8 ms·

For the sake of argument, let's assume that the headline is true -- local governments have taken on more debt than they can service in a slowing economy. What's

For the sake of argument, let's assume that the headline is true -- local governments have taken on more debt than they can service in a slowing economy. What's the endgame? Here are some possibilities, would love to see some economic modeling to quantify some scenarios. 1) Central government gradually inflates the currency to monetize the debt with a few defaults along the way. Damage is funded by Chinese creditors (defaults) and Chinese citizens (inflation), and it takes 20 years to fully play out. 2) Central government bails out bad loans by selling a portion of their $3T in foreign reserves, including $1T of US government debt. Chinese creditors, investors and citizens are made whole. Foreign bond prices fall and interest rates rise, causing recession and financial crisis in the US. 3) Central government bails out a few well connected players, but mostly allows market forces to run their course. Shadow banks and local government financing vehicles go bankrupt, causing a cascade of bankruptcies in the real economy, and economic growth is 200 basis points under potential until 2022.

btown 8y ago
In scenario (2), wouldn't Chinese companies be affected by the reduced demand from North America/Europe being in financial crisis? Is it understood that this would be devastating enough that China wouldn't use what is essentially a nuclear option?
- panarky 8y ago
  This is why I'd love to see a quantitative model, there are too many players and too many variables for good intuition. What matters for each scenario is (a) how much it costs, (b) who bears the cost, and (c) how long it takes. If Chinese creditors, investors and citizens bear 100% of the cost in scenarios 1 and 3, but they only bear 30% of the cost in scenario 2, then scenario 2 is preferable isn't it? But what if Chinese citizens don't have a vote, and the damage to well connected elites is lower under scenario 1? Maybe that winds up the preferred course even if total cost is greater. Who knows without the ability to even roughly quantify the primary, secondary and tertiary effects?
  - deleted 8y ago
    [deleted]
sailfast 8y ago
Possible that the central government is more exposed to this than anyone thinks due to creative accounting practices? Result might be central government is unable to conduct its policies at the same level of robustness as before? Doomsday here being that social programs, belt and road, etc might suffer. Potential downstream impacts would include dissatisfaction with leadership and a change there? Or, you know, just straight up war as a distraction of we’re talking real downsides.
riazrizvi 8y ago
I think 4) Since this is local government debt, local governments start selling off their principal assets, land. And as land prices hit rock bottom, there begins a massive transfer of ownership of local public owned land to private individuals and companies. Initially there may be a flight of Chinese capital out of the country as land prices begin falling off a cliff. Then once they stabilize, there will be a big whooshing sound as money is repatriated and people start snapping up choice holdings?
- nradov 8y ago
  Chinese capital controls including recent crack downs on money laundering make rapid capital flight or repatriation impossible on a large scale.
  - lifeisstillgood 8y ago
    I think a large amount of bitcoin prices are attributed to western banks explaining to wealthy chinese how to transfer money out of the country on a large scale.
    - adanto6840 8y ago
      Sincerely asking: Are you serious? Do you have sources, good or otherwise (even rumors or talk of this topic)? What exactly is it that you think is happening, if I may ask? Does a Chinese citizen, perhaps vacationing in the US, walk into BoA or WF and ask a wealth management advisor how to move money to their newly opened account there?
      - lifeisstillgood 8y ago
        yes.
    - Retric 8y ago
      Bitcoins don’t work for that. If you want to buy bitcoins with Currency X you need to find somone that wants to sell bitcoins for Currency X. Similarly if you want to sell bitcoins for Currency Y you need somone to buy them in Currency Y. Net result you can’t get large net cash flows unless people can exchange currency X for Currency Y. PS: Bitcoin mining is another story, but it’s little different than building anything in China and selling abroad.
paganel 8y ago
I'd bet on a combination of 1) and 3), more of 3), to be honest, the Chinese Central Government is known as picking losers and winners (which can be seen from the outside as "market forces running their course") and the subdued economic growth can be easily masked with aggressive foreign policy rhetoric, like building some new islets in the South China Sea. Choosing 2) will most probably escalate the dangers of a military confrontation with the US, I don't see the Chinese going that route, war it's bad for business (in most cases, anyway).
- cuddlypsycho 8y ago
  > war it's bad for business (in most cases, anyway). Most wars are great for business actually, even world wars! Let's not forget that WW2 was mostly responsible for dragging the US out of the great depression.
matco11 8y ago
