In today’s digital economy, businesses can grow faster than ever before. In China, for example, e-commerce sales grew 32% in the fourth quarter of 2017 compared to the same period in 2016. This rapid expansion has led to several debt problems in China and other countries. In any economy, debt is necessary to drive growth. However, debt can have dangerous consequences when it exceeds a safe threshold. We have outlined some simple truths about China’s debt problem and how to protect yourself from the fallout.
What is China’s Debt Problem?
China’s debt problem is a combination of two factors. Firstly, it has too much debt in general. Secondly, this debt is being used to fund projects that are not economically viable. China’s gross debt-to-GDP ratio currently stands at around 257%, meaning that China’s total debt (including the state and local governments) is equivalent to 257% of its total economic output. At the same time, China’s net debt-to-GDP ratio is around 66%, meaning China’s debt equals 66% of its annual financial work, a more manageable debt level.
Why Is China’s Debt a Problem?
China’s debt problem is a problem because it is being used to fund unproductive assets, which leads to a bubble that could burst, causing massive economic and financial upheaval. China’s debt is spent on construction projects such as highways, bridges, and real estate. However, this debt is not being used to fund infrastructure projects with positive long-term effects.
Instead, it funds projects with minimal social value and will be useless in the long run. A lack of regulatory oversight and a reckless approach to financing by the state and the private sector causes China’s debt problem. The debt is being used to fund unwise investments and is growing too quickly.
The Dangers of China’s Debt Problem
If left unchecked, China’s debt problem could have disastrous consequences. These consequences include financial issues for both the state and the private sector. For the state, debt-funded projects are unprofitable, so the state has little hope of repaying these loans.
In addition, the state will likely use its credit rating to guarantee these loans, which could lead to a situation where its credit rating is downgraded. For the private sector, debt is driving up asset prices and increasing financial risk. This could lead to a financial crisis if investors worry about the private sector’s ability to repay loans.
How China’s Debt Could Destroy the World Economy
China’s debt problem could destroy the world economy in three ways:
- It could lead to a financial crisis in the Chinese economy, which would cause investors to pull their money out of the country. If this happened on a large scale, it could cause a global economic crisis.
- It could cause a Chinese economic slowdown. This slowdown would result in lower demand for commodities which would drive down the prices of commodities and hurt commodity-producing economies.
- It could cause a Chinese economic crash, knocking on the rest of the world.
How to Protect Yourself From the Fallout of China’s Debt Problem
As investors, we can protect ourselves from the fallout of China’s debt problem by diversifying our portfolios, which means investing in different asset classes, regions, and sectors. In addition, we can invest in industries that will benefit from China’s slowdown. These include the tourism and healthcare sectors.
Finally, we should keep a close eye on the situation in China. If the debt problem becomes unmanageable, China could take extreme measures, such as shutting down its financial system, which could have disastrous consequences for the rest of the world.
The Case of Maladewa
China’s debt problem has been causing problems for a long time. In the early 2000s, Chinese construction companies started building roads in Maladewa, a region in the eastern part of the country. The streets were primarily unneeded but were funded with Chinese loans. The area was deep in debt when the project completed the roads.
It took a decade for Maladewa to repay the Chinese loans. Then, in 2016, Maladewa defaulted on the loans, leading to a standoff between China and Maladewa. Finally, the two countries agreed to restructure the loans. However, it is unclear whether Maladewa will be able to repay them. The Case of Sri Langka China has been funding many unnecessary construction projects in Sri Langka.
One example is a project to build a new port in the area. However, the port is not needed. In addition, the construction project uses substandard materials, leading to numerous accidents and deaths. As a result, the people of Sri Lanka are concerned about the future of their country. They are worried that Chinese debt will lead to losing control over their economy and government.
The Experience of Uganda
China’s debt problem extends beyond its borders. For example, it has been funding construction projects in Uganda. These projects include a new railway, an oil pipeline, and a new hydroelectric dam—however, the project constructed the oil pipeline through a national park.
In addition, the railway is being built on land that belongs to an Indian company—the government funded these projects with loans from China’s state-owned Export-Import Bank. However, Uganda’s government has been unable to pay back these loans. Therefore, it is likely that the Chinese will take control of these projects, leading to losing control over Uganda’s economy.
Kenya is facing many of the same issues as Uganda. In recent years, Chinese construction companies have built new railways, airports, and highways. They have also been given contracts to build power plants and dams. These projects have been funded with loans from Chinese state-owned banks. However, Kenya’s government has been unable to pay back these loans. Therefore, it is likely that the Chinese will take control of these projects, leading to a loss of control over Kenya’s economy.
Final Words: Stay Vigilant
When a nation proliferates, it will likely experience a debt problem because rapid growth requires more investment in assets such as technology, infrastructure, and housing. China’s rapid growth has been powered by debt. In particular, it has been funding construction projects with debt. However, the state will likely step in to avoid a debt crisis. That’s because a debt crisis would threaten the state’s power.
The form may use debt-funded projects to buy time while figuring out how to transition to a new growth model. This transition will be difficult because it will require a reduction in growth and increased government regulation. However, pulling it off will reduce the debt crisis risk if the state can pull it off. It will also allow the state to manage the economy more prudently, which will be good news for the rest of the world.