China’s Credit Expansion Dilemma

Today is the kind of day that drives you nuts in the markets. There are so many variables and data points to review that you can get lost in the details. The idea that you can constantly review and process new information and instantly update your investment strategy is probably going to drive a lot of investors insane this year. At the very least, it will make it easier to lose money quickly.

But remember, the first rule of a bear market is not to lose money. This is a bear market. It started in 2007 and could last years. When people pay down debt (deleveraging) instead of adding more debt, you get years of lower stock prices and slower growth. That’s where we are now.

There’s no arguing with the day-to-day price action, though. The market is up big this morning, for example. The People’s Bank of China (PBOC) lowered reserve requirements at banks over the weekend. That means Chinese banks can hold less cash on hand for an emergency and are free to lend more to businesses and households.

The poor old PBOC. It is caught in a nearly impossible situation. If lending expands too quickly, like it did in 2009 with government stimulus, you get inflation in food, fuel, and house prices. That makes life more expensive for China’s city dwellers. It also undermines the coveted government goal of “stability”.

But the PBOC can’t let itself get TOO worried about inflation. China’s economy must grow at 8% or better every year in order to create enough new city jobs to absorb the millions of immigrants leaving the farm for the factory. Without credit growth you get higher unemployment…or vast armies of unemployed peasants with no work to be found in China’s huge cities.

You can see what a massive social and economic challenge China’s central planners have. They have engineered the largest internal migration in human history. This was only possible with a giant infusion of credit. Now the whole economic fabric of the China relies on continued credit expansion.

Of course China is just copying the rest of the world. It’s at a different stage in its economic development. Europe finds itself at the opposite end of the credit pendulum. It enjoyed years of growth financed with government debt and low interest rates and the introduction of the common currency. Now, the debt hangs around Europe’s neck like a millstone.


Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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