Weekend special: Perverse Chinese banking

Take an hour today to view this spectacular discussion about the contemporary Chinese banking system from G+ (h/t Patrick Chovanec). It includes the history of reform, the epic fallout of the 08/09 stimulus, real levels of debt, off balance sheet and non-performing loans, asset bubbles, the role of inflation, triggers for crisis, durability of growth, the future of consumption and the evolving political economy of Chinese banking. Every Australian policy-maker – neh, every Australian – should watch these videos.

Houses and Holes
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  1. I just watched an interview with Michael Spence on Sky Business where he looked very uncomfortable when pushed about China’s debt levels. I’ll see if I can find a link.

    Spence advised China on its most recent five year plan and is a fully paid up member of the decoupling cult:

    But doesn’t China’s sustained growth depend on the rest of the US and Europe in regard to recession?

    Not any more, Spence says. “Right now the emerging economies that are trading with each other are self-sustaining. They can grow even if the major industrial powers just plug along.

    “If you go back ten years that wouldn’t have been possible. Weak growth in Europe or the United States of 1 or 2 per cent would have dented growth in China and associated emerging nations. But not now. China will become increasingly decoupled as time moves on. Its own emerging middle class will drive its own growth.”

    Well, that’s the plan, the reality is that (uneconomic) investment drives China’s growth.

    According to Spence in the Sky Biz interview China has very low debt levels, and more than enough in reserve to recapitalise the banking system in the event of a crisis, and plenty left over to fire up another investment boom to keep growth ticking along.

    Methinks as an adviser to the CCP and commentator he is somewhat conflicted.

  2. In China, there is no difference between ‘bank debt’ and ‘government debt’. Solvency will never be an issue. the problem is misallocation of resources and inflation. There is no private property in China, there is only a list of things which the government doesn’t want to admit they own.

      • No HnH, misallocation or resources is the problem. They (Government controlled/funded economies) can always “grow”…but growth that does nothing other than prop up GDP figures and does not allocate resources to their most most valued use (valued by the PEOPLE!) will always end in tears (bad debts).

        Trying to “grow” is where this whole probably came from…they should let the people be free.

        Australia under Gillard and Rudd has ‘grown’…we built over priced school halls, installed inflamable pink batts on the dodge, building a white elephant broadband network, traded houses for more and more money, paid consultants hundreds of millions…this was all “growth”

        The Austrian School will be 100% vindicated when CHina isd revealed as total sham. And all you quasi-Keynesians will realise that Government stimulus misallocates resources and is a political fix and does nothing to improve people well being in the long term.

        This is what Government sympathisers are missing. Strong economies are not about GDP figures, CPI and any other metric invented and manipulated by Government economists to show how good they are at ‘managing an economy’.

        Its about making sure resources are directed efficiently. People and markets do this – Government dont and in the long term China will collapse and burn.

        • I am yet to see Exhibit A from you for an Austrian or Free market economic success story.
          Fiction does not count – so that rules out Galt’s Gulch. Somalia perhaps?

          • Every nation that has developed has done through by allowign markets to operate freely. THe USA became the industrial powerhouse it is today because of the way they cherish freedom and reward success.

            China made the transition from poverty stricken nation in 70s to the second biggest economy in the world by embracing free trade.

            You want Exhibit A – try the whole developed world.

            The Government comes along later and screws things up…but the history of Western development is one long story of private innovation and market success stories.

            Your desire to point out failed States like Somalia shows how do not understand the role of the State. The role of the State is to prevent anarchy (such as what exists now in Somalia)…they do this by providing security for the people and promoting the rule of law.

            Talk about a strawman argument!

          • No argument from me. I am just asking you to provide a concrete example along with your rants, so that the rest of us are enlightened.
            All I can see so far from you, by way of example for Austrian economic success story, is communist China! Austrians will roll in their graves!!
            Chile under Pinochet is perhaps a more suitable example?

          • Why are my comments rants? I am not trying to enlighten, I am offering an Austrian perspective and there are many other bloggers on MB that share my desire for free markets to dominate.

