Grow your troubles away
China’s annual GDP growth of 9.1 percent in the third quarter is still the envy of the developed world. But the lowest rate in two years shows that the era of double-digit increases is at an end. China can no longer rely on using economic growth to smooth over the damage from a financial system run amok.
Growth helped China out of a financial hole in the late 1990s, when bad loans were 30 percent of bank assets. Lenders got new equity, and their toxic assets were popped into special, bond-funded vehicles. The $300 billion injected in three waves represented around 20 percent of 2004’s GDP. Those special vehicles probably never recovered their money – but because China’s economy has quadrupled in dollar terms since then, the missing billions have become a mere accounting footnote.
The losses are bigger now, and more complicated. Credit Suisse estimates 12 percent of bank loans could go bad, equivalent to 17 percent of GDP. But the financial system has burst its banks. So-called “shadow banking”, including sketchy underground lending, could be 15 trillion yuan, says Societe Generale, equivalent to around a third of GDP this year. No-one knows how much of that will go bad, or in what form the government may be called in to plug the hole, but the bill will be high.
In the 1990s, finance provided a solution, but now it looks like the problem. The U.S. subprime mortgage dilemma provides a grim precedent. An explosion of cheap financing helped to push up growth rates. But eventually financing got too top heavy. Lenders floundered and the property sector collapsed, knocking out the engine that might have helped America to grow itself back to health.
In China, the shadow system has kept property developers and small companies in business, creating jobs, houses, wages and prosperity when banks wouldn’t lend. But if the developers run out of money, the economy will be deprived of the best way to grow out of a rut. China is in danger of following the United States into a toxic financial-economic interaction.