China's bad loans threaten to bring down world economy
The longer China waits to create a functioning and stable banking system, the more it courts the kind of 'lost decade' suffered by Japan
The risk of what Nobel laureate Paul Krugman calls "Japanification" - a semi-permanent economic funk - has haunted China for at least a couple of years now. Last week a Bank of America Merrill Lynch report again asked: "Will China Repeat Japan's Experience?"
Let's dispense with the suspense: Yes, China very likely will. And the outcome will have far more serious global implications than Krugman's main worry, which focuses on the chances of stagnation in Europe.
China's "severely under-capitalised financial system," "imbalanced growth" and chronic "overcapacity" all remind Merrill Lynch analysts Naoki Kamiyama and David Cui of Japan in 1992, when its bubble troubles first began to paralyse the economy. China is even more reliant on exports than Japan was in the 1990s, and its all-important property market now "may be tipping over".
Most worrying is the shaky banking sector. What concerns Kamiyama and Cui is the lack of bold action in Beijing at a time when the scale of Chinese bad debt may be higher than Japan's ever was; they believe non-performing loan ratios are "significantly into double-digit" territory.
In the first half of this year, the analysts estimate, commercial banks had to book larger non-performing loan liabilities than for all of 2013. Mind you, this comes even as the government claims financial imbalances are being addressed.
As recently as July, total social financing, a proxy for debt, was still growing by almost 16 per cent year on year, a rate well above China's nominal GDP growth. In other words, China has spent much of this year adding to its debt and credit bubbles - not curbing them.
If this were 1992, China could simply force state-owned banks and enterprises to rein in excesses. But China passed the point of no return after the crash of Lehman Brothers in 2008, when it unleashed a four trillion yuan stimulus package, followed by untold smaller ones since. The moves put China, in the words of New York hedge-fund manager James Chanos, on a "treadmill to hell". If Beijing were to attempt a broad credit shake-out now, virtually every sector of the economy would suffer. The risks of social unrest would soar.
