Monday, July 8, 2013

Will There Be A Major Chinese Crash?


We have seen substantial volatility in the past in Chinese financial markets.  In particular the stock markets suffered sharp declines in both 2007 and 2011, with the former large enough to possibly even be called a "crash."  However, neither of these or earlier hiccups and declines slowed the real economy noticeably.  As it is, Chinese real growth has been slowing, which certainly reduces expectations of future income flows from Chinese financial assets.  The stock market has been declining since April, with that decline now more than 20%, the usual cutoff for a bear market.  The question is whether this decline is a period of distress following a peak in a larger scale adjustment that will be followed eventually by a much larger panic and crash that could then feed back on the real economy, slowing it much more dramatically with serious implications for the world economy.

Something that makes the current situation more disturbing is that we are finally seeing this decline  emanating significantly from the financial sector, particularly banking, which has long been known to be riven with corruption and bad loans, with overvalued properties in danger of sharply declining adding to the problems they face.  The peak came in April with a sudden spike of overnight interest rates up to  25%, following a massive surge of broad-based debt.  We know that the Chinese system is different from others and has many powers.  So, they may be able to overcome all this.  But the situation seems much more  dangerous  than previously, with this being beyond the control of the Chinese government authorities.

The depths of  the problems of the financial and particularly banking sector in China is summarized in an amazing sentence from near the end of an article on July 1 in the Financial Times by Robert Chancellor, in a column titled, "China crunch shows financial fragility."  Referring  to how  possible  investors in Chinese bank  stocks might view possible further purchases:

"They may note the  numerous indicators of financial fragility, including excessive credit growth; moral hazard arising from the belief that the state has underwritten all financial risk; related-party lending between state-controlled banks and state-owned enterprises; loan-loss forbearance; de facto financial liberalisation (accompanying the growth of the shadow banking system); extreme asset-liability mismatches created by WMPs [wealth management products] and interbank lending; elevated bank leverage hidden by off-balance sheet exposures; contagion risk posed by undercapitalised credit guarantee networks; and a financial system plaguedby Ponzi finance practices and contaminated with corruption and fraud."

The late Hyman P. Minsky could not have  put it better.

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