The biggest story in China in the new millennia has been nation’s debt explosion.  China’s debt-to-GDP ratio is currently estimated at nearly 300% (official numbers), with most of the liabilities accrued in the past 15 years.  Chinese debt spending accelerated in part because of the global credit crash of 2008, but a lesser known factor is their entry into the IMF’s Special Drawing Rights basket.  The process started around 2011 and the IMF requires any prospective applicant to take on a wide array of debt instruments before they can be added to the global currency mechanism.

By the time of China’s official inclusion in the SDR in 2016 they had nearly doubled their national debt.  After 2016 debt levels skyrocketed.

The debt problem is harder to quantify in China because of their communist structure posing as a free market structure.  Corporate debt in China has to be included into the national debt picture because of state funded enterprises and the level of government investment in property and industry.

It is here where we find the most blatant warning signs of deflationary crisis, particularly in property markets and infrastructure development.  The CCP has put a “great information wall” in place to prevent accurate data from leaving the country, but some reports on China’s failing infrastructure still escape.  China’s export market is crumbling in the past year, in large part because western consumers are tapped out due to inflation.  However, what they prefer not to mention is the damage they did to themselves after three years of near constant covid lockdowns.  This destroyed their retail sector and things have only grown worse since.

Then there is the real estate market which has suffered extreme deflation over the past decade, with a larger drop expected in the next year.  China deliberately popped the housing market bubble as a means to disrupt what officials considered out of control speculation.  This led to the now famous “ghost towns” dotting the Chinese landscape; thousands of neighborhoods and high rises left unfinished and empty after development companies went bankrupt.

One of the more disturbing trends in China, though, is the effort to use large infrastructure projects to hide the nation’s deflationary decline.  China’s propaganda machine is pervasive across the world and most people in the west assume  that China is on the cutting edge of progress because of videos on social media.  In reality, the Chinese have been building cheaply constructed and poorly designed false-front landmarks that look technologically impressive on the surface but fall apart in a matter of months.

China is planning another 1 trillion Yuan ($137 billion) in infrastructure projects in 2024 alone, but the debt cycle and the deflationary spiral seem to be catching up with them.  The IMF claims that China’s economy has stumbled but is “unlikely to fall”, yet, with their global exports falling, property markets plunging and consumer activity in decline it’s hard to see how they can continue without a depression-like event in the near future.

“Years ago there was a rather idiotic battle between financial analysts over what the end result of the Fed’s massive stimulus measures would be. One side argued that deflation would be the outcome and that no amount of Fed printing would overtake the vast black hole of debt conjured by the derivatives implosion. The other side argued that the Fed would continue to print perpetually, resorting to QE4 or possibly “QE infinity” and negative interest rates as a means to stave off a market crash for decades (like Japan) while at the same time initiating a Weimar-style inflationary bonanza.

Both sides were wrong because they refused to acknowledge the third option – stagflation.”

The process of stagflation is difficult to track because there are multiple paths that it can take, many of them largely dependent on the whims of the central bank and its policy decisions. All we can really do is look back at the limited number of historic  examples and guess at what will happen next. In the 1970s, stagflation nearly crushed the country with inflation rising by 7% to over 14% per year for a decade while the general public eventually faced high unemployment.

When I hear Zennials complain about being born into the “worst economy ever,” I have to laugh because they really have no clue. The 1970s was FAR worse in terms of erosion of buying power as well as overall poverty. If you look at film footage and photos of urban areas from LA to NY to Philadelphia during that time, many parts of these cities looked like bombed out war zones. The country was truly on the edge of disaster.

In the early 1980s, the Federal Reserve jacked interest rates up to over 20% – This stopped the inflation crisis but triggered a deflationary plunge that would sit like a giant boulder on the chest of the American consumer and small business owners for years to come. My own grandfather lost millions in his trucking and freight company during the rate spike; many people lost their businesses and homes.

In other words, as bad as the situation is now, we haven’t seen anything yet. Of course, we are quickly moving towards similar conditions and there is one thing we have today that the 1970s didn’t: A massive snowballing national debt.

Currently, the US national debt is $33.8 trillion and has a 120% debt-to-GDP ratio. In a single month (October) the US added over $600 billion to the debt, and at the current pace the total official debt will hit over $41 trillion in one year. The speed of this accumulation is frightening. To put this in perspective, the Obama Administration and the Federal Reserve added around $9 trillion to the debt in 8 years during the corporate bailouts. Under Joe Biden, this is set to happen in a little over 1 year.

How is this happening?

As I have noted in the past, the US economy has stacked so much fiat and so much debt that any deviation in interest rates is going cause huge ripple effects. We don’t even need to hit the 20% interest rates of the early 1980s – A constant rate of near 6% is enough to cause debt to skyrocket. Then there is the problem of “compounding interest.” The US government is borrowing money to make interest payments, but it also borrows to roll over the principal payments, and it borrows still more to fund the general spending which is in excess of taxes collected (deficit spending).

At higher interest-rate levels, borrowing enters a destructive spiral. There’s interest payments on debt, which was itself borrowed to make interest payments on debt. To put it in simple terms, it’s a bit like a broke person taking on a stack of new credit cards to make the interest payments on a stack of old credit cards. It’s financial suicide.

Eventually the avalanche of debt will stall inflation but it will also pop multiple asset bubbles cross numerous market sectors and trigger a deflationary crisis. We are already seeing this trend with a crash in manufacturing as well as frozen wages. We are seeing it in the freight industry, with layoffs and bankruptcies piling up in a shocking downturn indicating impending recession. Not to mention US home sales have plunged to a 13 year low as prices continue to rise.

These are all red flags of an impending deflation event that WILL lead to large scale job losses, likely within the next year. It would seem the magic of covid stimulus measures is finally fading away and we are beginning to see the real economy underneath.

All the negative news has led to a spike in stock markets recently. Why? Because bad news is good news for equities. The expectation among investors is that the Fed is poised to cut rates or return swiftly to QE. This is not going to happen, at least not anytime soon. The Fed, I believe, wants a crash. After addicting markets to easy money for over a decade, the central bankers know EXACTLY what will happen as they continue to cut off the drug supply.

I suspect we are about to see a major change in the behavior of the economy going into 2024. The stagflation phase is nearly over. The discussion around dinner tables across America will turn to the exploding national debt, and debt in general. The big debate will once again turn to this: Will the Fed keep rates steady, risking deflationary implosion and debt default, or, will they cut rates, return to stimulus to pay the debt and risk double digit inflation?

These are the two choices in front of us as debt overwhelms the system.