Not so long ago, London Telegraph’s Ambrose Evans-Pritchard was one of the handful of must-read financial journalists. He probably still is, but since he disappeared behind the Telegraph’s paywall his work is invisible to non-subscribers, only emerging when a free outlet runs one of his stories.

That happened yesterday when the Sydney Morning Herald carried his analysis of the financial Ponzi scheme that is China.

After taking on more debt in a single decade than any other country ever — in the process helping to pull the US and Europe out of the Great Recession — China recently shifted into an even higher gear, creating a world record amount of credit in the most recent reporting month.

And – more important for headline writers and money managers – it reported exactly the right amount of GDP growth.

This brings to mind a long-ago interview in which economist Nouriel Roubini asserted that China just makes its numbers up, frequently reporting GDP immediately after the end of the period being measured, something that even the US can’t do.

But it’s one thing to for the rest of us to suspect and/or assert that China is just giving the markets what they want to hear, and another thing to understand the implications and explain them coherently. Evans-Pritchard does this in his latest article.

Maximum vulnerability: China (and the world) are still in big trouble

China’s majestic and elegantly-stable GDP figures are best seen as an instrument of political combat.

Donald Trump says “trade wars are good and easy to win” if your foes depend on your market and you can break them under pressure.

He proclaimed victory when the Shanghai equity index went into a swoon over the winter. This is Trumpian gamesmanship.

It is in China’s urgent interest to puncture such claims as trade talks come to a head. Xi Jinping had to beat expectations with a crowd-pleaser in the first quarter. The number was duly produced: 6.4 per cent. Let us all sing the March of the Volunteers.

“Could it really be true?” asked Caixin magazine. This was a brave question in Uncle Xi’s evermore totalitarian regime.

Of course it is not true. Japan’s manufacturing exports to China fell by 9.4 per cent in March (year on year). Singapore’s shipments dropped by 8.7 per cent to China, 22 per cent to Indonesia, and 27 per cent to Taiwan. Korea’s exports are down 8.2 per cent.

The greater China sphere of east Asia is in the midst of an industrial recession. Nomura’s forward-looking index still points to a deepening downturn. “Those expecting a strong rebound in Asian export growth in coming months could be in for disappointment,” said the bank.

China’s rebound is hard to square with its own internal data. Simon Ward from Janus Henderson said nominal GDP growth – trickier to manipulate – is still falling. It dropped to 7.4 per cent from 8.1 per cent in the last quarter on 2018.

Household demand deposits fell by 1.1 per cent last month. This means that the growth rate of “true” M1 money is still at slump levels. It has ticked up a fraction but this is nothing like previous episodes of Chinese stimulus. It points towards stagnation into late 2019. “Hold the champagne,” he said. A paper last month by Wei Chen and Chang-Tai Tsieh for the Brookings Institution – “A Forensic Examination of China’s National Accounts” – concluded that GDP growth has been overstated by 1.7 per cent a year on average since 2006. They used satellite data to track night lights in manufacturing zones, railway cargo volume, and so forth.

“Local officials are rewarded for meeting growth and investment targets,” they said. “Therefore, it is not surprising that local governments also have an incentive to skew the statistics.”

Liaoning – a Spain-sized province in the north – recently corrected its figures after an anti-corruption crackdown exposed grotesque abuses. Estimated GDP was cut by 22 per cent. You get the picture.

Bear in mind that if China’s economy is a fifth or a quarter smaller than claimed it implies that the total debt ratio is not 300 per cent of GDP (IIF data) but closer to 400 per cent. If China’s growth rate is 1.7 per cent lower – and falling every year – the country is less able to rely on nominal GDP expansion whittling away the liabilities.

Debt dynamics take an ugly turn – just at a time when the working-age population is contracting by two million a year. The International Monetary Fund says China needs (true) growth of 5 per cent to prevent a rising ratio of bad loans in the banking system.

China bulls in the West do not dispute most of this. But they say that what matters is the “direction” of the data, and this is looking better. Stimulus is flowing through. It gained traction in March with an 8.5 per cent bounce in industrial output – though sceptics suspect that VAT changes led to front-loading. Suddenly the words “green shoots” are on everybody’s lips.

The thinking is that China will rescue Europe. Optimists are doubling down on another burst of global growth, clinched by the capitulation of the US Federal Reserve. It will be a repeat of the post-2016 recovery cycle.

Personally, I don’t believe this happy narrative. But what I do respect after observing late-cycle psychology over four decades – and having turned bearish too early during the dotcom boom – is that investors latch onto good news with alacrity during the final phase of a long expansion. A filtering bias creeps in.

So sticking my neck out, let me hazard that heady optimism will lead to a rally on asset markets until the economic damage below the waterline becomes clear.

Let us concede that Beijing has opened its fiscal floodgates to some degree over recent weeks. Broad credit grew by $US430 billion ($601 billion) in March alone. Business tax cuts were another $US300 billion. Bond issuance by local governments was pulled forward for extra impact. But once you strip out the offsets, it is far from clear that the picture for 2019 has changed.

Nor is it clear what can be achieved with more credit. The IMF said in its Fiscal Monitor that the country now needs 4.1 yuan of extra credit to generate one yuan of GDP growth, compared to 3.5 in 2015, and 2.5 in 2009. The “credit intensity ratio” has worsened dramatically.

I stick to my view that the US will slump to stall speed before China recovers. Europe is on the thinnest of ice. It has a broken banking system. It is chronically incapable of generating its own internal growth or taking meaningful measures in self-defence.

Momentum has fizzled out in all three blocs of the international system. We are entering the window of maximum vulnerability.

Lots of good data here – something notably lacking in most reporting on China’s “miracle.”

But the best — and scariest — single stat is the dramatic decline in the marginal productivity of debt. China, like the US, is getting progressively less bang for each newly-borrowed buck. There’s a point at which new borrowing doesn’t just produce less wealth but actually destroys it. The US and China are heading that way fast, while Europe might be there already.

As Evans-Pritchard, notes, the result is “maximum vulnerability”.