The Coming Collapse of China

Protect your finances if China's debt bubble implodes. Don't let the trade war ruin your retirement plans.

Protect your finances if China’s debt bubble implodes.

When the Western economic world collapsed in 2008 there was only one beacon of light: China.

For decades China has grown at nose-bleed speeds and looked like an unstoppable economic miracle. Now the foundations of that miracle are exposed and the house of cards is in peril. Shadow banks and ghost cities are only the tip of the ice berg.

Speculation over the years of fudged official economic numbers coming out of Beijing is starting to haunt the government there. As 2018 came to a close the government reported the slowest growth in 28 years. This was still a bit north of 6%.

Unfortunately, these slower growth numbers are probably a wildly exaggerated lie. Recently, a former chief economist for the Agricultural Bank of China mentioned a report that two recent studies show China’s economy growing at a mere 1.67% and another showing the economy actually declined.

While there is no doubt China has made massive economic leaps over the past several decades, much of the recent growth is built on a shaky foundation.

In many Western nations an economic crisis can ensue from excessive indebtedness. The difference between Western nations and China is what the debt funding was used for. In the U.S., for example, corporations can over-extend themselves, causing over-production and an inventory hangover. Household debt might be wasted on stuff that has virtually no value. But homes and autos have at least some value and a good amount of utility. Something we will see China wasn’t spending on.

 

Dangerous Foundation

China is mired in a massive amount of debt. Trustworthy numbers are hard to come by, but many reports claim China’s government and municipal debt are several times larger than the annual economic output of the country.

What China spent the money on is a bigger problem than the excessive debt! The growing mountain of debt is difficult to manage. However, if the debt was used to produce something of value it would be possible to work through the financial problems with only modest economic pain.

China did some of that (spending on productive investments) and a whole lot more creating rubble. 

People inside China have captured videos of buildings built in the last decade tipping over and put them on YouTube. Ghost cities in China are well known outside the country. Whole cities with virtually no people living there. 

What is worse is the quality of construction. A large number (based upon information from people living in China a long time) of buildings only a few years old look like they are more than a century old! It is hard to imagine the crumbling facade and disrepair huge parts of these cities can fall into after only two or three years. Again, YouTube videos allow you to glimpse the slow moving disaster in the works.

The layers of debt these unlivable buildings have is equally ill-constructed. Municipalities borrow so they can encourage growth which generates tax revenue. (The tax system in China is untenable as local governments frequently find the greatest source of funds though the crazy financial deals with developers.) 

Builders, which are frequently state-owned and very inefficient, pile on more debt to build the structures.

Then the final layer of debt is added when individuals buy, believing real estate never goes down in value. People in China buy real estate because they consider it a good investment even when they don’t live there or rent it out.

Renting is also far cheaper than buying a property in the populated areas of China. Rents frequently only cover a fraction of the mortgage payment so ownership is even more financially demanding.

 

Inside Information

A year-and-a-half ago this blog was one of the few websites allowed inside China by the government. Today it is officially banned!

My oldest daughter spent time in China last year and was able to pull up this blog. She taught English as a second language and lived with a host family. That is no longer possible.

Are you prepared for the collapse of China and the debt bubble? Protect your finances with these 3 simple steps.Many foreigners teaching English as a second language in China are sheltered from the worst parts of China. My daughter, Heather, sought the real experience and got it. Fortunately she had a host family who considered themselves unconventional and enjoyed Heather’s presence. Her friend stayed with a family that wasn’t unconventional and had a miserable experience.

When Heather returned home she stayed in contact with her host family. She grew a bond with the host mom and their 5 year old daughter. 

In the last few months contact has been more difficult. We actually lost contact for over a month and feared the worst. These are good people and we worry about them because they are friends. 

As we started to give up hope of ever hearing from our extended Chinese family the host mom made contact. The story was grim.

This family had another foreign teacher and they had to send her home early over safety concerns. From the inside China has already started to implode.

The government’s solution to the stagnant economy was to set off another round of debt spending. With state-owned firms extremely inefficient and getting a large portion of the additional spending it is like doubling down on stupid.

