China’s household debt problem

The rapidity and size of China’s debt boom in the past decade has been almost entirely without precedent. The few precedents that do exist — Japan in the 1980s, the US in the 1920s — are not encouraging.

Most coverage has rightly focused on China’s corporate sector, particularly the debts that state-owned enterprises owe to the big four state-owned banks. After all, these liabilities constitute the biggest bulk of the total debt outstanding, and also explain most of the total growth in Chinese debt since the mid-2000s.

Chinese households, however, are quickly catching up. This is bad news.

The simple story of China’s debt boom is that government-backed companies borrow from government-controlled banks to pay for wasteful investments to support jobs and other political objectives. This creates lots of problems for China today and in the future, but it does have one virtue: the losses from centralised credit allocation can be distributed over a broad population over a long period of time. While liquidating everything in one go and starting fresh may be the ideal approach, the likeliest outcome of China’s corporate debt binge still looks a lot better than the chaotic wrangling between debtors and creditors that happens in most other places at most other times.

Household debt is different. Borrowers are widely dispersed and lack political power. The lenders are often newer finance companies or loan sharks. Worst of all, there is essentially zero chance that additional household borrowing pays for productive investment. Some of China’s additional infrastructure and manufacturing capacity may prove valuable one day. Household debt probably won’t. Atif Mian and Amir Sufi have ably shown that increases in household borrowing tend to predict slower income growth and higher joblessness.

This chart is therefore cause for concern:

(The debt data come from the Bank for International Settlements but unfortunately end in mid-2017. The disposable income figures were calculated by combining the per capita numbers published by the National Bureau of Statistics with the population data published by NBS. To cover the pre-2013 period, we created a national disposable income number by adding up the incomes of urban and rural households. Neither the debt nor the income data go much further back than shown in the chart.)

As of mid-2017, Chinese households had debts worth about 106 per cent of their disposable incomes. For perspective, Americans currently have debts worth about 105 per cent of their disposable incomes, on average. The difference is that American indebtedness has been basically flat the past few years after steady declines since 2007.

Chinese households have been experiencing rapid income growth by rich-country standards for a long time, but their debts have grown far faster:

Since the start of 2007, Chinese disposable household income has grown about 12 per cent each year on average, while Chinese household debt has grown about 23 per cent each year on average. The cumulative effect is that (nominal) income has slightly more than tripled but debts have grown by nearly a factor of nine. The mismatch has been getting worse recently, as can be seen in the kink in the pink line towards the end.

All this is finally starting to affect the aggregate debt numbers. Household debt in China is still small relative to the total — about 18 per cent as of mid-2017 — but household borrowers are now responsible for about one third of the growth in total nonfinancial debt:

China’s household borrowing binge has gone under the radar for so long because the household sector is so small relative to the Chinese economy. Compared to gross domestic product, China’s household debt has grown rapidly from a very low base to a level that is still low compared to many other countries. This is shown by the pink line below, even though the claret line is a better measure of households’ financial position:

The problem is that households cannot service their debts out of GDP. Instead they have to rely on their meagre incomes. Since 2007 the share of Chinese national output going to households has ranged from as high as 46 per cent to as low as 42 per cent of GDP. (The rest of China’s national income is mostly captured by government-controlled enterprises and their elite managers.) The household share of income has dropped by about 1 percentage point just in 2017:

For comparison, disposable income in the US has tended to hover between 71 per cent and 76 per cent of GDP over the past few decades.

Michael Pettis’s latest newsletter addresses some of these issues, so we’ll give him the last word:

The trick for Beijing now is to bring non-productive investment down as rapidly as it can without causing unemployment to rise to dangerous levels. Because it has proven difficult to replace non-productive investment with productive investment (and, I have long argued, unrealistic even to expect it could happen), the only way to do so is to replace it with consumption. But levered consumption obviously cannot solve the problem of rapid debt growth, so rising consumption must be driven by rising household income, even as declining investment causes workers on investment projects to be fired. In the end this may be politically a difficult problem, but economically it is just an arithmetic problem about wealth reallocation.

Related links:
Over in China, a debt boom mapped — FT Alphaville
Reconciling Chinese Household Debt Statistics — Chris Balding
Deregulation creates China consumer loans boom — Financial Times
Digging into China’s debts — FT Alphaville