The scale of the economic challenges facing China is starkly illustrated by the quadrupling of total debt to US$28tn in the period from 2007 to mid-2014.

Fueled by property and shadow banking, China’s total debt has nearly quadrupled, rising to $28tn by mid-2014, from $7tn in 2007 according to McKinsey Global Institute (MGI).

MGI said in a report earlier this year that at 282% of GDP, China’s debt as a share of GDP, while manageable, is larger than that of the United States or Germany. It said three developments are potentially worrisome: half of all loans are linked, directly or indirectly, to China’s overheated property market; unregulated shadow banking accounts for nearly half of new lending; and the debt of many local governments is probably unsustainable.

 

However, MGI calculated that China’s government has the capacity to bail out the financial sector should a property-related debt crisis develop. "The challenge will be to contain future debt increases and reduce the risks of such a crisis, without putting the brakes on economic growth."

MGI said that since 2007, government debt globally has grown by $25tn. "It will continue to rise in many countries, given current economic fundamentals. Some of this debt, incurred with the encouragement of world leaders to finance bailouts and stimulus programs, stems from the crisis. Debt also rose as a result of the recession and the weak recovery. For six of the most highly indebted countries, starting the process of deleveraging would require implausibly large increases in real-GDP growth or extremely deep fiscal adjustments. To reduce government debt, countries may need to consider new approaches, such as more extensive asset sales, one-time taxes on wealth, and more efficient debt-restructuring programs."

Household debt is reaching new peaks. MGI said that only in the core crisis countries — Ireland, Spain, the United Kingdom, and the United States — have households deleveraged. In many others, household debt-to-income ratios have continued to rise. They exceed the peak levels in the crisis countries before 2008 in some cases, including such advanced economies as Australia, Canada, Denmark, Sweden, and the Netherlands, as well as Malaysia, South Korea, and Thailand. These countries want to avoid property-related debt crises like those of 2008. To manage high levels of household debt safely, they need more flexible mortgage contracts, clearer personal-bankruptcy rules, and tighter lending standards and macroprudential rules.

China has put a huge investment into infrastructure including bullet trains but local government have wasted funds on vanity projects and subsidies including the steel industry that accounts for half of global production.

China grew an average annual 10% in the period 1979-2014 and benefited many countries that are dependent on commodities. Now the tide is ebbing in many areas of the world.

China

In recent weeks, there has been mounting evidence of serious problems in the Chinese economy and a confusing response from policymakers.

China GDP growth 1979 - 2014

Emerging economies have been experiencing currency slides with some such as Malaysia dipping to a level against the US dollar not seen since the Asian crisis of 1997/98.

An index of 22 commodities compiled by Bloomberg is at its lowest since 1999 while world trade recorded its biggest contraction since the financial crisis in the first half of this year. The volume of global trade fell 0.5% in the three months to June compared with the first quarter, the Netherlands Bureau for Economic Policy Analysis, publishers of the World Trade Monitor, said on Tuesday.

After the Shanghai Composite plunged 8% early this week, earning the tumble the nickname 'Black Monday' from Chinese officials, the index is down 42% from its peak in June but the index remains over 40% above the level a year ago.

The Economist says "fundamental questions are being raised about China, an economy which now accounts for 15% of global GDP and around half of global growth. The government's ability to manage market gyrations and animal spirits is very much in question, suggesting that a descent into Japanese-style stagnation is a possibility. The odds of a sharp Chinese slowdown will grow if China's government reacts to market turmoil by ending the process of structural reform that is meant to facilitate a rebalancing."

The People's Bank of China (PBoC) late Tuesday lowered interest rates by 25 basis points and the reserve requirement ratio (RRR) for most big banks by 50 basis points.

China's $3.6tn in currency reserves have fallen from about $3.9tn in June 2014 and after the recent 3% devaluation of the currency, the PBoC has intervened to keep the level from falling further. However, depending on the severity of the economic problems, the government may resort to try and make exports more competitive.

The FT reports that analysts say the dramatic, negative headlines belie a vast, complex and increasingly competitive consumer market where companies have to fight harder to boost their sales, whether by offering cheaper, smaller package sizes at the lower end or improving their products and customer service.

Retail sales have been growing at an annualised 10% in recent months, according to official data, but analysts are sceptical about the government’s figures and believe that even in the best case they cover up wide divergences between companies.

“Consumer demand has always been there in China and in the past it was easy for companies to grab it,” says Spencer Leung, a consumer industry analyst at UBS in Hong Kong. “But things have slowed down and only those who can offer differentiated goods can capture demand.”

He says that multinational companies focused on the mass market in China have been particularly good at maintaining their performance as annual gross domestic product growth has dropped from more than 10% in 2010 to 7% in the second quarter this year.