“Can China Really Rein in Credit?” Michael Pettis, Bloomberg, 14 June 2017

“In the first quarter of 2017, China added debt equal to more than 40% points of GDP”.

Are China's regulators getting serious about reining in credit creation? Yes, if they're willing to allow economic growth to slow substantially, to 3% or less. And no if they aren't. There's a big difference between China's sustainable growth rate, based on rising demand driven by household consumption and productive investment, and its actual GDP growth rate, boosted by massive lending. Economists find it difficult to acknowledge the difference between the two rates, and many don't even recognize that it exists. Which shows how confused they are about GDP. A country's GDP is not a measure of the value of goods and services it creates but a measure of economic activity. In a market economy, investment must create enough additional productive capacity to justify it. Or be written down to its true economic value. This is why GDP, in a market economy, is a proxy for the value of goods and services produced. But in a command economy, investment can be driven by other factors, such as boosting employment or local tax revenue. Loss-making investments can be carried for decades before they're amortized, and insolvency can be ignored. So GDP growth can overstate value creation for decades. That’s China. If all this debt hasn't boosted China's GDP growth to substantially more than its potential growth rate, then what was the point? And why was it so difficult for the Government to rein it in? Credit had to accelerate to boost GDP growth above the growth rate of productive capacity. Much, if not most, of China's 6.5% GDP growth is an artificial boost in economic activity with no commensurate increase in the capacity to create goods and services. It must be fully reversed once credit stops growing. To make matters worse, if high debt levels generate financial distress costs for the economy -- as is happening -- the amount that must be reversed will exceed the original boost.

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“Can China Really Rein in Credit?” Michael Pettis, Bloomberg, 14 June 2017

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