Is China a Ponzi Scheme?
We continue to see the Chinese economy slow down, which is based on numerous sources both within the government and independent firms. The economic forecast of China has continued to move down according to many people, including myself. However, the worry is that if the economy were to crash suddenly, it would have a severe impact on the global economy, including the U.S. While the official government economic forecast cannot really be trusted, some information from the actual companies, the people on the ground, shows a disturbing trend for the truly bizarre.
Recently, a construction equipment maker in China called Zoomlion asked for $22.0 billion in credit so that it may fund its customers. First of all, this is a large amount of money for any firm, especially considering the company itself is only worth $12.0 billion. This is a sign of how desperate the situation is in China, as customers have no cash to purchase equipment. That doesn’t bode well for the global economy.
But it gets even more worrisome for the global economy. This equipment is used for construction in the real estate sector, a huge part of the economic forecast for China’s gross domestic product (GDP). We all know that the real estate sector in China is slowing as the monthly data shows. However, this request for additional credit to fund the clients of Zoomlion sheds light on how dire the situation is becoming. Similar to a Ponzi scheme, more and more money needs to be pumped out to continue the ever-escalating rise in sales. As customers run out of cash, they start borrowing and leveraging up to higher levels, which is dangerous for the global economy. If the global economy were strong, clients would have enough cash to fund their purchases, but they can only now buy this equipment with a loan from the company.
It gets even crazier. Reports are surfacing that machines purchased on credit are then being used as collateral! The customers who bought the construction equipment are getting credit backed by the equipment, which they in turn are financing their own clients! This is one giant house of cards. Essentially, none of the customers along this chain have the money to buy the goods. Purchases are being conducted solely on credit! It appears everybody is completely overextended; when you have a situation where collateral is being borrowed multiple times on the same assets, this is a huge warning sign for the global economy.
China is a huge player in the global economy. When this bubble bursts, the net impact will be severe. I hope this doesn’t come to pass, as the U.S. economy will be severely hit. But we cannot ignore these warning signs that might affect the global economy in our economic forecast. The amount of excessive leverage in China appears to be staggeringly high. Making an economic forecast when we have a situation of credit built on other credit is that much more difficult. The U.S. has seen what happens with too much leverage. While we can’t know what will happen for sure or when, we do know that anything that happens with an integral part of the global economy such as China will have a serious impact on U.S. investments.