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Imminent Chinese credit crisis is the next black swan for the global economy

Posted on 15 December 2013 with 2 comments from readers

The great shadow banking institutions of China are now teetering on the brink of failure just like Lehman Brothers et al in 2008. The cost of money in the Middle Kingdom has doubled this year putting unbearable pressure on the balance sheets of these highly leveraged lenders.

Its actually a bigger problem than the Lehman Brothers’ insolvency. The Chinese credit system has expanded from $9 trillion to $24 trillion in the past five years. The Bank of America has just advised clients to take out default insurance against Chinese debt.

Dubai x1,000

If you include the shadow banking system then credit has ballooned from 125 to 200 per cent of GDP, according to Fitch, and that is unprecedented for a major economy. This is the ‘Dubai x1,000’ accident waiting to happen first identified by hedge fund manager Jim Chanos a few years back.

Perhaps most dangerously of all the actors involved think that a real disaster is impossible due to the government’s huge role in the economy. Like the US Federal Reserve and the 2007-8 subprime crisis this will be true until it is not.

Governments can bend the laws of economics for a while and deceive the market. But they cannot reverse the laws of economics and the price is only a bigger reaction in the opposite direction when it comes. Remember how investors thought the Government of Dubai was able to make the impossible work. Well it did until it did not.

Still the timing of such events is very tough. China has extended its boom and postponed a correction for so long that it is easy to believe that the boom-to-bust business cycle does not apply. Unfortunately you can’t run what is essentially a model capitalist economy without it.

Interest rates double

Real interest rates in China have doubled this year from one to two per cent. Government bond yields are the highest in a decade. This kind of squeeze will produce a credit event somewhere in the economy and they do tend to happen suddenly and without warning.

What we do know is that the credit growth of the past five years was stronger than before Japan’s Nikkei bubble burst in 1990, or before the US housing subprime lending crisis in 2007. The writing is very clearly on the wall.

Last week the Governor of the Bank of England Mark Carney warned that the next banking crisis would come from the East and not the West without pointing a finger explicitly at the Chinese shadow banking system. It may come sooner than expected.

Posted on 15 December 2013 Categories: Banking & Finance, Bond Markets, Global Economics, Hedge Funds, Investment Gurus, Islamic Finance, Private Equity, Sovereign Wealth Funds, US Dollar, US Stocks

2 Comments posted by readers:

Comment by Andy - 15 December 2013

They will do exactly what they Americans did and that is to print money. Worked for America for 6 years straight entering the 7th year of Bull market next year.

Comment by ssad - 15 December 2013

While I completely agree with you article, just a minor adjustment to your claim that boom-bust cycles are part of the capitalist system- while it has been the part of the capitalist system for this long, it is not a inevitable and economies should not be experiencing a wide spread bust or a wide spread boom. The boom is always a result of easy money and easy credit policies, along with fiscal mismanagement.

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