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Chinese Banks: "An Accident Waiting to Happen"

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Readers may recall that it wasn’t all that long ago that China’s banks were sitting on big losses and the analysts debated how bad the mess was. In 2003, for instance, the damage was pegged at $500 billion, a stunning figure given the size of the economy, and meant the banking system was insolvent.

Even though the Western press has gotten excited about Chinese loan growth, seeing it as a sign of imminent recovery, appearances are deceiving. First, the government set targets, so loans had to be made, whether they made sense or not. Michael Pettis has reported some transactions were shams to meet the mandated goals. About 1/3 of the proceeds were estimated to go to the stock market, hardly a productive use. And the banking aurhorities themselves were recently reported to be trying to curtail loan growth, a confusing signal.

Ambrose Evans-Pritchard is even more dour, thanks to the reading a less than cheery reports from Fitch:

China’s banks are veering out of control. The half-reformed economy of the People’s Republic cannot absorb the $1,000bn (£600bn) blitz of new lending issued since December.

Money is leaking instead into Shanghai’s stock casino, or being used to keep bankrupt builders on life support. It is doing very little to help lift the world economy out of slump.

Fitch Ratings has been warning for some time that China’s lenders are wading into dangerous waters, but its latest report is even grimmer than bears had suspected….

“Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear.”

Note the phrase “able to bear”. Fitch’s “macro-prudential risk” indicator for China threatens to jump from category 1 (safe) to category 3 (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China’s public debt may be as high as 50pc-70pc of GDP when “correctly counted”.

The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a “massive lending spree”.

Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate…Roll-over risk is rocketing. China’s monetary stimulus since November is arguably more extreme than the post-Lehman printing of the US Federal Reserve, though less obvious to the untrained eye….

China’s Banking Regulatory Commission fired a warning shot last week. “The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy,” it said….

World trade may be stabilizing at last after contracting at faster rate than during the early Great Depression. But it will not rebound fast in a world where the US savings rate has risen to a 15-year high of 6.9pc. A trade policy based on the assumption that debtors in the Anglosphere and Europe’s Club Med can ruin themselves for ever is absurd.

Andy Xie, a Sino-bear and commentator for Caijing, said Western analysts are in for a rude shock if they think that China’s surging demand for raw materials implies genuine recovery.

Commodity speculators have been using cheap credit to play the arbitrage spread between futures and spot on the oil markets. They have even found ways to trade lumber to iron ore by sheer scale of leverage. “They’ve made everything open to speculation,” he said.

Mr Xie thinks the spring recovery is an inventory spike, to be followed a double-dip downturn into next year as stimulus wears off.

Reformers know what must be done to boost consumption. China needs a welfare revolution. But creating a social security net takes time, and right now Beijing is facing a social crisis as 20m jobless workers retreat to the rural hinterland.

So the regime is resorting to hazardous methods to keep excess factories humming: issuing a “Buy China” decree: using a plethora of export subsidies; holding down the price of coke, bauxite, zinc and other resources to lower production costs (prompting a complaint from America and Europe); and suppressing the yuan, again.

Protectionism is a risky game for a country that lives off global trade and runs a surplus near 10pc of GDP. Mr Pettis said he fears China is nearing its “Smoot-Hawley moment”, repeating the US tariff blunder of 1930 that brought the world crashing down on Washington’s head.

Two facts stand out about China’s green shoots. While the Shanghai composite index is up 70pc since November, Chinese imports are down 25pc from a year ago. China is still draining real stimulus from the global economy.

If the world’s biggest surplus state ($400bn) is too structurally deformed to help offset the demand shock as Western debtors retrench, we are trapped in a long deflation slump.

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12 comments

  1. mxq

    bloomberg just reported:

    "Chinese new bank loans worth about an estimated 1.16 trillion yuan ($170 billion) were invested in the stock market in the first five months of this year, China Business News reported, citing a government economist…A further 30 percent of the loans in the first five months may have been used for discounted bill financing, or short-term credits used to fund working capital needs, China Business News said today. These funds may help form a financial bubble, the newspaper cited Wei as saying, adding this is the economist’s personal view."

    Even more troubling, the FT ran a commentary written by one of China's top banking officials, espousing how great a shape the chinese banking system is in:

    "The better shape of the Chinese banking sector can partly be attributed to China’s prudential banking regulation. We believe banks are deeply rooted in the real economy and while the financial sector can temporarily outpace the real economy, this cannot continue for ever."

    I guess we're supposed to forget about those .5tr in bad loans from 6 years ago…

  2. marin belge™

    About 1/3 of the proceeds were estimated to go to the stock market, hardly a productive use.