 

Reality Test

You can hide fiscal malfeasance for a very long time if the government want the facts hidden. However, the natural laws of economics still apply and eventually assert themselves. 

The growing mountain of debt will eventually cause a crisis. The longer the delay before appropriate remedial action is taken the more pain will be measured out. 

China had started steps to resolve the issues. It would have taken a long time to fix the worst of the financial problems. However, the risk was high China would implode before they resolved the worst of the imbalances. The world community, knowing the approximate depth of the problems, quietly played along. What other choice did they have.

Unfortunately for China, the new American president had no patience for such slow resolutions. The trade spat exposed the underlying weakness of China’s economy quicker than expected and might be the trigger to set off the avalanche. 

The Los Angeles Times recently reported China announced more than $600 billion of economic stimulus. The goal is to fix the problem as fast as possible before catastrophe strikes. More debt seems a poor choice of ointment.

China’s history in not encouraging if the slowdown is too fast and/or a currency or debt crisis occurs before adequate safeguards are in place. 

The debt may be too large for an economy the size of China’s to navigate to calm waters. Many Chinese banks are insolvent because they can hide behind government censors. In a true capitalist economy these banks and other companies would have been shuttered long ago. So the inefficiency of the system trudges on and deepens.

Normally I would have an optimistic option at this point. And while I think this could be the next financial crisis to strike, I don’t think it will be the end of good times forever. All I’m saying is there will be a few moments when people get really scared if China collapses.

 

Preparing for the Storm

Dinny McMahon in his book, China’s Great Wall of Debt, does a better job digging deeper into the debt issues in China. This short post can’t cover the details the way a book can. The issues are deeper than I mention with shadow banks and incredible debt loads even greater than the government in China understands since they also know much of their data is faulty. I recommend reading this book. 

The risks posed by China should not cause undue alarm. Planning for the possibility is wise, but no one knows when, or even if (the miracle could actually be a miracle), the boom will drop. 

Is China's debt bubble about to burst? Learn how to protect your investments before it's too late.Since timing a crisis of this nature is impossible you can’t sell all your investments and hope it is the right move. The investments you sell might benefit from the Chinese crisis or the market could rally for years before the flood of Chinese debt consumes the news feeds.

There are some steps you can take to protect yourself if China implodes and if it doesn’t will bolster your financial situation regardless.

The 2008 financial crisis that started in the U.S. was a debt crisis. Home lending was out of control. Appraisals were based on fantasy and fake documents. Almost sounds like what China is dealing with today. 

Debt crisis are always painful events. Companies fail and jobs are lost. People with money hold it tight for fear things will never improve. 

As we saw in 2008, a financial crisis in a major world economy spreads. Very few parts of the world went unscathed by the 2008 events in the U.S. Even China was affected. 2008 set China on a massive borrowing for growth scheme they can’t seem to get off. Once the lie starts you need bigger and bigger lies to keep the charade going. 

Since debt is the cause of so many financial crisis I suggest you insulate yourself by reducing or eliminating debt. (I prefer the elimination of debt because the seriousness of the China issue is large enough to harm virtually anyone holding debt.)

Reducing debt is an easy (relatively) and simple (relatively, again) way to insure your fiscal soundness if China stumbles. Like all debt, it takes time to pay off. Today is the best day to start the process. When the tsunami is visible on the horizon it’s too late; there will only be time to grab something solid and hold tight.

A second security procedure is to keep some of your finances liquid. Most of your money should probably be invested in broad-based index funds all the time. Market timing just doesn’t work. Having two years of spending in a money market fund might also be a good idea. This is a similar tactic people in or near retirement use so they don’t have to dip into investments when the market is down.

 

Final Planning Tips

I wish I could share more, but I fear if I was totally blunt it might harm my friends in China. 

This is a serious issue China works hard to keep from the press around the world. It is easy to think China is loaded with cash since they hold so many U.S. Treasuries. In a crisis China may have to sell large amounts of these Treasuries to defend their currency causing an interest rate spike in the U.S. This would be economically disruptive even if the Federal Reserve fights to counter the effects of such a liquidation. 

