What do you see in the table below? Contrary to the belief that the global debt was reduced by deleveraging, McKinsey indicates that since 2007 there has been an increase in total global debt. In a closer look we can see that four main actors, Finance, Government, Corporate and Household have all increased their debts. The rise is higher in government and corporate than it is in household and finance sector. Both emerging and developed countries are apparently behind the rise on government’s total debt. Government filled the gap that emerged from household and financial institutions’ efforts to pay their debts under the conditions sourced by the bursting housing bubble and financial crisis in developed countries. It had to fill the gap because the contrary would have rapidly slow the economy by stopping consumptions and investments. We saw government in similar behavior with household and corporate that benefit from the slow interest environment in developed markets. Among these countries there is one that deserves a special attention. In the second table you are seeing a comparison of China’s debt dynamics in 2007 and Q2 of 2014. Blue indicates the non-financial corporates’ debt and green indicates the finance sector’s debt. China is one of the most important drivers of global loans’ growth. Following 2007, China that lived through a constriction in export markets tried to maintain its growth pace with an investment package. The fund was sourced from household savings in exchange for a low interest rate. This is the only possible way since there is no capital freedom. In a while China overgrew its inefficient investment amounts because it focused on the annual growth instead of quality in the long term. We must also consider the non-paying loans that are hidden in the system. KITS are known of benefiting heavily from those loans. Considering these conditions, Chinese government decided on a consumption based model for growth. And there came the deflationary pressure from the inefficient production elements that cannot be thrown out of the system due to reasons such as relationship with politicians and the employment volume they create. Monetary assets that grew a lot faster than GDP were limited to Chinese financial markets because of the closed system. It first created a bubble in housing markets then passed to stock equity markets and now in the bonds market. We haven’t been able to hear about a sole straight bond default because of the government’s open or covered grants or grey relationships. ٭ ٭ ٭ ٭ Recording a loan based growth and export surplus, the country established a large US treasury bonds reserve in US dollars as part of its keeping Yuan unworthy policy. Au contraire the common belief in the market, PBOC does not have a gratuitous money tap. Similar to any balance sheet, PBOC’s statement also has actives facing passives. The moment cash outflow began was the end of happy days and FX reserve sales started. Hence the reduction on required reserves that was announced in the end of October was a step towards restraining the liquidity squeeze caused by the cash outflow. Even though it looks right on the outside, interest rate cut is an option with high side effects due to the pressure it will create on Yuan-Dollar peg (this one and other Middle East currencies’ pegs will break in the mid-term) and its accelerative effect on cash outflow. Moreover reduction of interest means more investment or construction in China which is the source of the problem. While all this happened it was propagandized that the services sector would grow and fill the gap created by the manufacturing industry. Even though services industry is shown to have recorded a growth of 8.6% in the latest announced data however when we make a comparison with other indicators, we are having difficulties to be convinced. During the stock market bubble finance had a great contribution on second quarter GDP however the contribution seems to continue in 3rd quarter even though the bubble faded away in the 3rd quarter. It is similar to the 11% increase in retail even though a record number of malls are being shut down or the decrease realized in sales of giants such as Alibaba or Baidu. ٭ ٭ ٭ ٭ Summarizing all, China’s problem isn’t for a short while (it can in fact better in 4th quarter) and will make up the agenda for long years. The economy that grew with excessive loans has a serious idle capacity however it does not possess the economic picking mechanism and the political system to throw this capacity out of the system. Since financial system is closed it is not open to speculative attacks however its condition is disputable. Economic indicators are inconsistent and highly likely to be much lower in reality. ٭ ٭ ٭ ٭ What to expect from this situation? China’s growth need to decrease to 3-4% in order to follow a healthy trend. If this happens well balanced while manufacturing narrows and household grows rapidly it will become very rewarding for China and also for the global economy. A class becoming richer and hungry for consumption to be positioned above the middle class could suck up the excess supply in the world. On the other hand developments indicate that Chinese government did not establish the infrastructure to manage such slowdown. It is right to say that many industries and financial instruments will experience bankruptcies. Shortly, even though a base is established in industrial commodities, to see a high trend seems difficult. Yuan’s decrease in value will continue and it will pave the way for deflation export. Main dynamics believes that Yuan needs to find balance in lower levels even though entering the SDR basket or MSCI index establishes short term fund flow. We have experienced all of these before in crises in Japan, Russia and Latin America. The difference is that the global finance system does not have a warden now. One of the reasons behind the globalization of the 1929 crisis was declining British Empire and the rising USA’s inability to exert authority to establish global coordination. The biggest problem today is the absence of this inability.