By Minxin Pei
This discriminatory policy forces private firms to tap the “shadow banking system.” Such a system came into being because state-owned banks wanted to make more money with their low-cost (if not free) household deposits, because when state-owned banks lend to state-owned firms, they can charge only regulated (low) interest rates and repayment is not assured. Generally, such lending is politically safe (since no bank managers go to jail for making bad loans to state-owned enterprises) but economically unprofitable. On the other hand, lending money to private firms is politically unsafe (bank managers risk corruption charges should loans go sour) but economically lucrative (as they can charge high rates).
To manage the political risks of lending to private firms, Chinese state-owned banks created new investment options for their depositors, who are eager to invest their hard-earned savings at rates higher than government-controlled rates for deposits. Called “wealth management vehicles,” these new financial instruments effectively enabled state-owned banks to channel consumer deposits into loans targeting credit-starved private firms at rates that, when annualized, normally reach double digits. Effectively, the “shadow banking system” has been siphoning off credit from the state-owned banks. In the last few years, when Beijing opened the credit spigot to stimulate the economy following the global financial crisis, few noticed the effects of such leakage, which has grown enormously. Estimates by economists put the total amount of outstanding loans made by the “shadow banking system” at close to 20 percent of all outstanding bank loans.
However, as in the case of a falling tide, Beijing has been tightening credit to fight inflation for a year now. In this process, state-owned banks have been forced to call in the loans made through the “shadow banking system,” thus hurting the debtors and triggering a spate of bankruptcies.
The proposed short-term solutions – making more loans available, restructuring the terms or rolling over maturing loans – will do no more than put a dent in a more serious systemic problem. As long as the Chinese state monopolizes the financial sector and discriminates against private firms, corrupt and high-risk behavior such as lending hundreds of billions of dollars through an unregulated informal banking system will continue.
The question on everybody’s mind is whether the massive leakage from the formal banking sector into the “shadow banking system” will be big enough to sink the Chinese financial sector. While nobody knows the real answer (in all probability, private firms are better risks than China’s traditional deadbeats, such as local government entities and SOEs), what makes a Chinese financial meltdown a more probable catastrophe would be a combination of several similar disasters. While each of them may be financially manageable in isolation, their total severity and simultaneous eruption could overwhelm the Chinese state.
Of course, here we are talking about the other two big holes in the Chinese financial system: local government debt (roughly 30 percent of GDP) and loans to real estate developers (the magnitude of which nobody knows).
So it appears that Chinese private entrepreneurs are not the only naked swimmers. They are in some distinguished company.
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Leonard R.
I would be a bull on China if it had a different system of government.
Left to their own devices, the people there can accomplish wonders.
But if China had a different system of government, it would probably
already be running the world. It’s the CCP that warps the people.
@Arthur M.
My anecdotal evidence too, suggests growth continues.
But I have noticed inflation — A LOT — of inflation.
I shop for the same basic things on every trip to China.
I shop in the same stores. The prices have gone up 25-30% in two years.
And I have noticed that people I meet are more worried about
inflation than anything else.
I agree with you though. Inductive reasoning has value.
Small observations can reveal larger phenomena.
I think a crash in China is less likely than disastrous inflation.
Even with its foreign currency reserves, inflation has been spreading.
RealityBetraysUs
Once the depression kicks in the USA, and the government’s bailout money did not do anything to bailout the middle class workers who historically kept China afloat with cash, we will see the “emperor has no clothes” and is truly naked without American middle-class workers able to buy products at Wally’s world because they are now homeless and unemployed. The Chinese will be left with no-one to buy their products and the 1% in the USA (ubber-rich), will get stuck with paying the Taxes for the government at 94% just like they did during the last depression! It is a terrible thing to make the middle class jobless and homeless with suicidal trade policies! The good thing is when the USA goes down, we will take the Chinese with us! Globalization may have staved off the “depression for 16 yrs” so it did not happen in the 1990’s but when it does occurr it will be much worse than the last one, and will be “global” not national only. All I can say to the NEW WORLD ORDER TYPES and GLOBALISTS is “Welcome to MY WORLD” get in line at your local food bank, homeless dinner. Oh by the way don’t be surprised when all government efforts to “fix it” fail,they will instead try to start WWIII as a diversionary tactic so governments do not get held accountable for their past economic sins…. The truly informed will not be surprised…
Billusa
Excellent thoughts and comments. Thank you!!!
ChrisH
Chinese domestic consumption has not yet begun to grow. Chinese wealth comes now from outsourced western production. However when the Chinese feel they have sufficient control over markets, wages will rise, China’s middle class will expand and will increase GDP 10 fold from now. Every western economy made its money and economic growth from its own domestic market. China may be walking on a knife edge but we all are. I bet London against a brick Chinese domestic demand will kick off in the next 5 -10 years and it will outpace the west again but this time by an order of magnitude, ceteris paribus.
Arthur M.
It’s somewhat disappointing to see The Diplomat’s agenda shining through each article headline. Your bias is obvious and doesn’t reflect the truth of the situation.
Anectodal evidence (ie. mine,) suggests that China’s economy is thriving. The people here are active and industrious. The foreigners who come to the major trade fairs are plentiful. It appears that growth will not be slowing down anytime soon. Any comments otherwise are just blind hope from those countries who have squandered their wealth.
China has the largest surplus, full stop. It is now a powerful creditor, who happens to spend money on public works projects, such as modern subways. Contrast that with bickering Americans and/or Europeans who can’t decide if they want to add another station, never mind another line. Why don’t you ponder that while you drink your XXL coffee and think how great life is in Detroit.
Oh, and a good amount of talent has gone east.
BP
‘Gone-With-The-Wind’, China! Good luck!
http://chovanec.wordpress.com/2011/10/19/bloomberg-chinas-slowdown/
http://chovanec.wordpress.com/2011/08/26/bbc-how-vulnerable-is-china/
BP
Here you go! In case you still don’t get it!!
http://chovanec.wordpress.com/2011/11/06/deja-vu-all-over-again/
Billusa
Hello Art: What is this fixation on growth?? Can anyone explain why a self-limiting process is the last refuge of delusional economists? I stopped growing some years ago. Didn’t become wiser, but I have learned that growth, in the economic sense, is nonsense.
Matthew Hall
Ohhh, I do seem to have rattled some chinese cages. That is my point, of course. People’s insecurity is a sure sign of some larger truth. Oh, what wit. James Bond is fiction. . . how drole! touche!
RJD
It is clear that the Chinese banking system has been squandering the savings of the average Chinese on uneconomic projects driven by political concerns. If this were a western economy, China’s financial system woud be as broke as the USA’s or Europe. However, China has an ace in the hole, namely its massive currency reserves approaching $2 trillion. These can be used to recapitalize the banking system and keep the game going for a very long time.
arrrgh
“. . . massive currency reserves approaching $2 trillion. These can be used to recapitalize the banking system . .”
nope, reserves can’t be used that way.
“China’s reserves are often thought of as if they were a treasure trove available for spending. They are not. They are simply the asset side of the mismatched balance sheet. If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet. – it would still owe the RMB that it borrowed originally to purchase the $100. To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes. Reserves are effectively borrowed money.
So the PBoC cannot give away the reserves without causing an increase in its net indebtedness. . . . Beijing cannot just recapitalize the banks with reserves.”
http://mpettis.com/2010/02/what-the-pboc-cannot-do-with-its-reserves/