China has some off-the-books loans coming due in a dozen countries. The IMF wants leniency, and China wants a bailout. What’s the lesson?
May 22, 2023
By: Bobby Casey, Managing Director GWP
People and entities with limited means, are better off paying cash on the barrel, or keeping their debts to a minimum.
People and entities with greater means, can wield debt in a way that can actually make them very wealthy.
Each side of this calls the other a scam. They aren’t scams. It’s about having the means and the skill to utilize debt. If you don’t have them, then inevitably you’ll be in a world of hurt.
Student loans was a reckless proposition. Extending lines of credit to someone with no income, credit history, or collateral other than their parents was, and continues to be, the working definition of stupid.
What doesn’t make it stupid is the terms of the loan. The terms are the terms. Whether you’re dealing with a bank, a payday advance company, or a loan shark, you have to agree to the terms.
I agree that taking out a loan if you don’t have the means to pay it back is a poor choice.
I likewise agree that lending to someone without consideration for their ability to pay it back is a poor choice.
But there’s no villain here. There’s just two parties making dumb choices. In the end, if you cannot manage your assets, then you stand no chance of managing debt.
There are also smart uses of debt that have paid off. Smart businesses that take out loans to invest in growth, have done very well. Investors have likewise done very well. If you’re going to do something with the money that will pay off, and the interest on the loan is lower than the dividends on the investment, then of course, debt makes sense.
Where it hasn’t paid off is how countries, or rather governments and central banks, have dabbled in it. That’s because they aren’t much better than the 18-year-olds taking out student loans. It’s not the prefrontal cortex that’s the issue. It is economic ignorance, and a modicum of imperviousness toward answering how it will get paid.
China holds approximately $867 Billion in US debt. They are the second largest foreign holder of US debt to Japan. China is also the largest holder of foreign debt for many other countries around the world.
I’m not opposed to foreign lines of credit. Like any other form of debt, it’s not the lender, it’s whether you can manage it. Lending money is always preferred to foreign aid. China was much smarter to lend money to countries rather than be like the US who just gives money way willy-nilly.
The US has been giving foreign aid to African countries, and those countries never improved because the governments were so corrupt, they would squander it on themselves or on wars rather than economic development.
China lent them money for a specific purpose of building out their infrastructure, ostensibly to bolster their economy.
The US infantilizes its foreign aid recipients. China treats them like sovereign adults.
I once asked what would happen if China called in its mark, and people balked saying that’s not how it works. Perhaps, but how does it exactly work with China? No one really seems to know the answer to that as their lending practices aren’t all on the books.
We are starting to find out. In a recent article from Fortune Magazine:
“A dozen poor countries are facing economic instability and even collapse under the weight of hundreds of billions of dollars in foreign loans, much of them from the world’s biggest and most unforgiving government lender, China.”
The AP found some countries had over 50% of their foreign debt was held by China, others still were spending more than a third of their federal revenues on servicing the debt. Two countries, Sri Lanka and Zambia, have defaulted seeing crippling inflation. Others have resorted to extreme austerity measures. Pakistan can’t keep the lights on. Literally. Kenya isn’t paying its government workers.
China is a bit of a loan shark. When no responsible, well regulated institution will give you a loan, because you’re a hot mess of liability, a shark will. If you borrow from a loan shark, the credit agencies don’t know about it. They don’t know you’re in $20,000 to a man named Vinnie the Butcher.
If one country borrows from another country, formally, the IMF is notified and there is some transparency. The IMF would be like that of the credit agencies. That’s not what happened.
“[A]fter a few years of straightforward Chinese government loans, those countries found themselves heavily indebted, and the optics were awful. They feared that piling more loans atop old ones would make them seem reckless to credit rating agencies and make it more expensive to borrow in the future.
“So China started setting up shell companies for some infrastructure projects and lent to them instead, which allowed heavily indebted countries to avoid putting that new debt on their books. Even if the loans were backed by the government, no one would be the wiser.”
In China’s case, the loans are legitimate, but they were done in secret because it was individual banks and private lenders, rather than the People’s Bank of China.
Zambia and Indonesia did this. They took out $1.5 and $4 Billion respectively, and no one knew about it until it was time to settle the books and they were over budget.
China came up with another work around to help these countries keep their debts off the books, while lending them tens of billions of dollars. It’s a currency exchange or swap… but with a twist.
Foreign currency exchanges, called swaps, allow countries to essentially borrow more widely used currencies like the U.S. dollar to plug temporary shortages in foreign reserves. They are intended for liquidity purposes, not to build things, and last for only a few months.
But China’s swaps mimic loans by lasting years and charging higher-than-normal interest rates. And importantly, they don’t show up on the books as loans that would add to a country’s debt total.
China is unwilling to take any major losses or make any major concessions, which is understandable. They have their own real estate lending crisis to tend to, as well as a slowing economy. They can’t afford to be lenient on their lending terms.
The borrowers and IMF are condemning of China for not being more benevolent. And China is demanding bailouts from the World Bank and IMF for the borrowers.
To sum up: broke countries stupidly borrowed; Chinese lenders stupidly lent money to broke countries. Now 12 countries face collapse while China is just out those billions of dollars.
Did anyone learn anything? No. They didn’t. We’re all just going to continue to be surprised each time something like this happens.
Currently 13% of the US budget, or 2% of GDP, goes toward servicing its debt.
Subprime and student loans in the US are identical to this issue. No matter how you couch it, it you’re giving money to borrowers who have already demonstrated they don’t know how to manage it. We will just see the same fallout at different scale.
I’m reticent to call it an “upside”, but the inevitable opportunity here is, there will soon be a dozen countries that will become incredibly affordable to anyone wishing to migrate that way.
If you can’t manage an asset, you cannot manage debt. That’s the immutable lesson out of this.
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