Over the Christmas and new year lull there has been some audible muttering among a few credible economic commentators that China may be entering rough waters with its shadow banking system. This system appears to provide much of the financial fuel for China’s still extraordinary growth levels of more than 7 percent per annum.
George Soros, who is no slouch when it comes to making money in the currency markets, has recently expressed concern, as reported in this syndicated Bloomberg piece in the Sydney Morning Herald:
In a January 2 op-ed for Project Syndicate, Soros didn’t say whether he’s shorting China. But he did connect the dots in a way that can’t make President Xi Jinping happy. To Soros, the main risk facing the world isn’t the euro, the US Congress or a Japanese asset bubble, but a Chinese debt disaster that’s unfolding in plain sight.
“There is an unresolved self-contradiction in China’s current policies: restarting the furnaces also reignites exponential debt growth, which cannot be sustained for much longer than a couple of years,” Soros wrote.
Xi would be negligent to ignore Soros’s warnings. He’s hardly alone: Peking University professor Michael Pettis and Jim Chanos of Kynikos Associates have been beating this drum for years. Silvercrest Asset Management’s Patrick Chovanec worries about a “shadow” Chinese balance sheet that would be keeping policy makers awake around the globe, if Beijing’s obsessive opacity weren’t concealing the problem. […….]
China’s financial system is the ultimate black box. You don’t have to be a genius to conclude that when JPMorgan Chase estimates shadow banking to be 69 percent of China’s 2012 gross domestic product, it’s a wildly conservative guess. I wouldn’t quite add a zero, but if China fudges trade and other run-of-the-mill data, you can imagine the lengths to which it goes to hide the magnitude of its credit bubble.
“There are some eerie resemblances with the financial conditions that prevailed in the US in the years preceding the crash of 2008,” Soros wrote. “But there is a significant difference. In the US, financial markets tend to dominate politics; in China, the state owns the banks and the bulk of the economy, and the Communist Party controls the state-owned enterprises.” He added: “How and when this contradiction will be resolved will have profound consequences for China and the world.”
Similarly, Gordon Brown, former Prime Minister of Great Britain at the time of the 2007-2008 financial crisis, has recently written in a New York Times op-ed piece, deploring the failure to get systematic international financial regulation in place since then:
While the internationalization of the renminbi is opening up new opportunities for global investment in China, it is also increasing the exposure of the global economy to any vulnerability in its banking sector. China’s total domestic credit has more than doubled to $23 trillion, from $9 trillion in 2008 — as big an increase as if it had added the entire United States commercial banking sector. Borrowing has risen as a share of China’s national income to more than 200 percent, from 135 percent in 2008. China’s growth of credit is now faster than Japan’s before 1990 and America’s before 2008, with half that growth in the shadow-banking sector. According to Morgan Stanley, corporate debt in China is now equal to the country’s annual income.
Although sizable foreign reserves make today’s Asia different from the Asia that experienced the 1997 crash in Indonesia, Thailand and South Korea, we are all implicated. If China’s economy were to slow, Asian countries would be doubly hit from the loss of exports and by higher prices. They would face downturns that would feel like depressions.
And China’s banking system may not be Asia’s most vulnerable. Thailand’s financial institutions, for example, appear overdependent on short-term foreign loans; and in India, where 10 percent of bank loans have gone bad or need restructuring, banks will need $19 billion in new capital by 2018. […..]
In short, precisely what world leaders sought to avoid — a global financial free-for-all, enabled by ad hoc, unilateral actions — is what has happened. Political expediency, a failure to think and act globally, and a lack of courage to take on vested interests are pushing us inexorably toward the next crash.
And in a nice review of some of the latest financial reporting on the shadow banking issue, Raúl Ilargi Meijer over at www.theautomaticearth.org, concludes as follows:
China’s shadow banking system is opaque, built on risk, and extremely leveraged. China holds $1.3 trillion in US Treasuries, and that’s just the official number. So I wonder things like: what have these Treasuries been purchased with? Leverage? What if they dump them to pay off liabilities? Another question: how deeply are Goldman Sachs, Blackrock, JPMorgen involved in that shadow system? It seems easy enough: they have the cash, there’s little or no control, and if you thought US subprime was the ultimate stage for bigtime gamblers, you stand corrected.
And so yes, perhaps the real prize is control over the Forbidden City after all. But a growth rate of over 7% cannot be sustained by leverage levels of 100:1. Moreover, a battle for power at that scale never ends well for the people, neither in China nor in the west. Too big to fail banks can risk all they want, they’re not on the hook for the losses. That’s what you call a perverse incentive. Which exist in the US, in Europe, and, as we now know, also in China.
China’s economy is somewhere in the middle of a roller coaster ride, and the cars need to keep going at high speed, because if they slow down, they will derail. And we will all go down with them. Or do you think, or hope, that the world’s second largest economy, and its biggest supplier of gadgets and trinkets, will implode without you noticing?
Will China’s opacity and authoritarian power structure be sufficient to keep the lid on this and prevent a meltdown, by sheer force of centralized political (Communist Party) will?
The China syndrome metaphor was originally applied to the risk of a nuclear reactor melting down through the earth ‘all the way to China.’ But in this case, will we be looking at a debt meltdown in the opposite direction?
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