogether and went straight into shadow-banking investments such as wealth-management products and mutual funds, as well as insurance and trust plans.

Debt Feast
Three years of U.S. corporate bond issuance equals credit creation in China last year alone
Source: Bloomberg, Goldman Sachs

The overall number is staggering. To put it in perspective, it took U.S. companies and their subsidiaries three years to raise $4 trillion from international bond markets. How could credit demand in the People's Republic possibly be growing at such breakneck speed? The one-word answer, according to Mark Artherton at London-based research consultancy Ecstrat, is "financialization."

This occurs when instead of linking savers with real borrowers, banks become a funding mechanism for other financial borrowers. One way to see that's indeed the case in China is to follow Artherton's lead and break domestic credit claims down by debtors.

By absolute value, companies and individuals have borrowed the most. That's only to be expected. But to get an idea of their relative growth, ignore the difference in starting points and set all three categories to 100 in January of 2009. Now, it's the financial debtors jumping off the charts -- with 850 percent growth in a little over seven years.

When Banks Lend to Financiers
Domestic credit in China is growing for all debtors, but booming for financial borrowers
Source: PBOC, Bloomberg

The financial system's role an economy resembles the shape of the letter T, with one of its arms extending to savers, and the other to borrowers. Think of a lightly financialized economy as a smallish cluster of Ts. In a highly financialized economy -- like the U.S. of 2008 and China today -- the financial system takes on the appearance of a long string, like TTTTTTTTTTTTTTTT.

Not only is the level of financialization in China unusually high, it's also responsible for the astounding pace of credit creation. To see how, return to that portion of household and corporate savings that Goldman estimates goes into shadow-banking products, and plot it against banks' fresh credit to other financiers. The two are moving remarkably in tandem.

Financialization Drives Credit Growth
Source: Goldman Sachs, Bloomberg

Banks' balance sheets tell a similar story. As late as 2012, when Chinese lenders reported their "investment in securities," most of it used to be in government bonds or corporate debt. Among the 15 lenders studied by Gadfly, only 9 percent of such investments were in products issued by shadow banks. Now, that's jumped to more than a third, even as the banks' overall investment in securities has grown by 65 percent.

The credit bubble in China is indeed far bigger than the headline numbers of money supply or social financing let on. And because it's driven by financialization, problems are more likely to show up in asset markets than the corporate sector. Watch out.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. For more, see "Financialisation in China and How to Track It," published by Smartkarma on May 25

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net