China Has Debt Issues, and the US Does Not?

Moody’s has lowered China’s credit outlook from stable to negative. Despite this, China maintains an A1 rating for its long-term outlook, which is still considered investment grade. As long as the rating doesn't slide to non-investment grade, it should meet many institutions' investment criteria.

This development seems to have more of an optical impact, particularly in light of the media's successful portrayal of a pessimistic view of China. There's frequent emphasis on China’s debt issues, yet it's important to note that the U.S. also faces a significant debt problem. Focusing on another's challenges doesn't negate one’s own. More that later.

China’s economic challenges are well-documented. The country’s GDP growth has heavily depended on infrastructure and real estate development. Local governments sell land to developers and borrow funds for constructing roads, rails, bridges, and more. Developers have been aggressively acquiring land, spurred by rising demand and prices. The race for growth has led to a cycle of borrowing, building, and trying to outpace competitors.

However, this approach isn't sustainable, and the inevitable bursting of the bubble was a choice China made a few years ago. This decision led to the well-known real estate collapse. Now, China faces the difficult task of transitioning to high-quality development, moving away from using real estate as a primary driver of GDP growth to prevent future property bubbles from forming.

Property developers are nearing insolvency, and local governments struggle to generate revenue from land sales to repay loans. This situation creates a downward spiral, necessitating intervention from the central government, which includes instructing banks to provide support. These banks have likely extended credit to both developers and local governments. Additionally, trusts, which have acted as shadow banks, face default risks due to their inability to repay their lenders.

Ultimately, it seems the central government will bear the financial burden. If the cost becomes too overwhelming for banks, the government might need to bail them out, effectively stopping the financial crisis at its source. This situation could lead to increased bond issuances by the government, evidenced by the 1 trillion yuan issuance in October and the expansion of the budget deficit to 3.8% of 2023’s GDP.

Therefore, Moody’s downgrade of China’s credit outlook is justifiable. Last month, Moody’s also lowered the U.S. credit outlook to negative, placing both countries in similar predicaments.

Regarding debt levels, the U.S. holds the title of the most indebted nation, exceeding $30 trillion, while China's debt stands at around $14 trillion.

However, these figures become more meaningful when compared to their respective GDPs. The U.S. debt-to-GDP ratio is 116.1%, significantly higher than China’s 78.6%. While some argue that China's debt issue predominantly lies at the local government and private real estate developer levels, its debt-to-GDP ratio is expected to rise as it attempts to bail out these entities.

The U.S. has consistently experienced government budget deficits, with efforts to bridge this gap proving unsuccessful. Expenditures continue to increase, driven by rising healthcare and pension costs, compounded by escalating debt interest payments due to higher interest rates. The IMF projects that the U.S. debt-to-GDP ratio could exceed 140% by the end of 2030 if no corrective actions are taken.

In conclusion, both the U.S. and China face significant debt challenges, albeit of different natures. It is a case of the pot calling the kettle black, especially when the U.S. media persistently emphasizes China’s debt issue.