The most serious issue happened when we lost contact with Heather’s host family for over a month. They only contacted us because they were traveling outside China. This is very concerning. When things get really bad (and usually just before), totalitarian governments clamp down hard. Foreigners in China have been learning this. The security alert for Americans traveling in China is elevated and travel there is not recommended. This is not a warning to be disregarded.

If the same thing happened in Russia it would be less an issue since their economy is so much smaller. Even with inflated numbers, China’s economy is still one of the largest on the planet. If China stumbles we will all feel the ground quake, especially since some of the debt is in U.S. denominations.

This post is not about inciting panic, rather the opposite. Risk is high and even the U.S economy looks to be softening. Smaller refund checks this tax season means people were enjoying a slightly higher take-home pay during the previous year. That could lead to a softer U.S. economy for a while.

You can weather almost any economic storm without debt. Even in good times debt can be a burden. 

I worry because a family in China close to my heart is living dead center of where the storm will strike. I wish them and all of China well. 

We are all in this together. So take precautions, reduce debt, increase your financial cushion and be well.

 

 

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Keith Taxguy

18 Comments

  1. Tripplefiguy on February 10, 2019 at 11:35 pm

    Just when I was thinking of lowering my cash position to max 2 Roth’s this year. Granted I could always just keep the money in a money market inside the Roth but it kind of negates the benefits.

    The thing is, where else is there to invest? With 10+ years timeline, I don’t think cash is the way to go. Also, as you’ve said before, don’t you think debt ( as in just a mortgage) is a good motivator? Take that with a 30%+ loss to your portfolio, wouldn’t that just be all the more reason to light a fire under your butt to hustle and try to build back your wealth?

    I don’t know, I may just be blowing smoke. I do see the positives though for having a large cushion (for some people). Personal finance advice is so vast as it’s so personal. That’s why I love it all!

  2. sedge on February 11, 2019 at 9:04 am

    Two years of liquidity? Gives one pause as to just how bad you think this thing is. I mean long stretches of general badness have happened (remember the 1970s?) Would love to hear more on this topic, as long as nobody gets hurt. Thank you for sharing.

    • The Money Commando on February 11, 2019 at 11:07 pm

      Well, I won’t presume to answer for Keith, but a conservative financial planner (like me) will advise you to keep roughly 1 year of expenses in cash. As you approach retirement this could be increased to 2-3 years. The idea, of course, is that when the stock market tanks you can pay your bills with cash rather than selling your (hopefully) temporarily cheap investments to pay your bills.

      In this case, Keith is just advising the average person to be slightly more conservative. Personally (and for a variety of reasons) I have about 5 years of living expenses in cash right now.

  3. Susan @ FI Ideas on February 11, 2019 at 9:39 am

    I really appreciate you sharing your daugher’s first-hand information. My husband and I traveled to China in 2007 with our Tai Chi group and saw Beijing on the rise right before the Olympics. Still, the news was obviously filtered. The high rise buildings were everywhere and the growth rate at the time was huge. I can imagine, just from my brief glimpse into that nation and their ways, that this is a ticking time bomb. I also think we in the USA have another ticking time bomb with QE money that “saved” us in 2008 and beyond. As they say, if something can’t go on forever, it won’t.

  4. Robert on February 11, 2019 at 9:47 am

    Good China post. Very interesting first hand information. I’ve kind of left my int’l holdings remain with limited rebalancing to adjust for the paper losses I’ve taken the last several years. Emerging is only a small % in Vanguards Total Int’l fund so, it’s a horse-a-piece. China does scare me a bit, so again, good info to chew on.

    As for paying off your mortgage in addition to removing all other debt….. well I’m all in. It doesn’t always make 100% financial sense, but boy does it help me sleep soundly. Simply… I love saying we just don’t owe anyone anything!

  5. Randolph Hawkins on February 11, 2019 at 1:52 pm

    Wow not sure if you saw the article on Bloomberg about two large Chinese borrowers missing bond payments. Sounds like your article is very timely.

    • Keith Taxguy on February 11, 2019 at 3:18 pm

      I didn’t see the Bloomberg article. It would not surprise me if some serious defaults start soon, including some local governments and large banks. I don’t know if Beijing can hold the spinning top steady with so much to balance.

