Weak data on China’s bank lending raise new fears of an impending credit crisis

(Originally published Aug. 14 in “What in the World“) The economic news today from China is a dramatic drop in new bank loans in July, with headlines screeching that credit may be drying up to an economy that will die without it.

China’s banks issued 345.9 billion yuan ($47.80 billion) in new local-currency loans in July, down 89% from June and the lowest monthly level since late-2009.

For an economy as heavily indebted as China’s, where local governments and property developers are up to their eyeballs in debt, a sudden downturn in credit could touch off a wave of defaults and a credit crisis.

The June data underscore the risks facing China’s economy as it slips into a Japan-style zombification, with its declining economic growth being increasingly gobbled up to repay a mountain of property-related debts, leading to rising youth unemployment and falling prices and capital flight. Falling exports and weakening foreign investment, with Washington actively restricting both, are helping to further deflate China’s economy.

And everyone is now worried about China’s economy and how its downturn could affect the rest of the world. Even The New Yorker.

But the June data may not be as dire as it appears. Once again, monthly data for any statistic are volatile and bank lending is particularly so. Indeed, the reason bank lending was so low in July undoubtedly has something to do with the fact that in June banks made over 3 trillion yuan in new loans. That was 8.5% higher than they the loans they issued in June 2022 and capped a first half in which China’s banks made 15.73 trillion yuan in new loans, the highest ever.

Indeed, the problem in China isn’t that credit is falling, it’s that it keeps rising. Banks are pumping ever more new debt into China’s faltering system, inflating the bubble even further. Last year, China’s new bank lending rose almost 7% to a record 21.31 trillion yuan.

On a rolling quarterly basis, new loans in China dropped almost 12% year-on-year in the three months ended July 31.

So, the headlines are right that we should worry about China. They’re just worrying for the wrong reasons. China faces three potential scenarios:

The first and most dramatic is that Beijing somehow loses control of the supply of credit to the economy to market forces, which start to price risk appropriately and, risks being high, credit dries up, borrowers default, and a financial crisis ensues, leading to an economic crisis. That’s unlikely because banks do what Beijing tells them and Beijing controls what domestic media report about the banks and their borrowers. A huge borrower like Country Garden might not be able to hide missing bond interest payments to foreign investors, but it could default on a huge loan to domestic banks tomorrow, and no one else might even hear about it.

The second is that China continues to avoid this by following Japan’s example and continuing to “extend and pretend:” that is, keep pouring good credit after bad credit in hopes that growth and property prices recover enough that borrowers are no longer under water, and everyone lives happily ever after. In the meantime, though, real growth is stunted. This “muddle-through” scenario is the most likely because it suits bureaucrats and politicians alike: if you can hold on long enough, it’ll all be someone else’s problem.

The third and most unlikely scenario is that China pursues a middle path, continuing efforts it began almost a decade ago to allow for some defaults and debt-restructurings. That would gradually let the air out of the debt bubble but forcing banks, bondholders, and their shareholders to suffer massive losses. That in turn would likely send the Chinese economy into a painful recession and decimate the savings of a population that uses property as a piggy bank. So, politically difficult, and therefore not the path most politicians would choose.

Credit data, July excepted, suggest China continues to follow option No. 2: extend and pretend.