Two different articles asking the same question: Will China go bust?

Great Leap Backward

Great Leap Backward

What can’t go on forever, won’t, and the Atlantic is first up on this theme as it relates to China.

 China’s biggest bank just announced that it won’t make investors whole after it sold them a trust product called “Credit Equals Gold #1″—yes, that’s really what it’s called—that looks likely to lose money. It’s China’s version of Wall Street selling people crappy CDOs it told them were risk-free.

The good news is the rest of the world isn’t exposed to China’s financial system the way they were to ours. But the bad news is the rest of the world is exposed to China’s economy. A “hard landing” there would also mean a hard landing in the countries that sell China the raw materials it needs for its construction boom. It wouldn’t be a 2008-style crash, but it would knee-cap global growth just when things look like they might be taking off.

This morning I read this article in Forbes, concerning the same default incident, “Mega-Default in China scheduled for January 31st”.

A WMP [wealth management product] default, whether relating to Liansheng or Zhenfu, could devastate the Chinese banking system and the larger economy as well.  In short, China’s growth since the end of 2008 has been dependent on ultra-loose credit first channeled through state banks, like ICBC and Construction Bank, and then through the WMPs, which permitted the state banks to avoid credit risk.  Any disruption in the flow of cash from investors to dodgy borrowers through WMPs would rock China with sky-high interest rates or a precipitous plunge in credit, probably both.  The result?  The best outcome would be decades of misery, what we saw in Japan after its bubble burst in the early 1990s.

Most analysts don’t worry about a WMP default.  Their argument is that the People’s Bank of China, the central bank, is encouraging a failure of the Zhenfu product to teach investors to appreciate risk and such lesson will improve the allocation of credit nationwide.  Furthermore, they reason the central authorities would never allow a default to threaten the system.

Observers make the logical argument that “to have a market meltdown, you have to have a market” and China does not have one.  Instead, Beijing technocrats dictate outcomes.

That’s correct, but that is also why China is now heading to catastrophic failure.  Because Chinese leaders have the power to prevent corrections, they do so.  Because they do so, the underlying imbalances become larger.  Because the underlying imbalances become larger, the inevitable corrections are severe.  Downturns, which Beijing hates, are essential, allowing adjustments to be made while they are still relatively minor.  The last year-on-year contraction in China’s gross domestic product, according to the official National Bureau of Statistics, occurred in 1976, the year Mao Zedong died.

Why will China’s next correction be historic in its severity?  Because Chinese leaders will prevent adjustments until they no longer have the ability to do so. When they no longer have that ability, their system will simply fail.  Then, there will be nothing they can do to prevent the freefall.

So lots of caveats as to the significance of these events, but if you take into consideration that China’s GDP continues to slow, you might wonder where the money to keep the economic engine growing will come from. Years ago I heard the Chinese official who at that time oversaw the economy interviewed on NPR and he said that (I’m paraphrasing) “every morning, I wake up fearful that I will not be able to keep growth above 9%, which is the minimum we need just to keep up with the population of young people entering the workforce.” It’s below 8% these days, and falling.

I’m no financial analyst, just a pessimist, but it does seem as though we are entering interesting times.


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14 responses to “Two different articles asking the same question: Will China go bust?

  1. AJ

    Just “Credit Equals Gold #1″, not “Credit Equals Gold A #1″? Shocking!

  2. AJ

    What you’re not mentioning is will they start selling dollars (treasuries) to solve their problems?

  3. Walt

    Dude –
    Never underestimate the Chinee. They play ping pong. In Hong Kong. With King Kong. They will rule the world.

    Their Ambassador to the US, Sum Ting Wong, advised us many years ago that our policies were wrong. Wong?

    Then they sent Mi Fuk Yu over to advise us, but we didn’t listen. Then Yu Dum Fuk was our advisor, and we still didn’t listen. He asked for advice from his confidant, Sum Ting Wong, but it was too late.

    Then Pah King Wong got thrown out for to many driving violations. And since then, Lei Ying Lo has been keeping a low profile, so we will have to see where this all shakes out.

    Brunch tomorrow? Yu Stin Ki Pu.
    Your Pal,

    • FF

      Walt, you doofus. You know that Sum Ting Wong was the pilot on Asiana Airlines when it crashed in San Francisco. I saw it on the teevee

  4. AJ

    And speaking of gold, does the US even have any, or just a vault full of gold plated tungsten?

    ‘Germany Has Recovered A Paltry 5 Tons Of Gold From The NY Fed After One Year’


  6. NoGolfToday

    The Chinese wealthy are packing their bags and sneaking out the back door.
    More foriegn wealth is making its way into the US
    Which means, NYC!
    And eventually GTown.
    Bring back no doc home equity loans, I want to join Stanwich 🙂

  7. Once

    How much of that Chinese wealth leaving the country was from easy credit? Borrow and scram.

  8. Anonymous Citizenette

    On a related topic, per Fox News today: “Pollution from China travels in large quantities across the Pacific Ocean to the United States, a new study has found, making environmental and health problems unexpected side effects of U.S. demand for cheap China-manufactured goods”.