The Chinese economy is said to be stagnating as a result of the import tariffs imposed by the United States. However, there is a much bigger threat to their economy — a mountain of dollar debt.
The debt problem
Total global dollar debt is estimated to be US$12 trillion, out of which Chinese reportedly owes US$3 trillion. In the past, the spread between the U.S. and Chinese interest rates was very lucrative. This enticed traders and investors to raise cheap dollar debt and convert it into Yuan assets that produced higher yields. However, this is not the case now.
In a bid to support economic growth, Beijing has kept its interest rates low, only increasing them slightly. In contrast, the U.S. Fed has generously raised interest rates. As a consequence, the spread between the U.S. and Chinese interest rates is so narrow that investors no longer find it profitable to borrow dollar debt to invest in Yuan assets.
Since March, the Yuan has slid more than 11 percent against the U.S. dollar. Right now, it is trading around 6.95 per the U.S. dollar, very close to the psychologically important figure of 7.00. If the value of the Yuan to the U.S .dollar exceeds the 7.00 level by a significant margin, this will potentially create panic among Chinese investors and trigger a Yuan selloff, pushing down the domestic currency’s value even further.
The US$3 trillion debt that China owes will become more expensive. Combined with a slowing economy and lower revenues, Chinese businesses, investors, and traders will find it difficult to pay off their dollar-based loans. This can lead to massive defaults and a financial cataclysm that will not only affect China, but the entire world.
About 10 years ago, China’s debt to GDP ratio was about 160 percent. “Now, it’s somewhere between 280 and 300 percent… [When other countries have accumulated debt that quickly, they have] almost invariably experienced a financial crisis… That’s like the United States before the sub-prime crisis, or Thailand before the Asian financial crisis,” Dinny McMahon, an expert on the Chinese economy, said to ABC News.
Tough times for small businesses
The economic stagnation has raised an alarm in Beijing. The state economists are desperately planning several measures to ensure the economy keeps growing. Special attention is being placed on helping small enterprises, as they employ a large number of people.
Small business can only grow if adequate credit is made available to them. However, Beijing has been following a policy of restricting credit availability among businesses in a bid to control the debt bubble. “I think the key challenge on the SMEs is the lack of proper funding channels at a reasonable market rate to support their business,” William Ma, Chief Investment Officer at Noah Holdings in Hong Kong, said to CNBC.
In early November, Chinese President Xi Jinping had assured that Beijing would provide businesses with easier access to financing. However, China’s policymakers face a tough choice at present. On one hand, it can ease debt requirements and ensure that small businesses get the credit they need. This will potentially lead to economic growth and keep unemployment in check.
On the other hand, allowing businesses to take more loans would mean that the country’s debt bubble keeps building up uncontrollably.