That assumes you "only" have to deal with the static mass of $5.8 trillion debt. It gets even more complicated when you have to deal with the factors that have been building that debt in the first place. Wouldn't addressing the causes of the debt build-up have an even harsher impact on the economy?
nradov 8y ago
The Chinese government only holds 6% of US government debt. Selling it wouldn't cause a recession and financial crisis.
- onlyrealcuzzo 8y ago
  Also, you can't magically liquidate Treasuries to dollars. China would have to find a buyer for it's $1T in bonds. And I don't know who has that kind of money. They wouldn't get full price.
  - airstrike 8y ago
    They don't need to sell at once, and if rates continue to rise there will be increasing appetite for yields
    - panarky 8y ago
      When interest rates rise, bond prices fall. So when you see interest rates rising, that means there is more selling pressure than buying pressure. Just like anything else, it is harder to sell bonds and get the price you want when bond prices are falling (and interest rates rising). It's easier to sell and get a good price when bond prices are rising (and interest rates are falling).
      - A2017U1 8y ago
        In general demand is higher for bonds as their prices fall. They are both cheaper and paying better rates. This is econ 101.
        wahern 8y ago
        The rates are better for newly issued bonds. Existing bonds become devalued. The point (IIUC) is that unwinding is a tricky proposition and dependent on the mix of maturities.
  - deleted 8y ago
deleted 8y ago
[deleted]
mempko 8y ago
What about a 4) Chinese government cancels the debts of local governments like they never existed.
- panarky 8y ago
  Sure, defaulting on obligations is always an option. Who would be hurt in this scenario? Who are the lenders that don't get paid back? Are they banks? Ordinary citizens saving for retirement? When those people don't get paid back, what are the second-order consequences? Is there a cascade of defaults when they can't make good on their obligations?
AnthonyMouse 8y ago
> 2) Central government bails out bad loans by selling a portion of their $3T in foreign reserves, including $1T of US government debt. Chinese creditors, investors and citizens are made whole. Foreign bond prices fall and interest rates rise, causing recession and financial crisis in the US. That is unlikely to be the result. The US national debt is over $21T now. $1T is <5%. Dumping that much on the market at once would certainly affect interest rates, but not at a catastrophe-inducing level, and all of the normal tools used to control interest rates remain available. By comparison, the US deficit this year is ~$0.8T, i.e. the US itself is dumping nearly that amount into the market. The Quantitative Easing program after the housing crisis was $3.5T over a few years. It's also unlikely that they would dump the entire amount at once, because causing a sudden short-term rise in interest rates is not to their advantage (they would take a bath on bond prices). But if they divested something like $100B/year, the effect on the market would be minimized.
- divbyzer0 8y ago
  Russia recently dumped the majority of its UST, widely believed to cause the treasury rate to hit 3%. Some commentators speculated the reason for this was 1) to avoid future potential sanctions 2) a trial-run to gauge how the market would react to a similar move by China. At its peak Russia held less than $0.2T, Russia liquidated approx $50B per month for 3 months. If China dumped $75B per month for 6 months, there would be pain that would likely spread into corporate bonds. https://money.cnn.com/2018/07/30/investing/russia-us-debt-treasury/index.html https://money.cnn.com/2018/07/30/investing/russia-us-debt-tr... https://www.bloomberg.com/view/articles/2018-10-16/russia-s-bottom-for-u-s-treasuries-turns-out-to-be-zero https://www.bloomberg.com/view/articles/2018-10-16/russia-s-... (edit: formatting)
  - panarky 8y ago
    Did Russia liquidate their Treasurys or just move them offshore? The Kremlin may be trying to pull off a balancing act by mostly shifting its cache offshore, rather than selling outright. Analysts at the Council of Foreign Relations this week found that holdings of American bonds in Belgium and the Cayman Islands increased by about $45 billion in the same period that Russia was reducing its U.S.-based hoard, meaning it may have been an attempt to protect against seizure. https://www.bloomberg.com/news/articles/2018-08-15/russian-game-of-cat-and-mouse-with-u-s-puts-debt-cache-in-doubt https://www.bloomberg.com/news/articles/2018-08-15/russian-g...
dangjc 8y ago
2) Central government bails out bad loans by selling a portion of their $3T in foreign reserves, including $1T of US government debt. Chinese creditors, investors and citizens are made whole. Foreign bond prices fall and interest rates rise, causing recession and financial crisis in the US. Selling treasuries is a double edged sword. Driving up borrowing costs for the US also lowers bond prices, wiping out the Chinese government's portfolio value, right when they need the funds for a bailout. Dumping a lot of dollars on the market will drive the dollar down relative to the yuan, hurting Chinese exporters right when their economy needs it most. China has really twisted itself into a knot on this one.

