China crisis just wishful thinking

Many are longing to see the Communist Party overthrown, but social unrest caused by mis-sold investment products won't be how it happens

PUBLISHED : Thursday, 20 June, 2013, 12:00am
UPDATED : Thursday, 20 June, 2013, 3:53am

Beijing's ideological opponents - as well as those Westerners discomfited by the idea that Europe and North America could see their economic and political primacy usurped by Asia - love to forecast the fall of the Communist Party.

Encouraged by the speed with which the iron curtain crumbled at the end of the 1980s and the suddenness of the Arab spring in 2011, and heartened by the spread of social media in China and the growing number of local protests, they hope widespread unrest will soon coalesce into a popular revolution that will sweep the Communist Party from power.

For many, this is a seductive vision. But there is a problem with it. From land seizures to pollution, there are many reasons for Chinese citizens to be unhappy, but for the most part grievances are specific and localised.

As a result, those who long for a national uprising spend a lot of time looking for a single common cause to unify the discontents and trigger a popular revolution. Often they fix on China's financial system, and usually their script goes something like this: bank sales staff have persuaded legions of ordinary savers to buy high-yielding structured notes called wealth management products. According to Fitch Ratings, at the end of March there were more than 13 trillion yuan of these things outstanding, worth a quarter of China's gross domestic product.

Unfortunately they are a giant Ponzi scheme. Often the money from short-term notes goes to fund long-term local government infrastructure projects. Now, with trust companies and banks forbidden to issue new notes to repay the investors in maturing products, analysts expect an increasing number of wealth management products to blow up, leaving investors badly out of pocket. Savers, however, are unlikely to swallow their losses without complaint.

Beijing-bashers predict angry protests against the banks that sold the products. As rumours spread about the viability of financial institutions, they warn of bank runs as depositors attempt to withdraw their savings, degenerating into nasty riots when they find they can't get their money.

As the authorities try to quell the unrest, things get out of hand. Violence spreads, and what started out as a financial crisis broadens into a general political uprising that ultimately sweeps the Communist Party from power.

For many it's a seductive scenario, but for all that, it's nothing but a fantasy.

Yes, it's true that over the past few years China has seen shadow market credit growth on a scale that evokes the United States' credit boom ahead of the 2008 financial crisis.

But China's financial system is not America's. The state owns and controls the banks. To maintain stability, Beijing can force the banks to take wealth management product liabilities onto their balance sheets, while injecting as much liquidity as it takes to pay out investors.

And if a debt crisis wipes out the financial system's capital base, Beijing will recapitalise the country's banks much as it did ten years ago. For example, it could clean up the banks by ordering them to sell their bad loans to asset management companies - companies funded by bonds sold to the banking system.

Sure it would be a financial sleight of hand. But as long as the state operates capital controls to prevent money fleeing the country and can set a wide spread between deposit and lending rates to guarantee the banks large profits, it can prevent a financial meltdown indefinitely.

As a result, the crisis Beijing's critics are hoping for will not happen. The cost, however, will be a postponement of financial reforms that will constrain the economy's future growth potential.

But if the alternative is revolution, China's leaders will conclude that is a cost well worth paying.