For China, Even Good Numbers Don't Add Up

Despite booming exports, the mainland can't grow its way out of its debt problems.

The math doesn't work for a debt-burdened mainland economy.

Photographer: Peter Parks/AFP/Getty Images

The improving U.S. economy has brought some welcome cheer to officials in Beijing, which reported an unexpectedly high 9.7 percent jump in December exports on Tuesday. If those numbers continued in months ahead, they’d also be good news for a global economy that’s running short on viable growth engines.

Not all analysts are convinced they will; many predict that China will have to loosen monetary policy soon in order to ensure that GDP growth stays above last year’s target of 7.5 percent (it’s currently around 7.3 percent). That’s worrisome because of a different number entirely: 251.

That, in percentage terms, is Standard Chartered's working estimate for China's debt-to-gross-domestic-product ratio. Already worryingly high compared to where Japan was 25 years ago when its own bubble burst, the number will only rise further with additional stimulus. The more China gins up growth in 2015, the more irresponsible lending it will have to service in the decade ahead.

The math simply doesn’t work out. Even if China could somehow return to the heady days of 10 percent-plus GDP growth, its debt mountain would by then be nearly unmanageable. "We’ve got the biggest debt bubble that the world has ever seen and credit is continuing to grow twice as fast” as output, Charlene Chu, a former Fitch Ratings analyst, told Bloomberg Television earlier this week. Those who believe China can somehow grow its way out of this problem are fooling themselves. “Mathematically, that’s impossible when something is twice as big as something else and growing twice as fast,” as Chu noted.

From Japan to Argentina to Greece, recent decades offer many examples of governments thinking 1 + 1 = 3. It took Japan more than a decade after its bubble burst in 1990 to create the Resolution and Collection Corporation, modeled after America's Resolution Trust Corporation, to dispose of bad loans. China can’t afford to wait that long to head off a full-blown crisis. It's one thing for a $24 billion economy like Argentina to blow up; it would be quite another if the world’s second-biggest plunged into turmoil.

Yet for all the official talk about curbing borrowing and adjusting to a "new normal" of lower growth, Xi's government still hasn't shown the stomach necessary to bring China’s debt problems out into the open and deal with them. Even one of the first defaults on an offshore bond by a Chinese developer last week ended happily. Kaisa Group missed a $23 million interest payment, but quickly received a waiver from HSBC. Since all property companies won't get last-minute reprieves, these kind of maneuvers just delay a reckoning.

What should China be doing? First, clamp down more firmly on new borrowing, particularly to the state sector. While that would roil credit markets and crimp growth, it's vital to gaining control of the financial system. Next, conduct a truly transparent audit of public debt and the shadow banking system. China doesn't offer data on the latter, leaving the private sector to guestimate. Chu, who's now with Autonomous Research in Hong Kong, put Chinese bank assets at around $28 trillion the end of 2014, a huge increase from $9 trillion in 2008. As any 12-step program participant can attest, sobriety requires first admitting the magnitude of one’s problem -- and publicly.

Finally, China needs to create a mechanism to collect and write down bad assets. Only by doing so can Beijing prod wobbly banks to act openly and quickly to repair balance sheets. There are many ways China could go -- a Japan-like RCC or a Sweden-like purge and bank recapitalization. The point is to address its math problem frontally. However cheery, trade and GDP figures are the wrong numbers to focus on.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.