Global Tapering?

01/08/2014 12:01 am EST


Jim Jubak

Founder and Editor,

The slight decrease in the Fed's bond buying puts the focus on the Chinese government's efforts to taper, says MoneyShow's Jim Jubak, but it's not clear yet what impact it may have.

Let's talk for a minute about the other taper, not the Federal Reserve's decision to start purchasing a little less, not $85 billion, but $75 billion a month in mortgage-backed securities and treasuries, but the taper going on in China. This comes as the Chinese government and the People's Bank of China are trying to restrain the debt problems that are going on. We've had numbers for the first half of 2013, from the National Audit Office, that said local government debt grew at about 13% over the same period of last year so, a 13% increase in the first six months of 2013. This takes local government debt up to about 17.9 trillion Yuan, which is about $3 trillion. The question here, really, is, “What do you make of this number?”

In terms of past action, it looks like what we're seeing is the government's effort to restrain debt in this part of the economy is having some effect. Over the last two years, local government debt has gone up by about 46%, so, a 13% increase in the first half of 2013 is actually, maybe, below trend. The problem of course, is that it's very hard for the central government to have much control over these. Local governments are not allowed to issue bonds themselves, but that doesn't mean that they can't find ways around it. In the last ten years, they set up something on the order of 10,000 local lending, borrowing, financing entities that are affiliated with local governments but aren't local governments. That's where most of this debt is.

The problem, from the Chinese point of view, is that this kind of debt load is not sustainable given the revenue stream that local governments have. Local governments do about 70% of all government spending in China, but they only have about 40% of all government revenue. Most of it goes to the center, very little goes back. They fill that gap. They've historically filled that gap through real estate sales, by converting land from farmland, seizing it, basically, from farmers, and then selling it off to the builders of apartment buildings or commercial developments, or factories. As the property market has slowed, the revenue that these financing companies connected to the local government have available to them has decreased. The worry here is that there's not the cash flow to cover these things. We're looking at potential defaults. We're looking at bankruptcies. We're looking at this then cascading down through the whole economy, because a lot of local businesses, a lot of local developers, a lot of local property buyers have depended upon these local government entities to provide them with cash. If that cash isn't there any longer, then they go out of business. They cut back, whatever.

What you're seeing is that is the government puts on the breaks too hard, too fast, you'll see the economy really, really slowing because it's a major part of economic financing. On the other hand, if they don't restrain it all, you're talking about building up a bubble, building up debt load to a level where it's really completely unsustainable. Then you've got a problem, because when the problem occurs later on down the road, it's even bigger and there are even fewer viable alternatives. It's clear that the Chinese government is trying to retrain this. It's not clear how fast they're doing it. The most recent numbers, from the National Audit Office, if we believe them, seems to show that the government is having some effect in slowing this, that there is some taper going on in China but that's it not very big. This bears watching. I think, for 2014, China is probably the largest single source of volatility for global financial markets.

This is Jim Jubak for the Video Network.

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