Bearish on China

I participated in a small workshop today on contemporary issues in financial policy in Asia. I was the only political scientist there–the other participants were either academic economists or analysts affiliated with some of the big banks active around here (RBS, Citi, etc.). What was most striking to me is how bearish the group was–and this especially includes the analysts–on China's long-term prospects. The general tenor of the discussion was something like this: we (meaning the world) has escaped the worst of the crisis, and for that reason governments and banks alike are congratulating themselves on a job well-done rather than taking a hard look at the sustainability of current practices. We know that this is a problem in the US and Europe, but no one is really being honest about what this means for China.

The evidence of unsustainable financial practices in China is not direct, but it is quite suggestive. Between 2007 and 2009, private sector debt in China rose by 20%. That's a big rise in not a lot of time. By end-2009 private sector debt was over 150% of GDP…and if you think that sounds like a worryingly high number, it is. Now, clearly high and rising bank credit to the local private sector doesn't automatically produce problems, because China still seems to be chugging along. But if you look at these figures in the comparative-historical perspective, you see that this sort of rapid growth in domestic credit is nearly always an indication that some bad stuff is going down behind the scenes. We also see that market actors tend to ignore the signs of trouble as long as possible, because they believe that "this time is different," or because they believe that even if things are bound for a correction in the future, they are smart enough to get out right before the crash. We all know that China has problems with corruption, graft, and "non-economic motives" in the allocation of credit. It's just not plausible to believe that it is immune from the same consequences associated with such problems anywhere else in the world.

The prediction that I heard is that sometime soon, Chinese banks are going to realize that they are overleveraged. That will lead them to rein in their lending activities to protect their balance sheets, which in turn will begin to starve the domestic real sector of cash. In the best case scenario, this just leads to a difficult correction. In the worst case scenario, the real sector correction exposes further problems in banks' loan portfolios, which generates further real sector problems, etc.

So that's interesting, but not too specific of a prediction. As an academic point, though, what was really interesting was to hear the analysts talk about how their employers just aren't interested in hearing about the long-term unsustainability of China's credit expansion. From the employers' perspective, all they want to know is over their own relevant time horizons–that is, the next month or so–is China in trouble. And the answer to that question is, no. So while analysts and local economists are pretty bearish, the market makers are still doing business as usual, quite happily. I wonder if in five years we'll wonder how good of an idea that was.

Posted in Asia, Current Affairs, Economics
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