The big story of 2014 is the black cloud of debt hanging over China. Debate rages over how this tale will end. Most analysts believe that the Chinese economy will once again expand by more than 7% this year, despite ballooning private sector debts. But the pessimistic minority has history on its side. Only five emerging nations have ever seen a credit boom nearly as big as China’s, and all those stories ended very badly.
These are powerful precedents. Recent studies have isolated the most reliable signal of a looming financial crisis, and it is the ‘credit gap’ or the increase in private sector credit as a proportion of economic output over the most recent five-year period. Looking back over the past 50 years and focusing on the most extreme credit booms – the top 0.5% – turns up 33 cases, with a minimum credit gap of 42 percentage points.
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Today, China’s credit gap continues to grow and it is now the largest ever recorded in the emerging world, having risen since 2009 by 71 percentage points, taking the total credit burden up to 230% of GDP. Before China, the five worst credit binges had come in Thailand, Malaysia, Chile, Zimbabwe and Latvia, all of which saw the credit gap grow by 60 points or more. All five suffered a severe credit crisis and a major economic slowdown.
