Wall Street Journal: Asia’s Debt Trap: After the Debt Party Comes the Hangover

Last weekend I pointed out that record stocks hasn’t been about the popular notion of G-R-O-W-T-H but about record accumulation of DEBT

Record or near record stocks has become a dominant feature even in ex-Japan and China Asia. Yet if one looks at their respective economic G-R-O-W-T-H trends since 2011, they have MOSTLY been on a decline: Australia, South Korea, Taiwan, Singapore, Hong Kong, Indonesiaand Thailand. Only India, Vietnam and New Zealand appear to beat the region’s dominant trend.

On the other hand, what the establishment has mostly ignored has been the relationship of debt with record stocks…

In sum, record stocks (as well as record property prices and bonds) have mostly been about unbridled and rampaging speculative activities financed by credit that has been pillared on zero (or negative) bound rates, QEs and other monetary easing tools than they have been about G-R-O-W-T-H.

The Wall Street Journal says after Asia's debt shindig, the hangover comes.

The hangover… (bold mine)

Asian countries borrowed heavily to maintain growth during the financial crisis, but couldn’t break the habit even as the global economy healed. Now they are feeling the hangover.

Growth is slowing fast across the continent as consumers and businesses focus on repaying debt. Central banks have cut rates, pushing currencies lower, but economies haven’t picked up. Demand has stayed weak, keeping wages stagnant and price growth anemic, making borrowings even harder to repay.

This dynamic could significantly harm the region’s economic prospects, potentially dragging down global growth rates.

The previous phase… “Here comes the Boom”

Debt levels in several Asian countries, such as China, Malaysia, Thailand and South Korea, are higher than they were before the Asian financial crisis of the late 1990s. Some countries, such as South Korea, Malaysia and Australia, have household-debt-to-income levels greater than the U.S. had before its financial crisis.

Countries in the region had been careful about debt after the pain of the Asian crisis. That allowed them to borrow to maintain growth and serve as a buffer for the rest of the world during the global financial meltdown. But Asia kept borrowing even after the crisis.

“Asia has become addicted to credit and easy money has bred complacency among policy makers,” said Frederic Neumann, co-head of Asian economic research at HSBC Holdings PLC.

There is an element of irony in Asia’s debt binge. The U.S. debt boom that led to the financial crisis was made possible in part by low interest rates caused by high savings rates in Asia. Countries in the region, particularly China, gobbled up U.S. Treasury debt, driving down yields and borrowing costs in the broader economy.

Today, super-loose monetary policies in the U.S., Europe and Japan have caused cash to flood into Asia. Yield-hungry investors have driven down interest rates, allowing governments, companies and individuals to borrow more than ever before, at the lowest rates in history.

The borrowing has played out differently across the region. In China, giant state-owned businesses, real-estate developers and local governments loaded up on debt. In Malaysia and Thailand, it was consumers who borrowed to fund the trappings of a middle-class lifestyle, such as cars and home appliances.

Yep, the credit risk profile cannot be seen as a one-size-fits-all category. The causal dynamics of debt has been relative to the idiosyncratic structures of each political economy.

 

The Debt Numbers…

Even excluding Japan, debt in Asia rose to 205% of gross domestic product in 2014, compared to 144% in 2007 and 139% in 1996, just before the Asian financial crisis, according to calculations by Morgan Stanley. In China, total debt rose to $28.2 trillion in mid-2014, or 282% of GDP, up from $7.4 trillion in 2007, according to McKinsey. The ratio is 269% in the U.S.

Even excluding Japan, debt in Asia rose to 205% of gross domestic product in 2014, compared to 144% in 2007 and 139% in 1996, just before the Asian financial crisis, according to calculations by Morgan Stanley. In China, total debt rose to $28.2 trillion in mid-2014, or 282% of GDP, up from $7.4 trillion in 2007, according to McKinsey. The ratio is 269% in the U.S.

