Elephant on the Bicycle

Analysts warn China could face Japan-style debt crisis.

When financial crisis devastated its Asian neighbors a decade ago, China sat safely on the sidelines, its own markets and banks largely closed off from the world and insulated from the upheavals wracking more open economies.

But today, China could be ripe for a crisis of its own that might resemble the collapse of Japan's "Bubble Economy" in the early 1990s -- and have enormous global impact, analysts warn.

Just as in Japan at that time, stock and property prices here are soaring. Banks have lent billions to build malls, office towers and apartment buildings -- although many remain unfilled.

Authorities warn the economy may be overheating and are taking steps to cool investment and lending, but to little avail. An attempt in late May to rein in surging stock prices sent shares tumbling for a couple of days before they resumed their climb.

The likely trigger of a crisis, should it erupt, would be a pile-up of bad loans in a weak banking system, analysts say. "The banking system is still based on collateral and the collateral is all overvalued," says Andy Xie, an independent economist based in Shanghai and Hong Kong.

"If the bubble bursts, then you will have a banking crisis like Japan in 1990," he says. "The question is how China can manage after the bubble."

Given China's growing role in global manufacturing, financial markets and commodities, the repercussions of such a collapse would be far-reaching.

While there are differences between Japan's asset price bubble and China's situation today, the similarities are instructive.

Easy money from Japan's banks led to an estimated $3 trillion in investment in new plants, hotels and a glut of golf courses. Real estate prices soared.

Domestic investors piled into stocks, seeking higher returns than the paltry interest paid on savings accounts. The value of the Tokyo stocks soared from $2.6 trillion in late 1987 to $4.5 trillion at the market's peak in late 1989.

When the orgy of speculative trading collapsed after the Bank of Japan tightened monetary policy, a decade-long slowdown ensued.

In China today, many of the same factors are also at work -- low returns on bank savings, cheap capital, soaring stock prices and relentlessly surging property prices. In just two years, the value of shares traded in Shanghai and Shenzhen has skyrocketed to about $2.2 trillion from $393 billion.

"China is like a giant elephant riding a bicycle -- it has to maintain a fast speed, otherwise it will crash," economist Zhang Chunyue quipped in a recent commentary in the state-run newspaper China Daily.

"In the case of China you can make a very plausible case that we have all the conditions for a serious crisis when there's an adverse shock," Pettis says. "There's a lot more debt out there than we think."

Now there's a hoot: Andy Xie is worried about the collateral in China. How many trillions of dollars worth of CDOs are there in the US that are not marked to market? What % of the worlds economy is China anyway?

Is China more like an elephant riding a bicycle or a fish riding a bicycle?

I am not trying to understate the importance of China as I think years to come it is the world's ascendant power. It's just not there today.

I have to agree with Xie on this: "The banking system is still based on collateral and the collateral is all overvalued." Indeed it is. But what country should he be talking about?

Here's another interesting sentence in the article. "Given China's growing role in global manufacturing, financial markets and commodities, the repercussions of such a collapse would be far-reaching." Yes there are malinvestments in China, lots of them. But at least some of those investments are going into wealth building productive activities like manufacturing.

The US has all of its collateral based on pure debt with nothing backing it up: charge cards, houses, leverage buyouts at absurd prices, debt financed share buybacks, etc.

When it comes to debt, who's the elephant here? Instead all of the eyes are focused on the fish. It's as if the elephant in the room does not exist. It's a pretty amazing trick. The magicians at the Fed must be proud.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/