China's Debt_ China debt could bust world economy

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China debt could bust world economy

September 17 2014 at 09:38am

By William Pesek

The risk of what Nobel laureate Paul Krugman calls “Japanification” – a semi-permanent economic funk – has haunted China for at least a couple years now. Last week a Bank of America Merrill Lynch report again asked: “Will China repeat Japan’s experience?”

Let’s dispense with the suspense: Yes, China very likely will. And the outcome will have far more serious global implications than the chances of stagnation in Europe.

China’s “severely under-capitalised financial system”, “imbalanced growth” and chronic “overcapacity” all remind Merrill Lynch analysts Naoki Kamiyama and David Cui of Japan in 1992, when its bubble troubles first began to paralyse the economy. China is even more reliant on exports than Japan was in the 1990s, and its all-important property market now “may be tipping over”.

SHAKY BANKING SECTOR

Most worrying is the shaky banking sector and the lack of bold action in Beijing when the scale of Chinese bad debt may be higher than Japan’s ever was; they believe non-performing loan ratios are “significantly into double digits”. In the first half, the analysts estimate, commercial banks had to book larger non-performing loan liabilities than for all of last year.

The government claims financial imbalances are being addressed, but as recently as July, total social financing, a proxy for debt, was still growing by almost 16 percent year on year, well above the gross domestic product growth rate.

ADDING TO THE PROBLEM

In other words, China has spent much of this year adding to its debt and credit bubbles – not curbing them. If this were 1992, China could simply force state-owned banks and enterprises to rein in excesses. But China passed the point of no return after Lehman Brothers crashed in 2008, when it unleashed a $652 billion (about R7 trillion now) stimulus package, followed by untold smaller ones since. The moves put China, in the words of US hedge fund manager James Chanos, on a “treadmill to hell”. If Beijing were to attempt a broad credit shake-out now, virtually every sector of the economy would suffer. The risks of social unrest would soar.

China may soon face the dilemma Japan did in 1997, when 100-year-old Yamaichi Securities collapsed and threatened to turn the Asian financial crisis into a global meltdown. Rather than come clean about the magnitude of its bad-loan problem, Japan raced to prop up its banks with bailouts and interest rate cuts. The Japanese response shoved the country into the infamous “lost decades” Prime Minister Shinzo Abe pledges to end.

“GLOBAL ROUT”

The popular tonic is that China has $4 trillion of currency reserves to toss at its bad-loan problem. Yet any move to turn China’s US treasuries, European debt and Japanese bonds into cash could precipitate a global rout. A Chinese crash would hammer commodities markets, industries from manufacturing to hi-tech, and credit ratings of export-reliant economies from Australia to Japan to Brazil. It would be an untimely blow to the US and a fragile Europe.

Yet Chinese banks continue to open the spigots. Last month new local currency loans grew to $114bn from $63bn in July.

Leaders need to direct the central bank to drain credit and clamp down on the shadow-banking monster. It will have to stomach some bigger defaults to chasten lenders. Alas, China shows no signs of engineering such a purge.

As Japan proves even today, healthy growth depends on a functioning and stable banking system. The longer China waits to create one, the more it courts the kind of lost decade the world economy can scarcely afford.

William Pesek is a Bloomberg columist.

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