China’s cost of borrowing has increased substantially over the past year. With many local governments using debt to pay for large projects and listed companies, excluding financial firms, debt has doubled since 2009. The People’s Bank of China promised to lessen debt leveraging by increasing borrowing costs. Currently in the US, interest rates are being held low to spur economic growth after 2008. Fears that the Fed might allow interest rates to increase make some investors uncertain, and uncertainty does not encourage investing. The fear in China is that if borrowing costs rise, companies or even local governments will fail to meet debt obligations and default. Local governments currently owe roughly 3.3 trillion dollars. If the majority of this debt is invested in cities that have no residents and were the sites of other failed projects, entire cities may need bailouts or refinancing options. By increasing the cost to funding investment, many companies simply will wait until better market conditions to invest. Several manufacturing indicators in China have shown declines in the manufacturing sector. Manufacturing investment and productivity generally are signs of economic health of a country. Government officials claim that if a crisis occurs they would be willing to inject funds to faltering governments and companies to keep a recession at bay. State Owned Enterprises and local governments are at risk, especially in this economy. Currently, their debt equals 200% the national GDP. As we have talked about in class, local governments have small tax bases and probably wouldn’t be able to finance new investment to dig themselves out of old debts from failed projects.
How might this credit crunch impact the United States and other countries? During the US credit crunch due to the housing bubble bursting economies around the world saw decline. China seems to be lining up for a second melt down. If a housing bubble burst in China now, it might push weak economist back into a decline.