If I mention the phrase “debt crisis” most people will assume I’m talking about the U.S. federal budget deficit or the situation in the Eurozone. As if we didn’t have enough crises on our radars, there is one more that business owners need to monitor. This additional debt crisis could have a material impact on our profitability as it affects the largest supplier of goods for resale to the U.S.: China. There is a debt crisis in China no one is talking about. Let’s take a closer look at it.
China is a huge country. With a population of nearly 1.34 billion people spread out across 3.7 million square miles, managing China is no easy task. Over the past 10 years, Chinese cities have seen a tremendous population boom as people from the country moved in search of economic opportunity. In 1978 approximately 17 percent of the population lived in urban areas. Today, nearly half the population lives in urban areas. The scale and speed of this urbanization is unprecedented. While this has helped shape China’s economic rise, it has also taken a tremendous toll on municipal governments. Managing this growth through the expansion of services and infrastructure has cost a great deal of money. They obtained the money by borrowing it. Lots of it.
According to a study by Standard Chartered Bank, local governments in China owe the equivalent of an estimated $1.5 to $2.1 trillion. This debt burden is putting tremendous pressure on local governments across China. Interest payments alone total $7 billion to $10 billion per month. The problem is so extensive that it is unlikely that tax increases and the sale of municipal-owned land to private investors can solve the problem.
Making matters worse is that most of this money is owed to local and national banks across China. Municipal governments could soon start violating loan covenants or missing payments outright. This will negatively impact the financial integrity of banks that aren’t receiving what they are due. As banks weaken, depositors may worry that their money is at risk and go to withdraw it. This could lead to runs on banks. It could also lead banks to make knee jerk reactions and freeze their lending to other customers in order to preserve their capital.
This has all the ingredients of a crisis in the making. The Chinese government will most likely have to step in and offer some type of support to the banking sector as well as to local municipal governments. This has two important implications for U.S. businesses.
First, the cost of doing business for local Chinese companies will go up
As banks start to lose money on their government loans, they will try to compensate for this by increasing fees and rates to business customers. This will lead to an increase in prices, which means your cost to important goods from China will also go up.
Second, the Chinese government may choose to redirect significant resources—hundreds of billions of dollars—locally
This means reduced purchases of U.S. Treasury securities, European sovereign debt and other investments which have helped keep the global economy functioning. This will increase the already risky situation around the world.
The Chinese government has the liquidity and resources to address this problem successfully. But those countries that have grown dependent on Chinese capital will feel the effects. Sooner or later the effects of this crisis will be felt by U.S. companies. Take measures to anticipate how these trends may hurt your business.