China’s and investment efficiency are similar to pre-2008 financial

China’s credit growth has increased rapidly in response to the 2008 financial crisis, implementing policies to increase domestic demand in order to jumpstart the economy.The corporate sector has been the main driver of the excessive credit creation, with corporate debt being 120 to 130 percent of GDP(Bloomberg). Corporate sector debt is well above the level typical for developed economies, and despite this leverage, the financial performance of the corporate sector has been deteriorating. Around 15½  percent of bank loans to the corporate sector are considered at risk of default and the rise of investment post-financial crisis has not been matched by a large increase in profits(IMF). In actuality, profits have been steadily falling, which further limits the room to finance investment. As a result, the use of credit has become less efficient at the macro level due to the rapid scaling up in investment and the additional borrowing to finance the expansion of corporate balance sheets. Worryingly, these dynamics in credit and investment efficiency are similar to pre-2008 financial crisis behavior of other countries who experienced debt crises.The United States and China have built a strong economic relationship, with significant trade, foreign direct investment and debt financing. Trade between China and the United States has grown from $33 billion in 1992 to $590 billion in 2014, making the United States China’s largest export market. That being said, the U.S. has a significant trade deficit with China due to U.S. Treasury bonds. Currently, China is one of the largest holders of U.S. debt, amounting to $1.2 trillion. As long as China continues to hold a massive amount of forex reserves and U.S. debt, some market observers believe the U.S. economy could be essentially at the mercy of China. Given that the China’s current turmoil has been followed by a downturn in U.S. and global stock markets, a pessimistic reader might wonder if much more chaos should be expected if China’s economy continues to deteriorate. With China holding a great deal of Treasury debt, one worst-case scenario would be for China to dump their Treasury holdings, which could have fearsome implications for the U.S. dollar. But, at China’s current rate of Treasury selling, we haven’t seen any pressure being exerted on the U.S. economy. In fact, even if China really wanted to dump all of its U.S. debt, the move could easily backfire: they would find it extremely difficult to find any alternative asset as stable or liquid as Treasuries. Since the 2008 financial crisis, many global economies have been stabilized. However, the stable economic climate may be coming to a stop soon, because growth in China, has fallen to its lowest level since 2009. The U.S. and China relationship has been built on extensive trade. Although it is too early to know the consequences, if current trends persist, there could be significant ramifications for foreign trade, and economic growth in the U.S. For the past 30 years, China has grown at a rate of 10% per year largely due to its 1970 economic reform. “Over the following three decades, China encouraged the formation of rural enterprises and private businesses, liberalized foreign trade and investment and invested heavily in production” (IMF). China has also maintained productivity and as a result, per capita income in china has increased fourfold over the last few decades. However, over the past five years, China’s growth has decreased to 7%. Considering growth rates of the U.S hover around 3%, this would not seem indicative of any economic collapse. However, many market analysts believe that this could be the turning point for China. “China has suffered from sinking oil prices, a shrinking manufacturing sector, a devalued currency and a plummeting stock market” (IMF). Also, Chinese manufacturing has declined to its lowest level in three years. So a decision is needed to stop financing weak firms, increase regulations on corporations, and accept a lower GDP by accepting a GDP growth rate below the current 6% (Barnato). It is important to address corporate debt problems quickly and effectively before the problem becomes systemic, which would then slow economic growth much more and possibly lead to a disruptive adjustment. This decision should take place for all public enterprises and private enterprises. If the PBOC deems firms large corporations in need of debt restructuring necessary and possibly viable, then the PBOC shall allow for a bailout contingent a set of regulations to prevent excessive intake of debt and prevent speculative investments. These regulations could be a set of guidelines which must be met before the approval of a relatively large investment, regardless of where the borrowed capital comes from. This could be done by possible creating an entity, through which firms must go for large investments, to enforce the guidelines of a large investment, so that firms are investing based on value rather than speculation. That entity could also function to provide local financial consulting for firms, as well as fund subsidies to local enterprises in the industry of financial advising, or other tertiary sector firms that could help advise firms on responsible expansion. If  losses are recognized, techniques such as debt-equity swaps, and sales to third-party companies, can be useful and either required or suggested. Debt restructuring should be evaluated by a committee which shall perform a cost-benefit analysis on the costs to the Chinese people and the benefits to the chinese people, and by people we mean to take into account the government in the sense that positive effects on the government can be translated into positive effects for the people in that government. One possibility for the PBoC includes having a maximum debt to income ratio for firms based on their size and industry and subsidizing access to financial consulting firms. The creation of financial consulting firms provides a long-term solution to China’s speculative investments and unhealthy economic growth. Contractionary monetary policy such as higher lending rates, rather than the easing of lending rates the PBoC has promoted over the past few years is also a major solution to the current Chinese “pre-minsky” state. Although the future is uncertain, China’s claims to accept a lower GDP should be taken with caution. Rather than leaving the solution completely to the PBoC, the IMF should play a central role in encouraging its members to adhere to the practices of one classification of an economy. In many aspects China could be seens as a developing nation still, considering the widespread poverty, however, when looking at the Chinese economy, moving forward, China needs to accept that in the near future it will no longer be an emerging economy, but rather one which can not get away with unethical practices to promote its own manufacturing sector, and tip the trade deficit in its favor.

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