            China is an example of what can happen when some freedom is allowed (free trade). In this same thread I have clearly pointed out that China now needs to allow its people to be free and innovate and compete properly.

            The fact we have never had 100% free market does nothing to strengthen your argument.

            My whole point is that we have not had free markets due to political meddling and that is why we are having such problems now.

            The concrete example you are seekign is a rubbish argumwent and I cant be bothered wasting time with you as we are going around in circles.

            Today is a day for freedom lovers…Lybian rebels are about to topple another Government that has not allowed its people to enjoy Freedom. Many more countries will experience similar revolutions as this crisis morphs into a world wide revolution against the poltiical and financial elite.

          • Point is you are hard pressed to point out a single instance of Austrian/free market economic success story!
            Yes, these success story exists in the textbooks and minds of Austrian zealots – but I demand instances where the rubber hit the road.
            My contention is that before Austrian economic policies take hold, anarchy will take the reins.
            On the other hand, Keynsians have plenty of real world examples. And now, don’t tell me TARP and Obama stimulus are examples of Keynsian economics. They are clearly not – TARP was a bank recapitalization and Obama stimulus was 1/3rd tax cuts and most of the rest funding to states to prevent anarchy – avoid having to fire police, fire and teachers in order to keep state budgets from tipping over.

        • Actually I have to say I enjoy stavros’s input. That is not to say that I agree with everything he says, but this is a forum to share opinion.

          IMHO stavros’s perspective on the austrian school is most welcome. Misallocation of capital and poor interest rate policy are two things I completely agree with, both of these things are straight out of the austrian business cycle, and something the RBA should have been practicing for the last decade.

          • I welcome Stavros input too. But he has a tendency to cut and run off on a tangent, when things don’t go his way.

        • Stavros has hit the nail right on the head. I agree with every word he says. And let’s hope the day that neo-classical/Keynesian voodoo economics crashes in ruins arrives soon. We can’t suffer any more of this nonsense for much longer. Read the words of Andrew Mellon, US Treasury Secretary at the start of the Great Depression:-

          “liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

          • Cheers DE and coasty bloke.

            Looking at that quote from the the Great Depression – its amazing to see how frank politicians once were. Comapred to the economic spin and meaningless jargon the spurt now – its amazing…

            Look at the what Wayne Swan has been saying for the past few months…total reassuring spin, aimed at making the people think all is good in Australia and this is a ‘global problem’

            I really cannot believe journos are not lining up to wrtie opinions on how poorly prepared he is to face what is coming.

            I am amazed the bloggers on MB are not more critical of his misleading take on what is occuring and his refusal to admit to our vulnerabilities. Why attack the ‘Bullhawks’ and exclude Swan…he is the biggest Bullhawk going around – he swears all is good!

            And dont say he doesnt want to ‘spook them market’. His job is to represent the people and this requires him to be honest and candid with us. Not spruik like every other talking head on TV.

  3. Neither of the experts in these videos foresees an imminent Chinese crisis. Both, however, see slowing growth over time as bad debts accumulate in the banking system. That sounds very solid to me.

    Moreover, this consensus that China can grow without slowing significantly as the US and EU go into recession is completely bizarre in my view. 2008 proved decoupling a TOTAL myth. Now, two and half years on, and suddenly Chinese exports no longer matter, again.

    I can certainly see China stimulating more fixed asset investment as growth slows but that’s not not slowing.

    And as the videos show, that will only hasten the ultimate slowdown owing to accumulating bad debts.

    • Moreover, this consensus that China can grow without slowing significantly as the US and EU go into recession is completely bizarre in my view. 2008 proved decoupling a TOTAL myth. Now, two and half years on, and suddenly Chinese exports no longer matter, again

      Would someone please tell the likes of Michael Spence. The idea that Chinese domestic consumption can replace the American and Euro consumer overnight is every bit as bizarre as the idea that Australia’s long term future is in selling education, tourism and manufactured goods to the new Asian middle class.

      And yet, serious economists and important policymakers believe this nonsense.

