It’s a rib repeated regularly on the late night talk show circuit — how China essentially owns the United States because of how much the U.S. owes the Chinese. The only problem with this joke is that it’s stale — not because it’s no longer funny (it may still be) — but because the Chinese are just as much in hock to the hilt as the United States is.
China, once the world’s bank, with huge foreign exchange reserves, has, since the financial crisis in 2008, ratcheted up foreign debt on an unprecedented scale. From large scale infrastructure projects within the Middle Kingdom, to massive developmental assistance (often times with limited or unclear economic benefit) in Africa and the rest of the developing world, China has been on a spending binge. And while the media has been quick to report on how China is increasing its global influence through spending, what it has been slower to pick up on is that the bulk of that spending has been on credit. Just like the shopper whose gone on another shopping spree despite having maxed out all of their existing credit cards, China, is today, very much a debtor nation.
Officially, China lists its outstanding external debt at US$1.9 trillion, chump change for a US$13 trillion economy, but the headline significantly understates China’s actual debt position and the underlying risks beneath the surface. As of the third quarter of 2018, short-term Chinese debt, accounted for 62% of the total of US$1.9 trillion (and this is based on official Chinese data), which means that US$1.2 trillion will need to be paid up or rolled over this year. Chances are, the Chinese will roll over that debt. And as China’s economy has started to slow, the pace of growth of China’s external debt has been eye-watering — 14% in 2018 and 35% since early 2017. And foreign debt is no longer trivial against China’s reserves, with foreign debt comprising almost two-thirds of Chinese foreign exchange reserves of US$3 trillion — an amount that has hardly budged since over two years ago. In other words, China has been borrowing, but it sort of stopped saving any more since some time ago. Even more alarming is that a large portion of that debt is short-term debt, which increased to 39% of reserves in September, from 26% in March 2016.
And because Chinese economic data has always been more “interpretive” than “reflective,” it’s true debt load may be far heavier than admitted. According to a report by Daiwa Capital Markets last August, China’s external debt was estimated at between US$3 trillion to US$3.5 trillion. With other analysts estimating the figure to be between US$4 trillion to US$4.5 trillion. Part of the reason for such variance in estimations is that China also borrowed through financial centers such as Hong Kong, New York and islands in the Caribbean, none of which are considered the pinnacles of transparency.
To make matters worse, Chinese companies raced to borrow in dollars when there was a 3% to 5% spread between Chinese and U.S. interest rates and when it was widely assumed that the yuan would continue to strengthen. Even Chinese Bitcoin traders started to deal in yuan, convinced that their bet would pay off. Borrowing offshore became cheaper for Chinese companies and offered the prospect of likely currency gains. Many of these companies invested in capital stock and production stock and inventory, anticipating renewed growth. But since the hawkish Jerome Powell moved into the Federal Reserve, the spread in official short-term yields has evaporated to almost zero and the yuan has been battered against a rising dollar, buoyed by rising interest rates. For many Chinese companies today, the headwinds of a U.S.-China trade war, slowing domestic and global consumption and a depreciating yuan in the face of dollar-denominated debt means that refinancing their loans has become not just difficult, but risky to boot. Against this backdrop, China’s central bank has moved in to shore up some of the largest state-owned enterprises, pouring liquidity into these systemically and strategically important enterprises, but at the same time putting further downward pressure on the yuan.
And at a time when China should be tightening its belt, it’s been instead spending billions on a spectacular belt. Chinese President Xi Jinping’s Belt and Road Initiative — an ambitious (and extremely pricey) transport corridor from China, across the continents that China is attached to, has been borrowing dollars on international markets, lending the greenbacks around the world for everything from ports in Sri Lanka to industrial parks in Ethiopia. And given the patchy credit history of many of the countries that China has lent to (in an effort to shore up its global influence), China has not been reducing the risk of its lending, but actually gearing it upwards.
With 2019 and 2020 being peak years for Chinese repayments on debt, China faces dollar funding pressure. Between the Scylla of drawing from the People’s Bank of China’s foreign exchange reserves and Charybdis of buying dollars on international markets, China has only bad options. And before you can say “crisis,” China only has 617 billion yuan (US$90 billion) of offshore deposits in Hong Kong with which to buy greenbacks with, a number which steadily grows smaller as the yuan falls in value. And it’s not like China has the option to force firms to bring debt back onshore because that would exert even more downward pressure on the yuan.
For the longest time, China was portrayed as frugal and the Chinese, characterized as savers versus prodigious Americans who would rather borrow money against their last dime just to splurge rather than save. Yet today, the opposite is true. American households (thanks in large part to the financial crisis of 2008) are better capitalized than ever before. Bank regulations have meant that American financial institutions are now stronger than ever and Americans are saving far more today than they ever had before 2008. In contrast, the prodigious Chinese government has allowed a shadow banking industry to run amuck, betting on the world’s impression that China has low levels of external debt and large foreign-exchange reserves. Yet in reality, China’s external debt has been increasing by an average of US$70 billion per quarter since early 2017 and with Chinese as well as global growth expected to slow, Beijing is unlikely to dial down the debt binge, even though it can scarcely afford to ratchet things up.