In some poor countries such as India and Indonesia, debt is still relatively low compared to the size of their economies. But pockets of debt, such as among India’s infrastructure companies, are weighing on the economy. Other places, including South Korea and Thailand, are facing a difficult combination of high debt and ageing populations, meaning their already-slowing economies are unlikely to give the same kind of lift to the world’s growth as in the past.

But the Wall Street Journal attempts to ‘sanitize’ the risks

Despite the rise in debt, few expect a financial crisis in Asia. Most borrowing was done in domestic rather than foreign currencies, so a currency depreciation isn’t likely to boost the chances of default. Too much debt denominated in foreign currencies helped set off the Asian crisis in the 1990s.

Most governments in Asia have modest debt levels, allowing them to bail out borrowers and stimulate their economies. And borrowing is largely of the plain-vanilla variety, mostly bank loans and bonds, rather than the highly leveraged structured products that contributed to the U.S. housing bust.

But there are worrisome trends. In China, half of the debt is tied to real estate and a third of the outstanding borrowing came through the country’s shadow-banking system. That debt could ricochet onto bank balance sheets, as happened during the U.S. financial crisis. China’s stock-market rally has been juiced by margin lending, which is up 70% this year.

Fading bubbles prompt government to pump even more bubbles…(South Korea edition)

With a debt-to-GDP ratio of 286%, according to McKinsey, South Korea is among the world’s 20 most indebted countries, and its household-debt-to-GDP ratio of 81% puts it just ahead of the U.S.

Despite the debt overhang, South Korea’s economy is expected to grow by more than 3% this year, one of the fastest rates among developed countries, and the central bank still has room to cut interest rates.

Warning signs are piling up, however. Concerns about deflation, a decline in prices that makes consumers reluctant to spend and debt harder to repay, are growing. In March, consumer prices rose at their slowest pace in almost 16 years.

With rate cuts and a depreciating currency failing to boost demand, the government is trying to drive up prices of real estate, which accounts for three-quarters of household assets. It eased limits on bank lending for mortgages and increased price caps for developers.

The article demonstrates why Asia has now been trapped by its deepening dependence on debt—she cannot grow its way out of debt!

And because of this, governments (not limited to Asian governments) have become serial bubble blowers in the hope of kicking the can down the road or of resorting to new bubbles to solve the legacy issues of  previous bubbles.

There are some items to nitpick though. 

Bailouts are no free lunches. The assumption that low government debt may pick the slack up from the private sector will entail massive consequences. These will come the form of deepening cronyism and corruption (enlarged government), expanded financial, economic and civil repression (e.g. higher taxes, capital controls, social mobility controls etc.), transfer of risks to the public sector, higher inflation risks, prospective financial stability risks, and most importantly, diminished productivity.

The other misplaced assumption has been that the dominance of domestic debt presupposes lesser risks. 

Such is a very simplistic way to view credit risks. Even domestic debts have been prone to credit events. As Harvard’s Carmen Reinhart and Kenneth Rogoff warned in their chronicles of global debt crises,

we note that domestic debt is not static around default episodes. In fact, domestic debt often shows the same frenzied increases in the run-up to external default as foreign borrowing does. The pattern is illustrated in Figure 5, which depicts debt accumulation during the five years up to and including external default across all the episodes in our sample. Presumably, the comovement of domestic and foreign debt is produced by the same procyclical behavior of fiscal policy documented by previous researchers. As shown repeatedly over time, emerging market governments are prone to treating favorable shocks as permanent, fueling a spree in government spending and borrowing that ends in tears

Besides, current monetary policies have already been manifesting bailout measures in place, which is why dependence on debt keeps mounting. This means that at current rate of debt accumulation, existing government resources may not be enough to finance bailouts when volatility emerges.

Bottom line: There is no such thing as a free lunch. The world appears headed for a great debt default.

Record stocks in the face of record imbalances at the precipice.