Baoshang: End game for China’s debt monster

Nice podcast here from Grants discussing the significance of the recent Baoshang Bank default in China with Carl E. Walter, a former bank executive, coauthor of Red Capitalism:

“(Baoshang) is scaring everybody because they’re not the only one. They’re the one that couldn’t hold it together in the end, but… I’ve been trying… to figure out how many banks there are in China and supposedly there are 134 of these city commercial banks. 134 of which (Baoshang) is one, and all of these guys use wealth management products or borrowed in the inter-bank market to fund local things. Or, they borrowed in the inter-bank market or borrowed in wealth management products to support local asset management companies to hide other banks’ bad loans. I don’t think (Baoshang) is unique and I think the reason the markets are scared is because everybody knows that the emperor has no clothes. There is a lot more than just the one.”

“(Wealth Management Products) were used to move bad loans… off of bank balance sheets so that they could have a better NPL ratio (non-performing loan ratio)… They are sort of a fund made up of non-standard loans, government bonds, regular loans, stuff like this, and sold to retail customers and they are supposed to be off the balance sheet”

“… Now the CBIRC (Chinese Bank and Insurance Regulatory Commission) is forcing banks to set up subsidiaries to do this business and they’re forcing banks to stop guaranteeing them. So these are all supposedly going to be off balance sheet and the banks are supposedly not going to make customers good… The feeling about WMPs (Wealth Management Products) is that everybody believed no matter how bad the assets in the product were, the government would step in and make them whole. So, there is a tremendous amount of moral hazard and largely speaking, that has been true…”

“You cannot expect China to open up, to make its capital account open or make its Renminbi convertible as long as this situation exists cause as we saw a couple years ago, once they start loosening up on the capital account, money flow out like a son-of-a-gun…”

“…The main point is that the People’s Bank had gotten their way and opened on all these things. They liberalized the interest rates, so you got wealth management products… You saw what happened when the capital account opened up and they closed it again. There is no way in the world things like that are going to happen (again) in China in your lifetime, my lifetime, or anybody’s lifetime as long as the Party’s in control. No way…”

“I don’t think any of these (Chinese economic numbers) that you see are real. They’re fudged… I totally believe that nobody has a clue what’s going on… (China) is a confederation of 34 administrative units and the guys who runt the Party, or the senior guys in each of these units, or the provincial  governors…, are responsible for what goes on in their administrative unit. But, beneath them there are three more levels. This system is not based on telling the truth… Once you start going down into the provinces or the autonomous zone or so on… the farther you get from reality.”

All good. Note that the first casualty of this is not necessarily imminent or even eventual Chinese financial crisis. The primary victim is reform and that means economic stagnation. Even if the wild west of Chinese banks never goes belly up, which still seems to me unlikely given most are government owned and can be forced to lend even in crisis, neither will there ever be the liberalisation needed to bring discipline back to Chinese lending and return it to a path of productive growth.

This is end of any Chinese “rebalancing” as income growth remains captured within the debt-laden SOE sector and household income growth stalls.

It is the middle income trap of endlessly useless, and ever less efficient, force fed growth.

David Llewellyn-Smith

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