China Crushed By Debt

Over the recent days, financial markets again has been dominated by the ongoing trade war between U.S. and China. However, prolonged negotiations are just one of the many unsolved problems in Beijing.

Donald Trump raises tariffs on Chinese products

On Sunday, May 5, President of the United States announced on his Twitter account tariffs increase on Chinese products worth 200 billion dollars from 10% to 25%. New duties have been implemented on Friday, May 10. Trump added in his tweet feed that 25% tariffs on additional goods worth 325 billion dollars may be also imposed in the future.

After the announcement, indices in China recorded the strongest declines since January 2016. As it can be seen in the chart below, technology companies dropped by almost 8% (blue line), while the Shanghai Composite index, consisting of all companies listed on the Shanghai Stock Exchange, lost over 5.5% (red line).

source: zerohedge

In the U.S., at the beginning it looked similar - futures contracts on stock indexes were significantly losing, till the market opening. During the session, however, U.S. indices recovered almost all loses, closing the day slightly below zero.

source: zerohedge

During the following days, investors in the U.S. were slowly losing faith in a quick deal between the U.S. and China, as a result, stock prices on the American stock exchanges dropped by several percents. However, declines in the Middle Kingdom were much stronger.

Why do we mention this? The above situation shows the sensitivity of Chinese companies to any threats related to the ongoing trade war. For this reason, investors are very concerned about further developments in the Middle Kingdom. Continuing sell-off of Chinese shares is a very good proof of that - over the last week, foreign investors dumped stocks worth 3.8 billion yuan (555 million dollars), which was the biggest weekly sell-off in history.

China's problems, however, are much greater.

Debt problem

To better understand how problems within China were developing let's go back in time a few years. In the aftermath of the financial crisis in 2018, economic growth sharply decreased. As a result, the Communist Party decided to massively pump investments using debt. Party leaders assumed that economic growth should remain at a minimum level of 8% per annum. As it is shown in the chart below, GDP growth in China managed to stay above assumed 8% only until 2012.

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Gary Anderson 1 week ago Contributor's comment

Debt to purchasing power parity GDP is far lower. This analysis may prove to be flawed, just like Trump thinking he can win a tariff war is flawed.