Is China The Next EU?

When will China’s government banks need a bailout so the economists that have been forecasting this for years will finally be right? When will China’s housing market finally collapse? The answer is, nobody knows because China is a closed economy and will not tell the market anything it doesn’t want the market to know.  


For every article about non-performing loans, there is another quoting a government officials saying they’d pay the bills themselves if the debt become toxic. For every article about the housing market looking like it’s heading the way of Las Vegas real estate, there is a string of data from China showing that housing prices are still higher than they were a year ago.  There is no free fall in China. There is no crash. But everyone is wondering if China is the next EU. The den of China bears has roared back to life this week after being quiet for a few weeks.

In The New York Times, Paul Krugman wrote on Monday that China is possibly on the verge of becoming the next world crisis. Why? Because “there was rapid growth in credit – with much of that growth taking place not through traditional banking but rather through unregulated ‘shadow banking’ neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting – and there are real reasons to fear financial and economic crisis.”

Americans heard the same thing in 2007 and 2008, that a shadow derivatives market was going to destroy the U.S. economy.  The thing is, there is no shadow derivatives market.  Derivatives exist. Self-regulatory agencies exist to make the laws of trading them. There was, and is, no shadow. The only shadow would be a black market, which is criminal, and maybe akin to watching the Medellin drug cartel go bankrupt. It won’t take down Columbia. It won’t take down the investment banks where that money was held. (Maybe I’m misunderstanding something here, which is probably the case.)

Also on Monday, Nouriel Roubini said that his firm, Roubini Global Economics (RGE), increased the probability of their “crash and burn” scenario. They lowered their expectations for a soft landing, though this remains their base case scenario.

There are a few reasons for these forecasts, and none of them have to do with the crisis in Europe.  In 2008, China sent over $700 billion to states to invest in things like roads, trains, bridges, housing and entire cities.  Some of these projects were bridges to nowhere. Although the government estimates that public debt as a percentage of GDP is just 17%, Bloomberg estimates that it is at 80% because of fixed investment.

The findings also suggest China is failing to curb borrowing even with interest rates rising.  One central bank official told Bloomberg will slow growth in the world’s second-largest economy if not controlled.  But by how much? Is 8% China GDP hard to live with in China? Is it a downer for countries like Brazil, that have come to rely on China for export growth? Earlier this year, China’s premier Wen Jiabao said he wanted the economy to grow at just 7%. Nobody worried then, but that was because the market still believed Europe could save Greece and the IMF could save Portugal.

There’s also the issue of sales prices dropping in China’s real estate market. Economists warn that developers won’t be able to repay their debt to the states and therefore those same municipalities won’t be able to pay back their loans either because of poor cash flow and falling revenue from declining land sales that they relied on for much of their income.

In China, fixed assets account for nearly 50% of GDP compared to around 25% in the U.S. and an average of 30% in the emerging markets, said Ira Kalish, director of global economics at Deloitte in Los Angeles.

Is China that bad? One ex-China banker doesn’t think so.

“The banks in China are in better shape than people outside the country realize,” Frank Newman told me earlier this month. Newman is a former deputy Treasury Secretary under the Clinton Administration. But more impressive than that, Newman is the only American to ever run a Chinese bank. He was the Chairman and CEO of Shenzhen Development Bank up until 2010.

“Most of the fixed investment China did in 2009 were good projects.  And let’s not forget that this is still China and the government doesn’t want a banking crisis. So if the government doesn’t want a banking crisis, no matter what people say to the contrary, it’s not going to get one,” he said.

The last time the country’s big four state-owned banks went through a crisis, the government created a troubled assets management firm. The debt just gets rolled over and will never be fully paid, but the banks non-performing loans declined as a result.

Via: Forbes