    • “Neither of the experts in these videos foresees an imminent Chinese crisis” Good.

      In his response to one of the posts here at MB Saul Eslake stresses that he also does not see China as “immune” from global recession but believes strongly that China will reinvigorate fixed asset investment where he sees the major demand for Australian commodities. Good, hope so.

      I linked a while back another Victor Shih video where he touched upon some of these issues, overall he was relatively benign – I wondered whether he was of the Niall Ferguson view that eventually the Chinese government would ‘solve’ these issues in an unconventional way. Who knows, expect anything.

      Clearly something is terribly wrong with the entire global banking system, whatever structure it operates within. The Chinese banking system has its difficulties, dare I say, at this stage, mild in comparison to European and US banks – it is these latter banks that will potentially derail us, now.

      We’re hitching a ride with China for as long as we can!

      • China will reinvigorate fixed asset investment where he sees the major demand for Australian commodities. Good, hope so.

        Surely this is the Chinese version QE, or European bailouts? Re-lighting the investment boom simply kicks the can down the road, creates more bad debts, more NPLs, and more misallocation of capital, that will only result in a much bigger bust in the future, by which time Australia will be a hollowed out shell with no ability to respond.

        Why is this “good”, and who is it good for?

        • My first reply was lost!

          Good for Australia – the resources sector, affiliated sectors, government coffers, MRRT revenues, etc.

          Good for China – infrastructure develop to enhance demographic change and mobility, modernisation, some cushioning from global downturn, security and strategic interests and development of regional influence (not to be taken as a personal view on China’s regional role).

          • Good for China – infrastructure develop to enhance demographic change and mobility…

            But by definition its not needed. If it was needed, these investments would be economically viable propositions that delivered a return. Its building for building’s sake. Growth for growth’s sake. I fail to see how its any better (probably much worse) than the Americans over-building during the mid-noughties, and that didn’t end well.

            Sure, the Australian resources sector benefits hugely in the short term, but in the long term its creating a much bigger problem for both China and Australia.

            I’m sorry, but how is this not a case of short term greed?

          • No. The benefits of the boom give time for the Australian economy to adapt to this new, non (less) credit driven paradigm. Economic conditions have changed…we need to too. Many economies that have embraced the current model are also in this process.

            Over the longer period these infrastructure improvements are almost definitely needed. A country with a population approaching 2Billion requires major port, rail road, water, energy, housing infrastructure – not with a short term payback (Aussie style) but over decades.

            I have never said it was going to be easy. It remains our sole option.

          • China is not even remotely close to approaching 2Billion. It is approaching 1.4Billion and in all likelihood will fail to reach that level before its population begins contracting.

            China’s growth will slow as the West re-enters recession and fresh tides of debt-financied fixed investment increasingly fail to generate meaningful returns. Indeed, China will be playing with fire if it attempts to evade the ravages of the impending global slowdown with the same antidote of credit splurge + fixed investment binge as it did post-Lehman, given that local government balance sheets are already at breaking point, to say nothing of the Ministry of Railways. But play it will, as the alternative in Beijing’s eyes is destabilising social unrest; its greatest fear.

            The Bluescope closures show just how dependent Australia has become on China’s version of an old, centrally-planned, credit-driven paradigm. Scary times approach.

  4. Wow………..thanks for posting this H&H; it certainly is a sobering view. I think you guys at Macrobusiness have led the way in Australia on balanced Chinese assessments. I know the Fanboys will accuse you of being China Bears, but I would rather the label China Realists. It certainly is a refreshing change from the MSM view that China will carry us forever.

    The question now is where to for Australia? If you are to believe what these guys are saying (and I tend to over the local vested interest parrots), the endless ‘growth to the moon’ model that has benefited us over the last 5 years won’t last too much longer. The China slowdown therefore is an inevitability that we are simply not preparing for. By allowing policies that accommodate the resources sector at the expense of the rest of the economy, we are hitched to the wagon. Once the wagon slows or stops, what will pick up the slack? Retail, Real Estate and all other debt driven sectors have had their day in the sun, and are on the decline. Manufacturing is dead. Education is no longer competitive. Tourism will suffer long after the dollar falls, for the simple fact that Australia has a poor service culture, is very expensive regardless of the currency, and is a bit of an “Outback and Koalas” one trick pony.