  6. Michael Crosby on February 11, 2019 at 4:45 pm

    Thanks Keith. I also read the book on China you recommended.

    “Serpentza”, a Youtuber. He lives in China and does honest weblogs (quite popular) about life in China. He married a Chinese girl but believes it’s getting too dangerous to do honest reporting in China. Not sure if he’s still in China, but he does plan on leaving. Highly recommend checking him out, I learned a hell of a lot watching his videos.

    Seems that China is ultra nationalist and still suffers from the humiliating losses from the Opium Wars to the present. From what I’ve heard, since the head of China looks like Winnie the Pooh, it’s outlawed to say that word in China.

  7. John on February 12, 2019 at 4:34 pm

    As someone about to move to a new state for work and in the process of buying a house, I’d be curious if you advise not taking a mortgage. I’ve read and re-read several times your previous posts on the subject, and it seems like under the current conditions you outline above that you’d advocate the best thing to do with your money is to first, own your home outright, and then after that, own index funds. Is that an accurate analysis?

    • Keith Taxguy on February 12, 2019 at 7:20 pm

      That is an accurate assessment, John. I have no crystal ball. However, I can see excesses as easily as anyone. The best defense against against an economic break is no debt and a diversified portfolio. Those in debt always suffer the most in an economic downturn. With debt at record levels we know the pain is inevitable. I try hard not to sound as if I have some special knowledge of future economic moves, but I do know high debt levels never end well. My goal is to help insulate readers from catastrophe.

  8. Social Capitalist on February 12, 2019 at 6:55 pm

    Great post! Shows how what we perceive as socialism or communism is just capitalism run amok. Governments prop up capitalism through debt and money printing rather than face the reality that it must move in a cycle ( and risk a power shift.) But this too can only go on for so long.
    In China’s case, what we are really seeing is fascism. A totalitarian nationalist government directing the economy while controlling people’s lives. This enriches a few at the ultimate expense of many. Whether it’s corruption (China) or effected by law (US tax code) the funneling of wealth to the stratosphere if society always ends in collapse and usually war. If capitalism hopes to survive it must be open to continuous reform in the way that democracies should be.

  9. Katie Camel on February 13, 2019 at 10:32 am

    Wow. So informative! I’ve often wondered about the stability and strength of China’s economy, largely because I don’t trust their government and too many of their products have been recalled — not stringent enough standards for manufactured goods makes me wonder where other less stringent rules apply. You’ve illustrated exactly what I feared. Their collapse will definitely reverberate around the world. That thought is scary.

  10. Allie on February 13, 2019 at 7:38 pm

    Buy the dollar

  11. Stephanie on February 21, 2019 at 12:14 pm

    Very informative post, and something I’ve been thinking about for a while. If I recall correctly, you mentioned in another post that your index funds are 70% S&P and 30% international. Has your thinking changed on this?

    Thanks

    • Keith Taxguy on February 21, 2019 at 12:18 pm

      No.

  12. Dave on February 22, 2019 at 9:15 am

    Who is China in debt with?

    • Keith Taxguy on February 22, 2019 at 10:24 am

      That’s part of the problem, Dave. China hides pertinent data on who they owe. They are probably printing money like no tomorrow and the banks are saddled with bad loans at high levels and the government refuses to open the books (always a good sign). They hold ~ $1.3 trillion is U.S. Treasuries, but do so to stabilize their currency. It is likely a large portion of these bonds are collateralized so their “real” reserves could be much lower.

      In the end it doesn’t matter who is owed the debt. Much of it is internal so at some point their banking system enjoys what we did in 2008, only on a much larger scale.You can only hide that amount of bad loans before the natural laws of economics catch up.

  13. J @ Wealthier Lives on February 25, 2019 at 1:55 pm

    Very interesting post. I have witnessed many of these fantom residential projects, manufacturing plants, even “mini-cities” over the past 10 years while working in China. Sometimes gigantic factories with no workers. Lights are not even on. Enormous residential complexes (100+ towers) without a signle occupant. This unlimited credit to generate growth will soon catch up to them. Of course, any government data can’t be really audited. Interesting country to say the least. Stay diversified!

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