China has Debt Too
Asian markets may have risen on the good news from Greece, but they may want to pay more attention to bad news closer to home. China has recently told its banks to roll over $1.7 trillion in debt in a move to help Chinese municipalities avoid defaulting on its massive debt load.
Although many outsiders look at China as a model for economic growth, many of its local governments has a higher debt load relative to revenue than their American counterparts. This is thanks to a neat accounting trick, whereby China has made its books more attractive to foreign investors by offloading the debt burden to local governments. The trick stopped working around a year ago, when outsiders noticed and started pressuring Chinese officials to offer relief to local governments. In June 2011, the Chinese government promised to help local governments out by shifting that debt to the federal level.
Chinese banks have been restructuring loans to local governments after municipalities went on a massive spending spree to combat a feared contraction resulting from the subprime mortgage crisis and resulting uncertainty in global markets. The trick worked and massive building helped both to keep China growing at a double-digit rate and to inflate a property bubble that is now challenging the national government.
Still, outsiders remain optimistic about the government's ability to contain the bubble, thanks to the country's stronghold on economic movers and its highly centralized governance. Another thing helping China, according to some, is the fact that China is a nation of savers, not spenders, which will help control the bubble while the Chinese government manipulates property prices.
Who is affected? Anyone investing in Chinese construction should worry about mountains of locally held debt being restructured, because it signals the unsustainability of current debt levels and hints that future debt levels will also be unsustainable. China Construction Bank (HKG: 0939) has fallen nearly 5 percent in the past year after a steep rise since the market crash in 2008. Bank of China (HKG: 3988) is down a shocking 16.11 percent over the past year, although it is nowhere near as low as it was back in November, when the stock fell to levels not seen since 2008. While the stock price's valley last year seems to be closing up, it looks markedly like a similar valley in 2008, while American banks are rising steadily.
Bank of America (NYSE: BAC) has been criticized for being the magically shrinking bank, but its sell-off of China Construction Bank couldn't have been timed better. Other American banks are eager to jump into China, and some have been C) Chinese operations will not be too affected by high levels of municipal debt, meaning that American banks should not be too heavily affected by a debt crisis from the east.
However, some investment banks are still looking at China with hope. Goldman Sachs (NYSE: GS) recently raised its forcast for Chinese stocks as it expects greater growth in the Chinese economy. Goldman analysts need to wonder if depressed housing prices from a slowing market would slow down consumer spending and thus hinder Chinese stocks. A housing slowdown is, as many analysts say, a likely best-case scenario, since China is prepared for it.
However, a slowdown may translate into an easing monetary policy, which would boost stocks. On the other hand, such a move will be impossible for as long as rampant inflation hits the developing giant and incites public unrest and suicides.
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