The key measure of credit-market stress in China has widened to its worst level since Bloomberg started measuring it in 2007. As Paul Krugman pointed out this morning, the news is reminiscent of the TED spread in the United States, which was an early alarm of the coming financial crisis.
The Chinese credit bubble was one of my worries going into the new year. Total bank debt has reached a historic magnitude, far worse than what the United States experienced in the run-up to the Great Recession.
Non-performing loans hit a record in January. And not only are Chinese data unreliable, but the banks are a fraction of the problem. Local government debt and the shadow banking “system” are dangerously unstable. The Chinese central bank has had to step in repeatedly to bail out failed “trust products.”
Trust products are among the few places that mainland Chinese can invest to earn a better return than conventional bank deposits, but they are poorly regulated and often rickety. They tend to invest in industries that can’t get bank loans (echo: Subprime; the trusts even have “tranches”). Trust assets rose 46 percent last year to $1.8 trillion. Earlier this month, a last-minute bailout prevented the collapse of a $495 million trust.
Greater stress is coming as the U.S. Federal Reserve tapers. With American interest rates at zero and dollars flooding the system to avert deflation, investors sought higher yields in emerging markets, including China. With the Fed backing off its unconventional stimulus, investors are leaving these countries. For example, according to Bank of America, external borrowing from Chinese banks and bonds rose from $207 billion in the third quarter of 2008 to $849 billion in the same period last year.
This global “carry trade” — borrowing low here and investing high overseas — is unwinding, with painful consequences.
The consequences of a hard landing in China are difficult to overstate. A host of seeming alarmist scenarios — global depression, deflation — are not out of the question. With the credit-market stress so wide, we’re in the familiar territory seen in this country back in the Panic of 2008, where financial institutions don’t trust each other and lending freezes up.
One is reminded of the consequences of financial collapse in another rising economic power — America in 1929 — and the worldwide reverberations. (Inexact, to be sure: Both John Maynard Keynes and Herbert Hoover traced the roots of the Depression back to the Cathaginian peace after World War I).
This crisis comes as the Communist Party under President Xi Jinping is attempting to rebalance the Chinese economy to less dependence on exports and foreign investment, and more consumer spending.
For Washington state, the trouble affects the state’s largest export partner, worth $16.7 billion last year.
Averting the worst will be beyond the abilities of the People’s Bank of China. So what will Janet Yellen’s Fed do?
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