Financial tsunami heading for China

Australasia has relied for its insulation from the global financial crisis on continuing Chinese growth.

But where did China’s growth come from? 

From the beginning of 2009 to the end of June this year, Chinese banks have issued roughly 35 trillion yuan ($5.4 trillion) in new loans, equal to 73 percent of China's GDP in 2011.

Put that another way: Nearly three-quarters one-quarter* of the Chinese GDP (if that figure can be relied on) was produced directly from loans created out of thin air by its banks.

!

How could that possibly be sustainable? 

This was not organic growth—growth paid for by real savings  and real demand. It was growth propped up by raiding the pool of real savings, phony growth pumped up in the stages and sectors of the economic structure which are particularly susceptible not to long-term sustainable growth but instead to credit-fuelled expansion. It went

to fueling a property bubble, funding the profligacy of state-owned enterprises, and underwriting ill-conceived infrastructure investments by local governments.  The result is predictable: years of painstaking efforts to strengthen the Chinese banking system [and to build up the pool of real savings] were undone by a spate of careless lending as new bad loans began to build up inside the financial sector.

The result now is predictable.

Local governments had taken advantage of loose credit to amass a mountain of debt, most of it squandered on prestige projects or economically wasteful investments… Professor Victor Shih of Northwestern University has estimated that the real amount of local government debt was between 15.4 and 20.1 trillion yuan, or between 40 and 50% of China’s GDP… Chinese local government financing vehicles (LGFVs) are known mainly for their unique ability to sink perfectly good money into bottomless holes in the ground.  So taking on such a huge mountain of debt can mean only one thing — a future wave of default when the projects into which LGFVs have piled funds fail to yield viable returns to service the debt…. Chinese banks [could] have to write down 2 to 2.8 trillion yuan, a move sure to destroy their balance sheets.

And:

Over-leveraged real estate developers… are struggling to stay a step ahead of bankruptcy. The Chinese media has reported several instances of suicides of bankrupt real estate developers.…

And:

Chinese manufacturing companies, state-owned and private alike, could be next in line… a slowdown in economic growth will result in a rapid build-up of inventory and a glut of unsold goods in all industries.  Getting rid of their inventories at a discount will wipe out their slim profits and incur financial losses.  Some of the loans extended to them in good times will surely go bad.

And:

But the potential risk for a financial tsunami is greatest in China's shadow banking system.  Because of very low-yield for savings by Chinese banks (since deposit rates are regulated) and competition among banks for deposits and new fee-generating businesses, a complex, unregulated shadow banking system has emerged and grown significantly in China in the last few years… Borrowers that use funds provided by [China's shadow banking system] tend to be private entrepreneurs and real estate developers denied access to the official banking system… To evade regulatory oversight, [their loans] do not appear on a bank's balance sheet … [but] according to a recent report in the Wall Street Journal, [they could] account for 43 percent of total outstanding loans, 70 percent higher than at the end of 2009.
   Disturbingly, none of these huge risks are reflected in the financial statements of Chinese banks…
    Either we should not believe our "lying eyes" or Chinese banks are trying to hide the mother of all debt bombs.

China's massive bank-financed stimulus was intended to keep the economy moving. It may instead lead to economic disaster.

For them, and for those like us who’ve relied on their growth—almost all of which was built up by a debt bomb.

[Hat tip Russell W.]