Chinese Economy braced for a Reality Check

Valentin Schmid evaluates the Bank of America Report on the Chinese Economy.

The Chinese regime still has considerable power over the markets. After a 7 percent crash of the Shanghai Composite on January 4, it managed to reverseanother 3 percent drop on January 5.

So, in the very short term, all is well. In the long term and even in 2016, Bank of America sees big problems ahead for the Chinese economy. According to their analysts, the regime has to fight multiple battles at once and will ultimately lose to market forces.

“We judge that China’s debt situation has probably passed the point of no-return and it will be difficult to grow out of the problem,” states a report by Bank of America’s chief strategist David Cui.

The report points out that a spike in private sector debt almost inevitably leads to a financial crisis. China’s private debt to GDP ratio went up 75 percent between 2009 and 2014, bringing total debt-to-GDP to about 300 percent. Too much to sustain.

This is “a classic case of short-term stability breeding long-term instability. It’s our assessment that the longer this practice drags on, the higher the risk of financial system instability, and the more painful the ultimate fallout will be,” Cui writes.

For the coming crisis, Cui believes China will probably have to devalue its currency, write off bad debts, recapitalize the banks, and reduce the debt burden with high inflation.

After the events of last August, and after the International Monetary Fund finally included China in its reserve currency basket, the regime completely abandoned the stable currency objective and let the yuan drift lower. The regime promises reform, and even follows through in some cases. But if push comes to shove, it resorts to central planning to mould the market according to its needs, with less and less success.

“It seems to us that the government’s policy options are rapidly narrowing-one only needs to look at how difficult it has been for the government to hold up GDP growth since mid-2014. A slowdown in economic growth is typically a prelude to financial sector instability,” writes Cui, and predicts the Shanghai Composite to drop by 27 percent in 2016.

Source: Bank of America Report