Ed Driscoll

'The Mother of All Debt Bombs'

Boy, Thomas Friedman’s not going to like this news one bit: “Are Chinese Banks Hiding ‘The Mother of All Debt Bombs?'”

When the Chinese Central Bank (the People’s Bank of China) and banking regulators sounded the alarm in late 2010, it was already too late.  By that time, local governments had taken advantage of loose credit to amass a mountain of debt, most of it squandered on prestige projects or economically wasteful investments.  The National Audit Office of China acknowledged in June 2011 that local government debt totaled 10.7 trillion yuan (U.S. $1.7 trillion) at the end of 2010.  However, Professor Victor Shih of Northwestern University has estimated that the real amount of local government debt was between 15.4 and 20.1 trillion yuan, or between 40 and 50% of China’s GDP.  Of this amount, he further estimated, the local government financing vehicles (LGFVs), which are financial entities established by local governments to invest in infrastructure and other projects, owed between 9.7 and 14.4 trillion yuan at the end of 2010.

Anybody with some knowledge of the state of health of LGFVs would shudder at these numbers.  If anything, Chinese LGFVs are known mainly for their unique ability to sink perfectly good money into bottomless holes in the ground.  So taking on such a huge mountain of debt can mean only one thing — a future wave of default when the projects into which LGFVs have piled funds fail to yield viable returns to service the debt.  If 10 percent of these loans turn bad, a very conservative estimate, we are talking about total bad loans in the range of 1 to 1.4 trillion yuan.  If the share of dud loans should reach 20 percent, a far more likely scenario, Chinese banks would have to write down 2 to 2.8 trillion yuan, a move sure to destroy their balance sheets.

As with their ghost cities (see video above), China really is where bad Keynesian ideas go to die.

Well, aside from the Obama White House, of course.