There is a certain, and very tangible, irony in the central banks' response to the Global Financial Crisis, which was first and foremost the result of unprecedented amounts of debt: it was to unleash an even greater amount of debt, or as BofA's credit strategist Barnaby Martin says, "the irony in today's world is that central banks are maintaining loose monetary policies to generate inflation…in order to ease the pain of a debt "supercycle"…that itself was partly a result of too easy (and predictable) monetary policies in prior times."

The bolded sentence is all any sane, rational human being would need to know to understand the lunacy behind modern monetary policy and central banking. Unfortunately, it is not sane, rational people who are in charge of the money printer, but rather academics fully or part-owned, by Wall Street as Bernanke's former mentor once admitted (see "Bernanke's Former Advisor: "People Would Be Stunned To Know The Extent To Which The Fed Is Privately Owned"). Actually, when one considers where the Fed's allegiance lies (to its owners), its actions make all the sense in the world. The problem, as Martin further explains, is that "clearly if central banks remain too patient and predictable over the next few years this risks extending the debt supercycle further."

Translated: the bubble will get even bigger. Unfortunately, it is already too big. As Martin shows in chart 9 below, which breaks down global non-financial debt growth over the last 30yrs split by type (household debt, government debt and non-financial corporate debt), "it is currently hovering around the $150 trillion mark and has shown few signs of declining materially of late. Yet, the "delta" of debt growth over the last 10yrs has been on the non-financial corporate side. Government debt growth has slowed down recently as countries have clawed back to fiscal prudence. Households have also deleveraged over the last few years given their rapid debt accumulation prior to the Lehman event."

A more detailed look at the debt breakdown, as usual, reveals something disturbing: in terms of non-financial corporate debt growth, note the influence of China (Chart 10). Post the Global Financial Crisis, China debt-financed a large increase in corporate sector investment as external demand slowed. Much of this was in the form of a construction boom, which drove overstocking in real estate and overcapacity in upstream industries. Chinese corporates also borrowed more than was necessary in order to boost their cash buffers.

As can be seen, China non-financial corporate debt growth expanded far in excess (Chart 13) of that for Chinese households and the government sector.

And while Chinese authorities have now acknowledged the worrying levels of corporate debt, with the outgoing head of the central bank himself warning about a Chinese "Minsky Moment", the restraining of credit growth still appears to be quite selective (coal and steel industries, for example). Therefore, as Martin shows in Chart 11, Chinese non-financial corporate debt now accounts for around a third of global non-financial corporate debt!

To be sure, there is a reason why China has emerged as the world's most prolific debt creator in the past decade.  Since 2005, China has contributed an unprecedented one-third of total global growth – more than the combined contribution of advanced economies.

Furthermore, China accounts for around 10% of global imports and while that partly reflects China’s important position in global value chains, for many trade partners a significant  proportion of value added depends on final demand in China, which means that if something terminal, or merely "bad" happens to China's economy, it would likely lead to a global depression. Putting China's growth demands in context, the world's most populous nation is one of the world’s largest consumers and producers of many commodities, accounting for over half of  global copper, aluminium  and iron ore consumption, and a high proportion of global energy consumption.

Fundamentally, however, it's all about China's debt, whose broadest aggregate, Total Social Financing, which includes shadow debt as well, is now rapidly approaching 250% of China's GDP. 

What is even more concerning, is that not even a record amount of debt is enough to let China's economy grow at the rate it did just a few years ago. As the ECB discusses in a report released overnight, the state sector is playing an increasingly more important role through rapid infrastructure expansion by local governments. A sizeable part of the investment since the global financial crisis has been infrastructure investment mostly by local governments, which are forbidden from running budget deficits. And yet, in order to meet ambitious growth targets, they resorted various loopholes, including land sales and off-balance-sheet funding through local government financing vehicles, which borrowed through bond issues and bank loans. Factoring such finance into calculations of an “augmented deficit” suggests that in recent years the stimulus provided by government has been significantly larger than that shown by official deficit figures. This means that not only is all the talk of moderating stimulus total bunk, but China has never stimulated its economy as much as it does now!

All of the above (and much more) is why the European Central Bank issued a paper looking at not only the latent risks in the Chinese economy, but warning that the euro area is at “significant” risk of a sharp readjustment of China’s economy. According to the ECB, a swift rebalancing of the world’s largest exporter would slow the currency bloc’s economic expansion by about 0.3 percentage points. And while Bloomberg adds that this may not be much in the face of growth expected to top 2% this year and the next, it’s based on the assumption that the shockwaves of such an event across the world’s economy would be limited. Taking into account larger effects on trade, foreign exchange and global financial markets, the slowdown would amount to 1.2% points.

It gets worse.

An “abrupt adjustment” - i.e. a hard landing" - in China, with GDP shrinking 9% points through 2020 on the back of a sharp financial tightening - would slow euro-area growth by 1.5% points even under the more conservative assumptions. In reality, due to the global credit crunch that would ensue, it is safe to assume that Europe would fall into an instant depression when, not if, China undergoes an "abrupt adjustment."

That said, this being the ECB, which famously told Zero Hedge it did not have a "Plan B" for a Grexit (until it was revealed several years later that it, in fact, did and lied to us), these pessimistic outcomes are not the ECB’s baseline. Instead, the central expectation of the traditionally jolly central bank, with an unpleasant habit of buying far more bonds than are being issued, is for a limited rebalancing with gradual reforms and, consequently, continuously slowing growth. And while there are risks, especially in the financial sector, China has ample “policy space” to counter a slowdown, thanks to its vast reserves and current account surplus, the ECB said.

That said, the ECB's conclusion is troubling: “China has been the economic success story of the past four decades, but economic growth has been slowing and vulnerabilities are increasing... Spillovers to the euro area would be limited in the case of a modest slowdown in China’s GDP growth, but significant in the case of a sharp adjustment."

Actually, in case of a "sharp adjustment", one can kiss the past 10 year "recovery" not just in Europe but across the entire world. Which is why to all those who are confused what is the most important catalyst for the next economic and financial crash, the answer was, is and remains the same.