China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle
Book Review by Stas Margaronis
In the book, Red Capitalism; The Fragile Financial Foundation of China’s Extraordinary Rise, authors Carl Walter and Fraser Howie warned about the growing risk of Chinese banks and financial institutions supporting a rising tide of bad debt so as to maintain economic development. The book was written in 2011, but China’s economy continues to thrive.
In 2018, Dinny McMahon, a former Wall Street Journal reporter in China, writes: “China’s debt accumulation could be among the fastest in modern history.”[1] China’s total outstanding debt was worth 260% of its GDP in 2016, up from 160% in 2008.[2] Mc Mahon writes that there is a belief that China is somehow exceptional and that the conventional rules of economics seem somehow to have been defied by its forty years of growth and the scale of government subsidies and intervention, but “at the cost of storing up greater pain in the future.”[3]
He argues that the growth of ghost cities is one example of the bad debt threat. In the city of Tieling, population 2.7 million, located in the northern Chinese province of Liaoning, McMahon describes how the city has yet to realize the huge investment made in construction of a new urban area that is largely empty. Many cities in China have built new urban additions as a means of generating new economic development and now have created a stretch of empty so-called ‘ghost’ cities across China. Tieling spent US $3.8 billion building its new city addition over seven years and by 2015 had accumulated a debt of US $1.1 billion, compared to practically zero debt eight years earlier. The problem is that there are many empty or near empty buildings in the new urban area generating no revenue to pay off the investment which threatens Tieling with a financial burden “for years to come.”[4] The growing deficit for the city government as well as other city governments has contributed to the growing debt in China and for Chinese banks which supported what appear to be speculative real estate investments.
In 2013, plans for new cities and districts in China were poised to accommodate 3.4 billion people, twice China’s total population.[5]
A second area of bad investment is in the continued subsidization of companies owned by the state that have no future. Erzhong, is a government-owned manufacturer of large forges used to manufacture parts for the defense, aircraft and nuclear power industries. It was merged into Sinomach, China National Machinery Industry Corporation to avoid its collapse:
“By 2015, Erzhong had borrowed so much with so little payoff for its investments that without Sinomach’s intervention it would have collapsed. The company’s fortunes had turned for the worse in 2011, when it lost $40 million. Over the next four years, it would cumulatively lose about $2 billion. When I visited, what little work Erzhong had was being done at night so it could take advantage of off-peak electricity prices.”[6]
China’s banks, supported by Chinese government policies, continue these types of investments without sufficiently worrying about risk. This is because these investments support jobs and economic development. As China invests in new urban areas, it increases national consumption of steel, glass, cement and other building materials. This, in turn, helps China build trade surpluses with the United States and other countries.
However, new data shows that China’s current account surplus with its trading partners appears to have peaked and is slowly declining and could go into deficit. This is the result of increased domestic consumption and declining exports. To mitigate this problem, China could sell bonds to fund its deficit and allow the Chinese yuan to rise in value. This, in turn, could make the Chinese currency a credible global rival to the U.S. dollar. [7]
The Chinese government might also rationalize the risk of growing debts because more demand for steel helps drive the cost of steel down. For example it supports lower shipbuilding costs that help build lower priced bulk carriers and container ships. Government officials might further argue that this dynamic helps reduce the costs of China’s imports of raw materials and lowers the cost of exports transported by ships built in China. This all helps employ Chinese workers creating more domestic consumer demand for Chinese goods and services. The result is more tax revenue for local and national governments to mitigate higher debt payments. This trade expansionism helps ocean carriers, such as COSCO (China Ocean Shipping Company), dominate the Pacific and other ocean trades. China’s trade expansionism also supports investments in foreign ports which strengthen China’s logistical pipeline into European and United States’ markets. Today, Chinese companies own cargo-handling facilities stretching from the ports of Piraeus to Long Beach.
Another example of China’s expansionism is support for a rail service transporting containers between Europe and China. Reportedly, China is subsidizing the service at 60% of the rail transportation cost per twenty-foot container. By driving the price of rail transportation down, the Chinese government hopes to make the service viable one day and to control this trans-continental service.[8]
The subsidization of the China-Europe rail service appears to be part of China’s Belt and Road initiative. This is a trade strategy controlling rail links and other global Chinese trade routes on land, sea and in the air. Financing the rail service comes from a complex web of rail subsidies that exist on three layers: those provided by the central government, the regional government, and the city of origin or destination of a train, according to a report by an Australian firm, Wheeler Management Consulting. [9]
The additional rail business helps these cities reduce their debts from the recent urban expansions and might turn ghost cities into real cities. Thus, support for the Belt and Road initiatives, may offset the rising tide of debt.
McMahon warns that there is also a demographic time bomb ticking. In 2012 the number of Chinese people between the ages of 15 and 59 started to shrink. He cites a United Nations report stating that China’s working age population, which is currently at 1 billion people, will fall by 45 million between 2015 and 2030 and then lose a further 150 million by 2050. This trend is a result of China’s one child family policy which began in 1979 that reduced population growth and is now also reducing the working age population. China’s population “is aging faster than anywhere else in the world” McMahon writes. He cites a ratio of 7.7 working adults to seniors in 2015, which is expected to decline to 4:1 by 2030 and 2:1 by 2050. [10]
Only time will tell if China can outperform its debts and its demographics.
[1] McMahon, page xiv
[2] https://qz.com/990570/moodys-downgraded-chinas-sovereign-credit-rating-for-the-first-time-in-nearly-30-years/
[3] McMahon, page xix
[4] McMahon, page 69
[5] McMahon, page 59
[6] McMahon, page 34
[7] The Economist, May 19, 2018, page 64
[8] https://www.joc.com/rail-intermodal/huge-subsidies-keep-china-europe-rail-network-track_20180523.html?utm_source=Eloqua&utm_medium=email&utm_campaign=CL_JOC%20Daily%205%2F24%2F18%20TF%206%3A31am%20_PC9156_e-production_E-10074_DB_0524_0631
[9] Ibid
[10] McMahon, page 171