Belmont Club

Tiny bubbles

There were fears that a tide of lending by Chinese banks to keep the economy going was building up a “bubble” of uncertain proportions. Beijing-based Fitch Ratings said that it was difficult to estimate just how large the bad debts were because the Chinese banking system was so opaque. One party trying to peer into China’s economic future was Japan. At the recent G7 conference in the artic city of Iqaluit, Japanese Finance Minister Naoto Kan said Japan is “paying attention to China’s economic conditions, and we’re concerned about [signs of] a bubble” in the mainland’s economy. Fitch Ratings were quoted as saying that:


“The agency views ‘bubble risk’ as greatest for Chinese banks given their 32 percent loan growth in 2009; this looks likely to be followed by a further 20 percent in 2010,” Fitch said in a statement.

“Credit growth of more than 50 percent over a two-year period in an economy where bank credit is already quite large relative to gross domestic product almost inevitably involves some misallocation of credit,” it added.

New loans extended by China’s banks nearly doubled in 2009 from the previous year to 9.6 trillion yuan (1.4 trillion dollars) as banks heeded Beijing’s calls to pump up lending to keep the economy growing.

Fitch however noted the limited transparency of Chinese banks and said their tendency to reschedule loans meant any bad debt problems would surface slowly.

CNN’s Katie Brenner quotes a number of academic authorities who claim that even if a Chinese bubble popped its effects would be speedily managed by an authoritarian Communist Party which is far better than the West at managing such crises — or so the experts said. Beijing can prevent capital flight by draconian control; prices can simply be set by fiat, banks can be forced to extend credit whether they like it or not.

“The [Chinese] government can really push money into enterprises to keep them going even amid a crisis,” says Peter Morici, a public policy professor at the University of Maryland. “You wouldn’t see a credit shortage like the one we saw in the U.S.”

As for the rash of bad loans that could be made amid a period of forced lending, China has an answer to that, too. The government pushes debt problems off into the future and is notoriously opaque when it comes to reporting problems. For these reasons, bad debts would surface in a slow and hopefully orderly manner, Fitch wrote in its recent report.


But Brenner notes these measures “solve” the problem by widening it. They create huge resource distortions that ripple outward to foreign markets and pass risks on to the outside world and to the political system. An unmanaged bubble, Brenner says, is an existential risk to the Communist Party of China. Maybe a bubble in China isn’t a realistic possibility but if one does inflate it will be a sight to behold indeed.

Bubbles in China are about much more than finance. Economic upheaval is a source of potential mass unrest, threatening the Communist Party …

In fact, to keep things flowing, it might open the spigots on exports and try to grow its way back, doubling down on its main engine of growth — exactly what it did during the global meltdown. And that’s where the U.S. needs to worry. An even more export-focused China would mean ever less-expensive goods flowing into the biggest market in the world — the U.S.

“Because prices are so heavily managed, China could easily flood the U.S. and the world with extremely cheap stuff,” says Morici. If nearly everything America buys is made in China now, just wait. The trade imbalance would spiral further out of control; and manufacturers in other nations fighting China for market share would be at a greater disadvantage.

“Remember, when we talk about bubbles, the stakes are the future of the Communist Party,” says Morici. “They’ll try to survive no matter what; and it could mean destroying other economies to do it.”


With the ante set so high, in the worst case scenario a collapsing Chinese economy would essentially keep its cash flow going by selling underpriced goods at slave-labor wages to the outside world. It’s unsustainable strategem which in the process will destroy not just the Chinese economy but the economies of those who trade with it. Japan’s exports, now in the doldrums would go completely into the tank. American producers, faced with the last brilliant flare of a dying economic supernova, would be burned to a crisp. Then the Chinese bubble, no longer able to sustain itself from outward forces will shrivels on itself like a dwarft star, leaving only the cinders of a world economy in its radius of effect.

But Shaun Rein at Forbes says there is nothing to worry about. There will be no Chinese collapse in the foreseeable future. The reason he gives are that the high rate of Chinese savings means that the lending burst is based on a real basis, not airy discounted cash flows. Moreover, there is more money in China than Westerners think because they don’t understand Chinese accounting. Lastly, China is going to keep its currency low and keep exporting. With savings, a higher than reported income and a steely determination to keep on making money, China is safe, Rein says.

Whether you believe that or not, the WSJ says the key components of Beijing’s export strategy are provoking a kind of hidden protectionism among other economies and may fuel the inflationary forces internally. In other words, China’s exports are part of what is inflating the bubble not simply what is preventing the bubble from collapse.


Key elements of the strategy—including a cheap currency, regulated interest rates and low energy prices—are stoking discontent in fellow developing countries, not just Western capitals. … At the same time, many economists argue, China’s export-friendly policies are fueling inflationary pressures at home, placing a burden on the rest of the economy.

The economic downturn has forced consumers in the West to switch to cheaper — typically “made in China” products — creating an even greater demand for its export goods. “According to International Monetary Fund projections, if current trends continue, China’s share of world exports could reach 12% by 2014, a higher portion than Japan managed at the peak of its dominance in the 1980s.” Can it continue? Some researchers have their doubts.

But some researchers at the IMF say current trends aren’t likely to continue. A paper by IMF researchers published last year suggests that for China to continue the rapid export gains of recent years, it would need to boost its share of world exports to about 20% in coming decades, an unprecedented level. The fund’s researchers said China is unlikely to be able to do that without using even more government subsidies, which would further aggravate trade tensions and cause domestic economic problems.


In any event, huge global economic pressures with complex interrelationships are building up based on asserted information. Beijing, Brussels and Washington’s economic managers are embarking upon ambitious strategies. By setting values, concealing debts, accumulating toxic assets and acquiring obligations on the basis of almost fictional cash flows the world’s economic managers are setting up a series of bets may save the day or sink the ship; which it is will sooner or later will be judged by the market. An economy can only undervalue things and overborrow for so long. Eventually the laws of supply and demand, like gravity, reasserts their control over the situation and the entire edifice settles into an equilibrium that will leave those who bet on the wrong horse holding the bag. We certainly live in interesting times.

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Hat tip: Onetailtest

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