    Politically we are being crippled by the mental midgets across all parties, who fear reform. The average voter is a mug who rarely thinks beyond the tip of his nose, and politicians know this and exploit it. Courage is a word they no longer know the meaning of.

    Sobering stuff for a Sunday morning (apologies for the length of the rant, but a fired brekky and coffee combo does fir me up!!). If I had to find a word to describe our future, the best I could come up with at this time is Buggered.

    • I’m a China realist.

      I realise it is the only opportunity for any significant growth in any sector that Australia currently has. Yes, one day China may falter and then we certainly will also, in the meantime it’s China baby!

      That is being a China Realist.

      • It is nearly impossible to plan for a China collapse – what do all these people that want to plan for such an event suggest. We don’t control our exchange rate, we don’t control global demand for our exports. Until recently lowering interest rates was not an option due to the property boom. Suggestions anyone?

        • Delraiser, apart from what I’ve said above – I tend to agree with your summation (at least if the China story fails).

          • You can’t plan for a collapse, that would be nuts. But we are planning for an endless boom, which is also nuts. I just see so little growth prospects for the non-mining sector, which is being allowed to whither on the vine. I just get frustrated at the total lack of vision that sees no planning for diversification

        • – You can influence your exchange rate through taxation and and an SWF.
          – You can fight against the forces wiping out your other tradable goods sectors through any number of other policies, rather than gleefully embracing their destruction.
          – Of course you can fight Dutch disease (and beat it), if you have the will, which is sorely lacking in your comment.

          • – Government has clearly said NO SWF. They are happy with MRRT and super. Recently commodity based economies have expressed currency gains. We are not unique in this regard.

            – I do not ‘gleefully’ embrace the destruction of other tradable goods sectors, unlike the many who do gleefully rally to the destruction of the Australian resources sector. I’m a long-term advocate of a broadbased economy supporting manufacturing and industrial processes (both of which sadly have a limited future in light of Green advocated policies even without the additional challenges set by high AUD) and a long-term sceptic on the viability of an economy based on services only.

            – If it is even Dutch Disease, an ‘ailment’ open to selective interpretation! As I’ve said before, we were in the process of being hollowed out in any case. A high AUD is a recent experience, decay elsewhere was already happening. Resources were nothing to do with decades of neglect to a range of sectors and massive foreign borrowings to finance our property induced credit binge.

            My comment reflects the will of Australian leadership which is devoid of generational vision. I have often stated my views – they did include the necessity for a SWF protected from government general revenue spend. Comments made by “He who changes his name often” have led me to reassess the viability of a SWF.

            We have embraced the globalisation model and enjoyed much good that derives from it, however, we are now looking at the other side of this dual-edged sword – and we don’t like it. But we are a part of it, cannot simply extract ourselves at will because we don’t want to play anymore and we will be forced to see it through…to whatever outcome. All economies and sectors within those economies experience cycles and change. Unlike many other nations we remain fortunate to have our natural resources (hopefully) to act as some buffer in times ahead.

            It remains that as long as China growth continues we are tied to it. Bloxham’s recent paper really had very little to add to counter the effect of DD apart from the usual SWF and more tax on resources, that tax then targetted to support floundering sectors. Well, the government has negotiated the MRRT – let’s see what they do with it. Nothing else is likely.

            As I said elsewhere, I’m a China Realist!

    • These assessments always come with a bias IMO, but as you say it’s good to hear another side of the story. Bear in mind Carl worked for JPM, and while he’s selling you a product he’s shorting it. Let’s see the same analysis of the US banks as well. Check this out for example: http://globaleconomicanalysis.blogspot.com/2011/08/former-moodys-senior-vice-president.html

      Government and MSM will never publically give an honest assessment or risk analysis, and as we saw recently, the Liberals are being fired on by Swan for talking down the economy. It’s more political BS, but if we saw a balanced view more often, for me at least, it would be more re-assuring.