One of the primary reasons Beijing has to keep borrowing is its tacit agreement with the Chinese people — that they not take to the streets for as long as the Chinese Communist Party continues to deliver the good life. But that good life has proved increasingly elusive for millions of Chinese workers, caught in the middle. Labor unrest and disputes in China’s industrial heartlands are becoming more frequent, as are late or unpaid wages. In response, Beijing has been placing its workers on projects from Kenya to Azerbaijan, building railways, industrial parks, factories and everything in between. But already, scores of wealthy Chinese have been stealthily siphoning monies offshore, primarily in dollars and other currencies, but to a lesser extent also in Bitcoin and property, art and other collectibles, all in an effort to ensure that they will have sufficient safety offshore, should the inevitable happen.
According to one Chinese Bitcoin trader based in the southern industrial city of Shenzhen and who requested anonymity,
“Last year my business was terrible, but towards November, things really started to pick up, the demand (for Bitcoin) in the last two months of 2018 probably exceeded the first six months of 2018.”
A quick scan of the Bitcoin blockchain seems to support the Chinese trader’s observation. Although trading on cryptocurrency exchanges (most of which have know-your-client requirements) has fallen sharply in 2018, the volume of Bitcoin exchanged on the Bitcoin blockchain has actually increased — supporting the theory that most of the trade in Bitcoin is happening off-exchange and over-the-counter (OTC), facilitated by personal intermediaries.
The Chinese have long been accustomed to OTC Bitcoin trading. Cryptocurrency exchanges have been banned in China since 2017 and even before the ban, Chinese Bitcoin traders had a preference to deal OTC as opposed to over an exchange, with some buyers citing the personal relationship with their counterparties as being key to trusting them. In a country where “guanxi” or “relations” still matter very much in getting things done, it’s no wonder that there is a preference from counterparties to deal in Bitcoin off the exchange. In addition to the personal touch, OTC trades are also far more discreet and less likely to attract the ire of Beijing. BTC has long been anathema to Beijing as it frustrates state-instituted capital controls, obfuscates value transfer and circumvents economic control structures.
The relative stability of Bitcoin in the last few months (hovering around the US$4,000 level) has also contributed to its viability as a means for Chinese citizens to facilitate capital flight. But before you start betting big again on Bitcoin, part of the reason that Chinese have been re-entering Bitcoin is its relative stability. Also, Chinese who are buying into Bitcoin are not doing so with a view to “hodl” the digital asset, instead, it’s merely a conduit by which to facilitate the ultimate purchase of dollars, which puts downward pressure on Bitcoin dollar appreciation.
For the Chinese, Bitcoin (at least for now) is a means to an end rather than an end in itself. With signs that the yuan will continue to come under pressure and the prospect of more stringent capital controls, which have of late become regularly enforced (previously they had been observed more in their contravention than their enforcement), Bitcoin has suddenly become a viable alternative. Add to the mix that most Chinese have grown accustomed to dealing with digital payments (through WeChat Pay and Alipay), and it’s not difficult to see why Chinese are ever willing to adapt to Bitcoin to suit their needs when push comes to shove. The Chinese are always adaptable, given their tumultuous history, adaptability is synonymous with survivability and Bitcoin or cryptocurrencies for that matter are just another tool in their substantial toolkit to ensure the perpetuation of their existence.
Patrick is an innovative entrepreneur and a lawyer passionate about cryptocurrencies and the business world. He is the CEO of Novum Global Technologies, a cryptocurrency quantitative trading firm. He understands the business concerns of founders and business people helping them to utilise the legal framework to structure their companies to take advantage of emerging technologies such as the blockchain in order to reach greater heights. His passion for travel, marketing and brand building has led him across careers and continents. He read law at the National University of Singapore and graduated with Honors in the Upper Division and joined one of Singapore’s top law firms, Allen & Gledhill where he was called to the Singapore Bar as an Advocate & Solicitor in 2005. He created Purer Skin, a skincare and inner beauty company which melds the traditional wisdom of ancient Asian ingredients such as Bird's Nest with modern technology. In 2010, his partner and himself successfully raised $589,000 from the National Research Foundation of Singapore under the Prime Minister’s Office. He has played a key role in the growth of Purer Skin from 11 retail points in Singapore to over 755 retail points in Singapore and 2 overseas in less than a year. He taught himself graphic design, coding, website design and video editing to create the Purer Skin brand and finished his training at a leading Digital Media Company.