With the Chinese government tightening credit, the massive leakage from the formal banking sector into the ‘shadow system’ ultimately risks sinking the country’s financial system.
For quite some time, analysts of China have been puzzled by a strange phenomenon: the country’s public and financial institutions are decidedly subpar by any international standard, but its economic growth rate is anything but. This puzzle can only be explained by two conclusions: either China has been fudging its growth data, or Chinese institutions aren’t as bad as outsiders commonly think.
There is, however, a third possibility. During the peak of the credit bubble in the United States, bankers on Wall Street had a popular saying: “When the tide is high, nobody knows you are swimming naked.” What this aphorism means is that apparent economic prosperity can cover up many dubious if not outright shady practices that eventually lead to financial calamities.
So if we apply this expensive lesson learned from Wall Street, it’s hard not to suspect that a lot of people have been swimming naked in China in recent years as well. The prudish Communist Party hasn’t acquired Scandinavian-level tolerance and allowed nudist beaches in China (it has not). Instead, based on the recent spate of worrying financial news out of China, it’s obvious that high economic growth has concealed many high-risk and illegal activities and practices that may have bolstered growth, but also sowed the seeds for financial mass destruction.
Of all the disquieting news from China these days, such as stubborn inflation, slowing growth, and social unrest, the sudden bankruptcy of a large number of private firms in Zhejiang, the most entrepreneurial province in all of China, is by far the most disturbing. Press reports suggest that most of the bankruptcies involved small and medium-sized private firms that couldn’t service their debt or had their credit lines withdrawn by China’s “shadow banking system.” This consists of state-controlled banks and illegal private financial intermediaries that funnel loans to credit-starved private firms.
Of course, the bankruptcies themselves have led to a panicked reaction in Beijing because they not only made tens of thousands of workers jobless and ignited some protests, but because they also could cause financial contagion within China, leading to the “shadow banking system” to call in loans and triggering a cascade of new bankruptcies. So Chinese Premier Wen Jiabao and senior officials hurried to Wenzhou, the epicenter of the emerging financial distress, to try to restore calm and confidence.
But the task of stanching off this incipient financial panic is daunting. In the short-term, this involves the formulation and execution of policies that would effectively bail out those who have been swimming naked in China’s high but turbulent economic tide. For years, China’s state-owned banks systematically restricted credit to China’s dynamic private sector. While Chinese private firms are the fastest-growing economic entities and creating most of the new jobs, the Chinese government channels the bulk of bank loans to state-owned companies. The data on bank loans show that, as of 2009, explicitly identified non-state firms accounted for only 2 percent of all outstanding loans.
Photo Credit: Harvey Barrison
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Leonard R.
I would be a bull on China if it had a different system of government.
Left to their own devices, the people there can accomplish wonders.
But if China had a different system of government, it would probably
already be running the world. It’s the CCP that warps the people.
@Arthur M.
My anecdotal evidence too, suggests growth continues.
But I have noticed inflation — A LOT — of inflation.
I shop for the same basic things on every trip to China.
I shop in the same stores. The prices have gone up 25-30% in two years.
And I have noticed that people I meet are more worried about
inflation than anything else.
I agree with you though. Inductive reasoning has value.
Small observations can reveal larger phenomena.
I think a crash in China is less likely than disastrous inflation.
Even with its foreign currency reserves, inflation has been spreading.
RealityBetraysUs
Once the depression kicks in the USA, and the government’s bailout money did not do anything to bailout the middle class workers who historically kept China afloat with cash, we will see the “emperor has no clothes” and is truly naked without American middle-class workers able to buy products at Wally’s world because they are now homeless and unemployed. The Chinese will be left with no-one to buy their products and the 1% in the USA (ubber-rich), will get stuck with paying the Taxes for the government at 94% just like they did during the last depression! It is a terrible thing to make the middle class jobless and homeless with suicidal trade policies! The good thing is when the USA goes down, we will take the Chinese with us! Globalization may have staved off the “depression for 16 yrs” so it did not happen in the 1990′s but when it does occurr it will be much worse than the last one, and will be “global” not national only. All I can say to the NEW WORLD ORDER TYPES and GLOBALISTS is “Welcome to MY WORLD” get in line at your local food bank, homeless dinner. Oh by the way don’t be surprised when all government efforts to “fix it” fail,they will instead try to start WWIII as a diversionary tactic so governments do not get held accountable for their past economic sins…. The truly informed will not be surprised…
Billusa
Excellent thoughts and comments. Thank you!!!
ChrisH
Chinese domestic consumption has not yet begun to grow. Chinese wealth comes now from outsourced western production. However when the Chinese feel they have sufficient control over markets, wages will rise, China’s middle class will expand and will increase GDP 10 fold from now. Every western economy made its money and economic growth from its own domestic market. China may be walking on a knife edge but we all are. I bet London against a brick Chinese domestic demand will kick off in the next 5 -10 years and it will outpace the west again but this time by an order of magnitude, ceteris paribus.