      IMO China will want our minerals for some time to come, but we will see a slow down, and prices dip. There are many other cheaper sources being developed by China in the resource sector, and that will be clear in the near future even for MSM and Government.

      The lack of vision is my biggest beef with all thing policy, and that is were IMO we are being let down by all parties.

      • Adrian, assuming no calamities, my best estimate for good demand at reasonable prices extends to 2015, continued no calamities – beyond that date. For example, there are enormous hurdles not well understood in getting ore to port – I think the Indians are realising this at present with a recent truck drivers strike ie they are getting their ore to port via cavalcades of trucks!! Extraordinary.

        Quality infrastructure has to be put in place – rail, deep water harbour/ports, loading facilities etc. Additionally, some of the projects to come on line are further challenged by seasonal weather patterns and many are a going concern only at elevated price levels – a position the majors here are largely insulated against.

        The biggie for Australia, as you correctly point out, is lack of vision, something of an Australian affliction and exacerbated by a government reactive only to short term measures to maintain power. Even the carbon tax was not a path they particularly wanted to go down – a tax on the operations of the very industries many now realise aren’t ‘dirty polluters’ at all, but businesses operating in this country employing thousands and adding to national wealth.

        Unbelievably, some would like to see an end to all we have going for us at present, the resources sector. Next agricultural – land won’t be threatened by just mining companies, but on a far larger scale by companies seeking to trade carbon offsets via tree plantations. We are signing our own fate.

        • assuming no calamities, my best estimate for good demand at reasonable prices extends to 2015

          Europe will surely blow up before 2015.

          Unbelievably, some would like to see an end to all we have going for us at present, the resources sector.

          We have plenty going for us, but the resources boom is denying others the ability to earn a living. I for one would definitely still be in business with the AUD at 80c.

          No-one wants an end to the resources sector, what I object to is the resources boom denying others a living.

          companies seeking to trade carbon offsets via tree plantations.

          Yawn. Your ceaseless fear-mongering about climate change policy is incredibly tiresome. You’re raking in the cash from the biggest boom in centuries (while the rest of us struggle) and yet you never fail to have a whinge about some fantastically unlikely implication of climate change policy that years away at the earliest.

          • Would global markets price the AUD at $1.05 – $1.10 if weren’t sitting on a sh*t load of valuable dirt?

            The chance of Australian agricultural land being threatened by carbon offset plantations anytime in the foreseeable future is zero. Nil. Nada.

            You are engaging in fear-mongering to distract attention from an immediate threat. Plenty of prime agricultural land is already under threat from CSG and coal mine expansion.

            I try not to read McCrann on anything related to climate change. He’s only slightly less unhinged than Andrew Bolt. Oh look, its in The Australian, the nation’s premier broadsheet!

            FWIW, I’m not in favour of trading carbon offsets internationally, although many argue its the least cost abatement. I’d prefer we reduced our emissions at home via a straight carbon tax or fee-and-dividend system.

          • I too am opposed to any ETS.

            The agricultural land aspect generally does not apply in WA (except for small pockets in the south-West – a coal company did want a little action but was thwarted by the local community, large number made up of holiday home owners no doubt associated with resources sector further north! NIMBYism.) Just testing the waters.

        • Yeah, lots of things can blow up now like the EU/US and given they are the two biggest China trading partners anything that hits that flow with impact Australia to some degree.

          2015 is the year many mining MD’s told me as well, and that involves getting the mines to operation and supply lines setup for production (ore etc. on a boat).

          I’m very cool with a carbon tax if it’s implemented properly, but I honestly can’t see this system working, and all the modelling done is far from conclusive. I want all the tax to go to green energy, and no handouts. If this is going to hurt let it be, and I want to see green industry jobs come. We have great scientists and engineers in the country, and other than the CSIRO, and some medical stuff not much else gets a look in.

          The vision thing will scupper any real change IMO.

