While President Obama continues to gloat that the US economy (and by extension the global economy) was rectified and on the path to growth thanks to his intervention, he must not be paying attention to what is going on in China.
Thanks to the market interventionist policies of the US, EU, Japan, and China, the 2008 economic crisis was never fully remedied instead a bandage solution was used to cover the symptoms. While analysts and pundits continue to rave about the rise of the Chinese Dragon and how future global economic prosperity lies in China, they are missing the emergence of a new bubble. This bubble is on the verge of popping and when, not if, it pops, the entire global system will feel the ripple effect. The crisis that will emerge due to the Chinese economy collapse will make the 2008 economic crisis pale in comparison.
The Chinese Banking System
Since the opening of China’s market to the US by Deng Xiaoping and Richard Nixon, China has experienced unprecedented growth for the past thirty (30) years. Even during global economic slowdowns such as the 2008 crisis, China’s economy still grew. While in the past, growth had been centered on manufacturing, with the new found wealth and increased living standard, the Chinese economy sees itself shifting to a service-based economy. With the global economic system in malaise, this shift can hurt China.
China’s system of government is not democratic rather a one-party authoritarian system that derives legitimacy from the sole basis of being able to provide employment and food to its massive population. This implied social contract between the people and the government has proceeded thus far relatively stable. But in the recent decade, China finds itself at odds with its ability to sustain employment and a strong economy versus market forces dictating otherwise. In order to preempt such detrimental forces, China has intervened in the markets by propping up difference sectors or devaluing its currency in the hope of buoying its economy.
Estimates of the 2008 financial crisis put US economic losses around $900 billion while the global losses were around $15-20 trillion. Based on the current trajectory, the losses due to the Chinese banking bubble will surpass the 2008 crisis by leaps and bounds. In the past decade economic growth has slowed down, as a result the government has dumped money into the real estate sector in the hopes of propping things as well as the stock market. All these efforts did little to perturb the downward trajectory . To help decelerate their downturn, the Chinese devalued the Yuan in the hopes of exporting goods cheaply. The problem with that approach has been that the entire global economic system is still reeling from the 2008 crash, hence demand has slowed down. The culminations of all these factors are now laying the groundwork for the Chinese banking sector bubble to pop. But unlike the downturn in the real estate and stock market, the effects of this collapse will cause upset around the globe. A review of the Chinese banking sector will help one gain a better insight into the Chinese bubble.
This graph illustrates the number of loans made by Chinese banks from 2003 to 2014. The loans were used by people for real estate, businesses, and other means of investments. The returns from these different investment vehicles would be used to pay back the loans. These loans have grown from approximately $4 trillion (2003) to over $30 trillion dollars today. In addition, the graph depicts the banking assets as a percentage of GDP. Unfortunately, the growth in the percentage of loans has greatly outpaced the economic growth in the same time frame. The current trajectory of the banking assets represents a system that is unsustainable and on the path of crashing.
It is reported that almost half of all new Chinese loans are undertaken just to pay the interest on the existing loans. While official Chinese government reports put the nonperforming or bad loans at 2-5%, in reality, it is believed to be closer to 15%. With such a large amount of toxic loans, one can safely assume the next bubble is around the corner.
While the larger victim from this fallout will be China, the world will not go unscathed. Aside from being the second largest economy in the world, economic globalization has created an interconnected system that when one giant sneezes the rest of the world feels it. The crash of the Chinese banking sector can be the black swan event that will cause the entire global system into depression and in a much worse position than the 2008 crash.
Conclusion
While analysts and pundits continue their endless admiration and fascination with the Chinese rise, their adoration has caused them to become blind to the growing bubble. This bubble can only be neglected for so long before it comes due and takes everything down with it. When it does, the 2008 crisis will all be but forgotten due to how relatively dire the impact of this crisis will be.