Arthur M.
It’s somewhat disappointing to see The Diplomat’s agenda shining through each article headline. Your bias is obvious and doesn’t reflect the truth of the situation.
Anectodal evidence (ie. mine,) suggests that China’s economy is thriving. The people here are active and industrious. The foreigners who come to the major trade fairs are plentiful. It appears that growth will not be slowing down anytime soon. Any comments otherwise are just blind hope from those countries who have squandered their wealth.
China has the largest surplus, full stop. It is now a powerful creditor, who happens to spend money on public works projects, such as modern subways. Contrast that with bickering Americans and/or Europeans who can’t decide if they want to add another station, never mind another line. Why don’t you ponder that while you drink your XXL coffee and think how great life is in Detroit.
Oh, and a good amount of talent has gone east.
BP
‘Gone-With-The-Wind’, China! Good luck!
http://chovanec.wordpress.com/2011/10/19/bloomberg-chinas-slowdown/
http://chovanec.wordpress.com/2011/08/26/bbc-how-vulnerable-is-china/
BP
Here you go! In case you still don’t get it!!
http://chovanec.wordpress.com/2011/11/06/deja-vu-all-over-again/
Billusa
Hello Art: What is this fixation on growth?? Can anyone explain why a self-limiting process is the last refuge of delusional economists? I stopped growing some years ago. Didn’t become wiser, but I have learned that growth, in the economic sense, is nonsense.
Matthew Hall
Ohhh, I do seem to have rattled some chinese cages. That is my point, of course. People’s insecurity is a sure sign of some larger truth. Oh, what wit. James Bond is fiction. . . how drole! touche!
RJD
It is clear that the Chinese banking system has been squandering the savings of the average Chinese on uneconomic projects driven by political concerns. If this were a western economy, China’s financial system woud be as broke as the USA’s or Europe. However, China has an ace in the hole, namely its massive currency reserves approaching $2 trillion. These can be used to recapitalize the banking system and keep the game going for a very long time.
arrrgh
“. . . massive currency reserves approaching $2 trillion. These can be used to recapitalize the banking system . .”
nope, reserves can’t be used that way.
“China’s reserves are often thought of as if they were a treasure trove available for spending. They are not. They are simply the asset side of the mismatched balance sheet. If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet. – it would still owe the RMB that it borrowed originally to purchase the $100. To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes. Reserves are effectively borrowed money.
So the PBoC cannot give away the reserves without causing an increase in its net indebtedness. . . . Beijing cannot just recapitalize the banks with reserves.”
http://mpettis.com/2010/02/what-the-pboc-cannot-do-with-its-reserves/
Thomas
China will not collapse so all the anti-China wishful thinkers can go to hell! It’s very simple…In China, the government owns the Banks and Corporations!!!
PMcDonald
I saw a link to this article and was astonished to see that The Diplomat still exists. I thought it had been closed down because it contains such drivel as
“it’s obvious that high economic growth has concealed many high-risk and illegal activities and practices that may have bolstered growth, but also sowed the seeds for financial mass destruction”
Does anybody get any news or valid insight from doom-mongering like this. No analysis just anti-China ideology. The Diplomat will never get a market beyond Right Wing nationalistic, prejudiced Australians with bilge like that. Not much of a readership to be proud of.
Andrew P
I am sceptical of an impending crash in China. As long as the Chinese Government makes full use of its monopoly power to issue Yuan, there will be nothing more than some hiccups as some over-leveraged private sectors implode. But the country as a whole will maintain growth, until their available energy supplies can no longer be increased. Global growth is energy constrained, and so is China’s.
Matthew Hall
This is going to end like a james bond movie. James (the west) will do things that cause the bad guy (china) to explode, like stopping buying chinese goods, deflating the dollar, and activley working to undermine the ccp and james barely escapes the explosion with his life. He is badly injured and the movie ends with some beauty(probably a brazilian bombshell or Indian princess) tending his wounds. It will be painful for the west, I mean James, but it had to be done. And everyone (except the ccp) will celebrate in the end. THE END, credits role.
HT
Think deeper about what you claim to be “things to make the bad guy explode” and how they can be implemented and if at all they do get implemented the contagion effect they would have.
BP
The coming down of this mercantilist titan is surely just a matter of time, sadly inescapable this time around!Without a sufficient domestic consumption market for its goods, this titan’ll see that its export-oriented economic model will soon be grinding to a halt due to the crisis in the major western markets! Fixed-asset investment growth model has also aready been problematic with pervasive bad debts that could bring down its whole financial & banking system! Too late to readjust itself!
http://chovanec.wordpress.com/2011/10/03/economy-on-the-edge-of-a-nervous-breakdown/
John Chan
@Matthew Hall,
Dude, James Bond is a fantasy in Hollywood; it is never real but a cold war propaganda. Since you believe 007, you are living in an unreal world of cold war in the past. You need to wake up to the real world and donate all your wealth to your nation, otherwise James (the west) will go into coma forever and to be rotten away gradually.