    Funny item on a UK paper or US blog, even one called "naked capitalism". Of course this is wrong. But it is difficult not smile in view of the way the credit system was distorted in our countries.

    At least, part of the money is not getting into additional useless manufacturing capacities. This is joyfully spoiled money running out of an inflationary pegged currency windmill. Inflation has obviously just started and there still a long way to go. It will make those credits much more bearable by the Chinese banks on the long run.

    Those to bear the brunt in the end? All us going to Wal-mart, Carrefour and al. Quite fair. The introuvable Chinese consumer. And this ain't fair and even possibly risky on the long run for all of them. And us of course. This planet is a village now…

  3. Brick

    Macquarie Research suggest that the lending is mostly going into the state owned enterprises.
    "most of this increase in bank lending would be channeled to the least deserving customers: the many clapped-out large state-owned enterprises, rather than the far more numerous thriving private sector companies short of cash"
    "The most deserving borrowers, China’s dynamic entrepreneurial Small & Medium Enterprises (SME), mainly came away empty-handed when all this new lending was being handed out."
    "the government-owned banks make loans to other government-owned bodies, which then default, causing losses at the government-owned banks that then need to be recapitalized by – you guessed it – more money from the government"
    http://www.chinafirstcapital.com/blog/?tag=china-bank-lending
    This I think would tend to shift the risk to the state owned enterprises which off course with their government backing means a bailout from the state. The question then becomes where does china get the money for the bailout from.
    As Edward Hugh points out
    "producer price index, which measures prices paid at the factory gate, fell 7.2 per cent in May"
    which suggests that China has got itself into a deflationary spiral which could very easily spread to other economies. China would then be taking up the mantle of the US in the 1930's.
    http://chinaeconomywatch.blogspot.com/2009/06/chinas-prices-continue-to-decline-as.html

  4. Russell

    The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a "massive lending spree".

    Sounds exactly the same as the unrealistic expectations of US pension plans.

  5. "DoctoRx"

    China made a deal w the devil when it signed on to import the industrial pollution the West no longer wanted and become the mfr of first and last resort. Their banking system appears to be as polluted and subservient as the rest of their economy.

  6. The Rude One

    As a Communist state and a distinctly mixed economy, China is subject to a 'political business cycle.' The good news: when the banks go bust, the dark cloak of secrecy averts full-blown panic there and produces only urgent whispers here. The bad news: nobody in the world, and certainly not the Chinese, really know the value of any investment at any time. The result: wild swings from deflation to inflation and back again, muted but frantic government response in imposing and removing price caps; epic movements of labor hither and thither at the drop of a hat. Who said that capitalism is the only dynamic system? Having said all this, in the long run one must be bullish. One just does not know where or perhaps, when.

  7. D

    How China's banking system went from one of the most troubled ones in the mid 90s to apparently a healthy one in the mid 2000s is an amusing story.

    The real story is Chinese banks have the worst features of Capitalism and Socialism, all in one set of institutions.

  8. marsha donner

    Yves, what percentage of the fed and US bailout to banks has gone to unproductive use? how much into stock, recapitalization etc etc?

  9. Peripheral Visionary

    @Brick: "The question then becomes where does china get the money for the bailout from."

    Easy: they print it. They clear out bad debt and depress their own currency, in one fell swoop. I'm not sure where the fears about Chinese deflation are coming from when they have every incentive to inflate their own currency.

    Unfortunately, this can continue for quite some time. In the long run, of course, inflation will set in and will ravage the Chinese economy as consumers and manufacturers are forced to pay atrocious prices for fuel and raw materials. But until then the Chinese have the perfect formula for fending off all challengers int their domination of the manufacturing sector.

  10. Hugh

    China is another bogus green shoot much like our suckers market.

    For me, China's actions are all over the place and do not represent a coherent response to what looks increasingly like global depression. As here, we are seeing massive diversions of resources into unproductive, even fraudulent, sectors of the economy. It is further evidence of the lack of any real attempt at a coordinated international response. All we have are individual nations mostly in denial flailing away, addressing the wrong problems with worse solutions.

  11. Aki_Izayoi

    "Note the phrase "able to bear". Fitch's "macro-prudential risk" indicator for China threatens to jump from category 1 (safe) to category 3 (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China's public debt may be as high as 50pc-70pc of GDP when "correctly counted".
    "

    What does "correctly counted" mean? Does it include debts from municipalities? What is the US' "correctly counted" debt if you include municipal governments?

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