btown 8y ago

In scenario (2), wouldn't Chinese companies be affected by the reduced demand from North America/Europe being in financial crisis? Is it understood that this would be devastating enough that China wouldn't use what is essentially a nuclear option?

panarky 8y ago
This is why I'd love to see a quantitative model, there are too many players and too many variables for good intuition. What matters for each scenario is (a) how much it costs, (b) who bears the cost, and (c) how long it takes. If Chinese creditors, investors and citizens bear 100% of the cost in scenarios 1 and 3, but they only bear 30% of the cost in scenario 2, then scenario 2 is preferable isn't it? But what if Chinese citizens don't have a vote, and the damage to well connected elites is lower under scenario 1? Maybe that winds up the preferred course even if total cost is greater. Who knows without the ability to even roughly quantify the primary, secondary and tertiary effects?
- deleted 8y ago
  [deleted]

sailfast 8y ago

Possible that the central government is more exposed to this than anyone thinks due to creative accounting practices? Result might be central government is unable to conduct its policies at the same level of robustness as before? Doomsday here being that social programs, belt and road, etc might suffer. Potential downstream impacts would include dissatisfaction with leadership and a change there? Or, you know, just straight up war as a distraction of we’re talking real downsides.

riazrizvi 8y ago

I think 4) Since this is local government debt, local governments start selling off their principal assets, land. And as land prices hit rock bottom, there begins a massive transfer of ownership of local public owned land to private individuals and companies. Initially there may be a flight of Chinese capital out of the country as land prices begin falling off a cliff. Then once they stabilize, there will be a big whooshing sound as money is repatriated and people start snapping up choice holdings?

nradov 8y ago
Chinese capital controls including recent crack downs on money laundering make rapid capital flight or repatriation impossible on a large scale.
- lifeisstillgood 8y ago
  I think a large amount of bitcoin prices are attributed to western banks explaining to wealthy chinese how to transfer money out of the country on a large scale.
  - adanto6840 8y ago
    Sincerely asking: Are you serious? Do you have sources, good or otherwise (even rumors or talk of this topic)? What exactly is it that you think is happening, if I may ask? Does a Chinese citizen, perhaps vacationing in the US, walk into BoA or WF and ask a wealth management advisor how to move money to their newly opened account there?
    - lifeisstillgood 8y ago
      yes.
  - Retric 8y ago
    Bitcoins don’t work for that. If you want to buy bitcoins with Currency X you need to find somone that wants to sell bitcoins for Currency X. Similarly if you want to sell bitcoins for Currency Y you need somone to buy them in Currency Y. Net result you can’t get large net cash flows unless people can exchange currency X for Currency Y. PS: Bitcoin mining is another story, but it’s little different than building anything in China and selling abroad.

paganel 8y ago

I'd bet on a combination of 1) and 3), more of 3), to be honest, the Chinese Central Government is known as picking losers and winners (which can be seen from the outside as "market forces running their course") and the subdued economic growth can be easily masked with aggressive foreign policy rhetoric, like building some new islets in the South China Sea. Choosing 2) will most probably escalate the dangers of a military confrontation with the US, I don't see the Chinese going that route, war it's bad for business (in most cases, anyway).

cuddlypsycho 8y ago
> war it's bad for business (in most cases, anyway). Most wars are great for business actually, even world wars! Let's not forget that WW2 was mostly responsible for dragging the US out of the great depression.

matco11 8y ago

That assumes you "only" have to deal with the static mass of $5.8 trillion debt. It gets even more complicated when you have to deal with the factors that have been building that debt in the first place. Wouldn't addressing the causes of the debt build-up have an even harsher impact on the economy?

nradov 8y ago

The Chinese government only holds 6% of US government debt. Selling it wouldn't cause a recession and financial crisis.