  5. Everything I see in the shops comes from China now bar cars, some perishables and some niche stuff. Same in the rest of the world. Something else to thank gov’ts, self seeking business and multi-nationals for doing to us. In the light of that, any downturn in the Western world immediately affects China.

  6. Thanks H&H. I saw some of what they discussed in April on a business trip, but it’s good to know the full context of what we encountered. We were told lots of stories by bankers and officials, but the story kept changing so I immediately got very concerned.

    Even the move to invest more in central and western China has slowed from what we saw.

    I believe as you that we won’t see a crash, but slower growth; that does not mean that they won’t get social unrest etc. I’m not ruling anything out. They are already encountering labour cost issues and outsourcing, and it’s an early sign for me.

    I’d really love to see these guys do the same analysis on the US banks, and wonder if we’d hear.

  7. Wow!

    Thanks for the link! You got to ask what is the rest of the world smoking.

    First we had American caused GFC
    Now European solvency/currency /banking crises
    Next on sequeal – Asian Meltdown

  8. I wonder how much money from those infrastructure loans has been defrauded and ended up invested in our real estate. There is definitely a high correlation between the Chinese buying our (and other western countries RE) and their capital investment boom. As accidently revealed by the People’s Bank of China there have been a lot of embezzled funds being transferred abroad ($120 billion) for quite some time but the peak coincided with our housing boom in 2009-2010. In the situation when 1000’s of loans are rubber stamped the potential for fraud is massive.


  9. If Victor Shih is right that the Chinese leadership is not really concerned about inflation which is there by design, we can’t expect that commodities including food will be cheaper. This will feed into our headline CPI, especially the analytical living cost indexes. Since it will be price inflation with stagnant wages and growing unemployment (at least in non-mining sectors) we will see further destruction of retail and the housing market.

  10. I don’t think a Chinese slowdown needs to be feared necessarily.

    By suggesting that commodity prices will crash if there is a China slowdown implies that the Chinese, Indians and Indonesians can maintain or increase their production of coal indefinitely (or that there will be mass civil unrest throughout Asia….)

    But like all other countries who produce coal, oil and gas, the rate of extraction cannot increase indefinitely.

    If you include oil, natural gas, hydro and nuclear China is already a net importer of energy.

    And China’s key energy resource, coal, is being extracted at record rates, at a rate three times higher than the US, but with reserves just one and a half times bigger than Australia.

    They are extracting coal at a rate eight times higher than Australia!!

    When China hits peak coal extraction (which will be within this decade), Australia will hardly be able to make up the slack left by the Chinese. So barring a civil war in China/ unprecedented conversion to alternative fuels *coughs* there is going to be a world wide shortage of coal. Remember: China already produces half of the worlds coal!

    As an Australian who is concerned by global warming, this is one time where you can have your cake and eat it too!

  11. Great viewing. Thanks for these.

    The implications for the structure of the Chinese economy – and the source of future economic growth – are sobering. What they are saying is that inflation in China is deliberate and inevitable. High inflation depresses real household disposable income, sapping the ability of the household sector to contribute more to demand and pushing up the costs of exports at the same time.

    As well, because the population is aging rapidly and the social welfare system is inadequate, the household savings rate is likely to go up even though real interest rates are negative.

    This in turn will further detract from the potential for domestic demand to replace exports if – as seems likely – foreign demand for Chinese goods were to recede.

    Ultimately, the reliance on fixed capital investment funded by an opaque and non-rational banking sector will become self-defeating. At some point, the endless creation of new credit must boil over into runaway inflation. Perhaps the tipping point has already been passed. The China authorities have recently allowed a sharp appreciation in the CNY and, despite efforts to tighten credit, inflation seems to have accelerated through 2011.

    None of this augers well for Australia. Equally, the implications would be negative for the US and Europe as well. The last thing they really need would be a new Asian economic shock, which would deprive them of their only fast growth pathway while upending product pricing and global capital flows all at the same time.

    It is weird to be hoping that a corrupt and unsustainable system continues to function for as long as possible. Yet it seems this what we now rely on!