Magazine article New Internationalist

Shadow over China

Magazine article New Internationalist

Shadow over China

Article excerpt

The impact of shadow banking in China has been relatively recent. It grew from only several hundred billions of dollars in total assets under management in 2008 to more than $9 trillion in 2014.

At the centre have been so-called 'investment trusts', which grew five-fold between 2010 and 2013 and account for about a quarter of the total. Trusts provide credit (and therefore generate debt) to local governments for infrastructure spending, to industrial and commercial enterprises, to real-estate and financial institutions, and to investors in stock and bond markets. Local government debt in particular has risen by more than 70 per cent since 2010. In other words, shadow bank credit has gone mostly to those sectors of China's economy where debt has accelerated fastest and produced financial bubbles.

This explosion of shadow banking and speculative investing originated in the wake of the 2008-09 global economic crash. In 2009 China introduced a fiscal (spending) stimulus package of nearly 15 per cent of its GDP. Accompanying this was an equally massive monetary injection. Part of it came from the central and state-owned banks. But part also came from an opening in late 2009 to shadow banking and massive capital inflows from foreign investors.

Credit extended by shadow banks is mirrored in the explosion of total private debt in China. It rose from 130 per cent of GDP in 2010 to more than 240 per cent in 2014, the growth almost exclusively in the private sector. A good deal of it has taken the form of dangerous short-term debt. By 2014 a third of all new debt was 'roll over' refinancing of prior debt. Should interest rates rise too far or too fast, many businesses will not be able to roll over that debt and will have to default. In turn, defaults could result in panic sell-offs of financial securities, followed by a general 'credit crunch' that will slow the real economy faster even than at present.

As China's economy continues to slow, the massive credit creation underlying the recent bubbles in housing, local infrastructure, wealth management products and currency speculation could result in financial instability should any of the following developments occur, singly or together: asset prices for housing or commercial real estate decline too sharply; revenues of older industrial enterprises like coal and steel collapse; or local governments can't make interest payments on their massive infrastructure debt. And all of the above have begun to happen in China since mid-2013.

In other words, shadow banks in China, in just four years since 2010, have created the economic preconditions for major financial instability and a subsequent economic contraction that would undoubtedly spill over to the rest of the world.

Direct measures

But the negative impact of shadow banks is not just something potential, in the future. A struggle has been underway between China and its shadow banks since about 2012. In spring 2013, China tried to slow asset price bubbles by making loans more expensive and raising interest rates. That had unintended counterproductive effects. It soon resulted in a credit crunch that slowed almost the entire economy. Unable to get loans from traditional banks, local governments borrowed even more from shadow banks. Bubbles in housing and infrastructure grew further. …

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