By David Caploe PhD, Chief Political Economist, EconomyWatch.com.
Regular readers of this site know that, at this point in history,
with the US and EU on the early downside of what is going to be a long bad trip for both,
we have considered what happens in China to be the key to the immediate future of the world economy.
This is NOT because China has YET become the CENTER of the world political economy,
which will remain in the US, for a variety of reasons, for the foreseeable future.
Nevertheless, ever since Black September 2008, China –
and its regional fraternal, certainly not identical, given their radically different strategies, twin India –
HAVE been the bright spots of the global economic scene.
That said, the pace of growth in China throughout 2009 and the first quarter of 2010
was so frenetic that almost all observers have considered it unsustainable –
which is a view the Chinese political leadership seemed to share –
and the general view has been there was going to be some kind of slowdown.
The question has been “what KIND of slowdown” ???
Is it going to be the total “Black Swan bust” predicted by people like Andy Xie and Vitaliy Katsenelson ???
Or would it be the “soft landing” we have consistently predicted ???
Or were both those views wrong, and it was basically going to be full steam ahead, albeit at a slightly lowered rate than before ???
In this context, the recent crackdown on banks and other financial institutions by the Chinese government
is a potential development of major proportions,
which could hold the key to the immediate future of not just the Chinese, but also East / Asian and world economies as well.
Let’s start with an anecdotal illustration of the situation to which the government was responding.
Disappointed with his low “official”
a 29-year-old chemical company salesman named Zhang Zhenlei says
he took $19,000 out of his savings account last November
and bought into a higher-yielding investment trust through his bank’s wealth management division.
The money, the bank told him, would help finance two government highway and infrastructure projects.
“They told me the details and which companies would get the loans,” Mr. Zhang said.
“And they told me the risk was under control.”
But last month, the China Banking Regulatory Commission issued a sharp warning,
ordering investment trust companies to stop selling such products in cooperation with banks.
Regulators were apparently worried that banks and trusts were forming partnerships
and using products to, in effect, finance loans without calling them loans.
The government evidently suspected that banks were using such maneuvers
to evade rules put in place this year to rein in rampant lending and excess credit.
Those conditions have been cited as a reason for rising property prices and overall inflation.
Regulators, suspecting that banks and trusts are secretly repackaging old loans and moving them off bank balance sheets,
are concerned that financial institutions in China may have engaged
in the same sort of financial engineering that got Western banks into trouble,
which was, of course, EXACTLY what we said when we first found out about these practices.
On Aug. 10, government overseers acted again,
ordering banks to move any off-balance-
and to make provisions to safeguard against a rise in bad loans.
Several weeks ago, the Fitch credit rating agency warned that
such off-balance-
thereby masking the risks associated with an increase in dodgy loans.
Fitch estimates that Chinese banks had about $350 billion in trust-related products on their balance sheets at the end of June,
and that much of that lending had not been publicly disclosed.
“Regardless of how the transaction is structured,
credit is disappearing from bank balance sheets,
resulting in pervasive understatement of credit growth,”
a Fitch analyst, Charlene Chu, wrote in a June presentation.
“Credit risk has not disappeared but merely been transferred to investors.”
The off-balance-
While China’s economy remains robust —
it overtook Japan in the second quarter to become the world’s second-largest economy, behind the United States —
analysts worry that a surge in bank lending last year and early this year
might have led to wasteful spending on infrastructure and real estate projects.
In recent years, the government has been trying to harness what it deems wasteful spending:
“luxurious”
and so-called image projects constructed in poverty-stricken areas.
The basis for these worries was laid last year,
after the government encouraged aggressive lending as part of a huge economic stimulus package.
The result was a record $1.4 trillion in new bank loans in 2009,
about double the previous year.
Some analysts fear the sharp increase in lending
included many bad loans that will begin to show up over the next few years.
Aware of the risks, Chinese regulators are pressing state-run banks
to raise billions of dollars in capital to cushion any downturn —
a task that could be complicated by any perceptions among private investors
that the banks are exposed to a lot of risky debt.
Beijing is now trying to restrict lending and
ease asset price inflation without setting off a slowdown.
“They’re stuck in a policy bind,”
says Michael Pettis, a professor of finance at Peking University in Beijing,
noting China’s heavy dependence on investment-driven growth.
“They have to choose between cleaning things up and maintaining high growth.”
Or they could do what the US / EU / and Japan have been doing –
which is NEITHER cleaning up NOR maintaining high growth ;-) .
Pushing in the opposite direction, not surprisingly, are banks and investment trusts,
which want to continue pumping money into the economy to bolster their profits.
Analysts say they have been adept at evading the rules with clever and complex financial products.
Even though most banks contacted said they had stopped offering such products,
several said they had found ways to continue to sell them ...
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