onlyrealcuzzo 8y ago
Also, you can't magically liquidate Treasuries to dollars. China would have to find a buyer for it's $1T in bonds. And I don't know who has that kind of money. They wouldn't get full price.
- airstrike 8y ago
  They don't need to sell at once, and if rates continue to rise there will be increasing appetite for yields
  - panarky 8y ago
    When interest rates rise, bond prices fall. So when you see interest rates rising, that means there is more selling pressure than buying pressure. Just like anything else, it is harder to sell bonds and get the price you want when bond prices are falling (and interest rates rising). It's easier to sell and get a good price when bond prices are rising (and interest rates are falling).
    - A2017U1 8y ago
      In general demand is higher for bonds as their prices fall. They are both cheaper and paying better rates. This is econ 101.
      - wahern 8y ago
        The rates are better for newly issued bonds. Existing bonds become devalued. The point (IIUC) is that unwinding is a tricky proposition and dependent on the mix of maturities.
- deleted 8y ago

deleted 8y ago

[deleted]

mempko 8y ago

What about a 4) Chinese government cancels the debts of local governments like they never existed.

panarky 8y ago
Sure, defaulting on obligations is always an option. Who would be hurt in this scenario? Who are the lenders that don't get paid back? Are they banks? Ordinary citizens saving for retirement? When those people don't get paid back, what are the second-order consequences? Is there a cascade of defaults when they can't make good on their obligations?

AnthonyMouse 8y ago

> 2) Central government bails out bad loans by selling a portion of their $3T in foreign reserves, including $1T of US government debt. Chinese creditors, investors and citizens are made whole. Foreign bond prices fall and interest rates rise, causing recession and financial crisis in the US. That is unlikely to be the result. The US national debt is over $21T now. $1T is <5%. Dumping that much on the market at once would certainly affect interest rates, but not at a catastrophe-inducing level, and all of the normal tools used to control interest rates remain available. By comparison, the US deficit this year is ~$0.8T, i.e. the US itself is dumping nearly that amount into the market. The Quantitative Easing program after the housing crisis was $3.5T over a few years. It's also unlikely that they would dump the entire amount at once, because causing a sudden short-term rise in interest rates is not to their advantage (they would take a bath on bond prices). But if they divested something like $100B/year, the effect on the market would be minimized.

divbyzer0 8y ago
Russia recently dumped the majority of its UST, widely believed to cause the treasury rate to hit 3%. Some commentators speculated the reason for this was 1) to avoid future potential sanctions 2) a trial-run to gauge how the market would react to a similar move by China. At its peak Russia held less than $0.2T, Russia liquidated approx $50B per month for 3 months. If China dumped $75B per month for 6 months, there would be pain that would likely spread into corporate bonds. https://money.cnn.com/2018/07/30/investing/russia-us-debt-treasury/index.html https://money.cnn.com/2018/07/30/investing/russia-us-debt-tr... https://www.bloomberg.com/view/articles/2018-10-16/russia-s-bottom-for-u-s-treasuries-turns-out-to-be-zero https://www.bloomberg.com/view/articles/2018-10-16/russia-s-... (edit: formatting)
- panarky 8y ago
  Did Russia liquidate their Treasurys or just move them offshore? The Kremlin may be trying to pull off a balancing act by mostly shifting its cache offshore, rather than selling outright. Analysts at the Council of Foreign Relations this week found that holdings of American bonds in Belgium and the Cayman Islands increased by about $45 billion in the same period that Russia was reducing its U.S.-based hoard, meaning it may have been an attempt to protect against seizure. https://www.bloomberg.com/news/articles/2018-08-15/russian-game-of-cat-and-mouse-with-u-s-puts-debt-cache-in-doubt https://www.bloomberg.com/news/articles/2018-08-15/russian-g...

dangjc 8y ago

2) Central government bails out bad loans by selling a portion of their $3T in foreign reserves, including $1T of US government debt. Chinese creditors, investors and citizens are made whole. Foreign bond prices fall and interest rates rise, causing recession and financial crisis in the US. Selling treasuries is a double edged sword. Driving up borrowing costs for the US also lowers bond prices, wiping out the Chinese government's portfolio value, right when they need the funds for a bailout. Dumping a lot of dollars on the market will drive the dollar down relative to the yuan, hurting Chinese exporters right when their economy needs it most. China has really twisted itself into a knot on this one.