China’s debt levels demystified using personal finance

Chen Zhao, Chief Global Strategist at Alpine Macro, makes the case that China has a low risk of a debt crisis. Chen says that China’s debt to GDP level is safe.

I will relate what Chen Zhao says to how some people can safely afford mortgages that are ten times their income level.

Chen makes a couple of observations :

1. Many countries with higher debt to GDP ratios pay low interest rates. There is no risk premium.

2. High savings rate can support more debt

China has a high savings rate and will continue to have a high savings rate. Just like Japan and Singapore have high savings rates. This is like a person who has a high salary and has a family with high salaries. The people can borrow money from their family at a low interest rate. The family can control and insure that the interest rate stays low.

Other countries (like Brazil or Russia) do not have a high savings rate and have to pay outside people or institutions for loans and have to pay a higher interest rate. This interest is even higher when they have a bad credit history.

When Chen points out that countries with a lot of debt to GDP pay low interest rates, it saying the same thing as looking at the people in New York and California with their multi-million dollar homes.

In the US there is tracking of the ratio of price of houses to monthly rents. High value property in New York and California can see price of houses going to 40-50 times the monthly rent. In Texas and Florida and other low price places it is 15 times. However, the ratio does not mean non-payment of mortgages is more likely in California and New York. More defaults can occur in Florida. Just as Brazil and Russia with less debt could be the ones more likely not to pay.

Locked in low interest rates

The high income and higher home prices can be safely affordable with 30 year fixed interest loans. The mortgage is locked in at a low interest rate. Then so long as the persons income does not go down there is no risk of default.

A person with a good income say $100,000 and a low interest rate (say 1%) can afford to buy a 1 million dollar home. The Interest payments $3216 per month.

China has a lot of assets which are owned by the government. This is like a person with a lot of other mostly paid off property. People without property have to pay higher interest rates and where they have no useful assets it can be like living on a credit card with high and fluctuating interest rates.

The rule of thumb that someone or some country might only be able to afford a house worth 3 times their income would apply at higher interest rates or if there is risk of interest rates going far higher.

China with its high savings rate has effectively locked in low interest rates. Especially locked in the bonds used to fund companies and government activity.

It is not the GDP to Debt ratio that matters. What matters is what will cause the person (or country) to not be able to meet their monthly payments ?

Someone with credit card debt that could spike up to 30% could not safely hold debt that is even half of their overall income.

This is another reason why hyperinflation is bad and the high interest rates and stagflation of the 1970s in the US was bad.

What can cause the monthly debt costs increase to the point that their income does not cover it ?

The interest rates escalate or the debt keeps piling up or a combination so that the debt costs balloon beyond the growth in salary.

If my income goes up to $200,000 from $100,000 and I am getting 10% annual raises then I can keep moving up into bigger and bigger houses.

But if the interest spike from 1% to 10% then suddenly I cannot afford even the first house.

This is where it matters who you owe the money and how much control you have over interest rates.

China has a lot of control over interest rates because they are lending money that is being saved by its own citizens. Like owing money to family.

Also, the money that was borrowed in Chinese currency. This means that if things got really bad China can just print money and make the old loan worthless. This is like a person being able to just write bad checks where there is no police or system that can force them to write only good checks.

When does a financial crisis happen ?

A personal financial crisis happens when you cannot make your monthly payments.

In a country it is when vast numbers of people and businesses or the government itself cannot afford to pay their debt and there is a cascade of non-debt payment.

All of the financial crisis that US has had is when the growth rate drops below the cost of debt.

It is the ratios but the inability to meet the monthly.

More of the more finance terms and information that Chen used to explain

More relevant metrics are:

* Net asset position
* debt-servicing costs
* the mix of local versus foreign currency- denominated debt.

China’s $4 trillion in outstanding public sector debt is far less than the vast assets controlled by the various levels of governments.

China’s domestic saving rate is 48 per cent is almost $6 trillions of new savings each year.

The latest value for Interest payments on external debt, total (INT, current US$) in China was $7,762,314,000 as of 2014. Over the past 33 years, the value for this indicator has fluctuated between $38,879,870,000 in 2012 and $539,179,000 in 1981.

the USA has a domestic savings rate that is about 17-22% of GDP.

Alpine Macro has sign up at and a special report entitled ” Debt Creation: What Is the Limit?” will be provided.