China must now tackle its debt crisis or face 'malaise', Ray Dalio says

By Louis Goss

Hedge fund billionaire Ray Dalio has said China's leadership has now reached a "fork in the road" where they have an opportunity to make a series of "difficult and painful changes" that would let the country tackle the structural debt problem currently undermining its economy.

In a post on LinkedIn, the longtime China investor said policymakers must now engineer a "beautiful deleveraging" to lower the debt burden currently faced by Chinese citizens, businesses and local government, or instead face a period of "malaise."

Dalio first invented the term 'beautiful deleveraging" in the aftermath of the 2008 financial crisis in seeking to outline ways economies worldwide could reduce their debt burdens, while at the same time avoiding economic shocks and increasing growth.

The hedge fund manager said China now faces a pivotal choice between making the tough structural changes it needs to make in order to achieve such a "beautiful deleveraging," or instead facing a period of "economic and psychological malaise" like Japan's 'Lost Decade' in the 1990s.

Dalio's comments follow the unleashing of a major monetary stimulus package from the People's Bank of China last Tuesday that saw the central bank make a 50 basis point interest rate cut and inject -Yen1 trillion ($142 billion) into the country's financial system.

The billionaire, who founded Bridgewater Associates in 1975, said last week's stimulus measures could now "go down in the market-economic history books as comparable to the week Mario Draghi said that he and the ECB would 'do whatever it takes'" - if China underpins last week's stimulus package with the necessary structural reforms.

In his famous 2012 comment, former president of the European Central Bank, Draghi, vowed to "do whatever it takes" to tackle the European Union's sovereign debt crisis, in a moment viewed as pivotal in restoring confidence in the eurozone in the wake of the 2008 crash.

Dalio, who started Westport, Connecticut hedge fund Bridgewater Associates out of his New York City apartment almost 50 years ago, said China must now take a similarly combative approach in order to restore confidence in its own economy.

He noted that the "barrage of fiscal and monetary policies" unveiled by China last week came at a time when Chinese assets were already "very cheap," meaning Chinese stocks received a boost.

Dalio said China's leadership must now go further in reinforcing the package via more far-reaching structural reforms, if they are to successfully improve the fundamentals underlying China's economy.

China's reforms must include debt restructurings for the debts currently owed by the country's heavily-indebted local governments that sit at the center of the current debt crisis, Dalio said. He noted the restructuring of local government debt will be inherently "politically charged because they will have huge effects on people's wealth."

The hedge fund founder said China must also reform its "highly ineffective" tax system, to ensure local governments are able to effectively raise revenue through income taxes, property taxes and inheritance taxes - even if enacting those reforms might be politically unpopular.

Local governments in China had previously relied on selling land to property developers in order to raise the bulk of their revenue, while at the same time building up huge debts themselves in order to fund their own development projects.

The crisis in China's property market caused by central government measures introduced in 2021, aimed at reigning in the country's heavily-indebted property developers, led to a sharp decline in local government revenue, as property developers like Evergrande (HK:6666) slowed spending on land.

China's local government debt crisis has undermined wider confidence in the Chinese economy, as investors have become increasingly concerned about the private sector's exposure to the heavily indebted local government sector.

Dalio also said China must also tackle its "demographic problem" which is currently leading to fast-paced declines in the size of its working age population. The hedge fund manager, however, held back from offering any suggestions on ways to fix China's demographic issues.

-Louis Goss

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10-01-24 0749ET

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