We get plenty of criticism for banging on about China.
But don’t mistake our China bashing for anything more than concern for the enormity of the problems there and the potential impact on Australia. Because the impact will be huge. It’s just that we’ve had it so good for so long, the Australian commentariat have no imagination when it comes to the potential economic problems we face.
We’re not trying to fear-monger or drop a bucket of faeces on the place. We’re trying to dig deep into the morass created by a credit boom and trying to work out what it means for you.
The rise of China began around 2003. Ultra-low interest rates in the US kick-started the boom. Because China pegged its currency to the US dollar, it effectively imported easy US monetary policy.
You can see the effect of this in China’s accumulation of foreign exchange reserves (mostly US dollars, and euros too). China began 2003 with reserves of around $US350 billion. In the space of just 10 years, those reserves have ballooned to around US$3.5 trillion – a 10-fold increase.
These reserves, purchased with newly printed yuan in order to keep the exchange rate low, provided the fuel for China to engineer its own credit boom in response to the 2008 credit crisis.
The boom got underway in 2009 and is still going. Fitch ratings agency says it’s ‘unprecedented in modern world history‘.
Credit bubbles can continue for longer than nearly anyone expects them too. And they go on so long that most observers simply cannot see a catalyst to end the boom. But Federal Reserve tapering, or simply threats to taper, could be the catalyst that sends the China boom bust.
That’s because the threat of tighter monetary policy, or, to be more precise, the threat of ‘less loose’ monetary policy, causes a reversal in speculative capital flows. Such a reversal puts pressure on the most fragile parts of the financial sector.
And you’re seeing evidence of that pressure in China’s economy right now. A key measure of banking sector liquidity, the interbank lending rate known as SHIBOR, has surged in recent weeks. That tells you that cash is tight, and no one really wants to lend to each other at low rates. The higher lending rates reflect the higher perceived risk in the system.
And it’s not just perceived risk. A few weeks ago, there was a technical default in the banking system as China Everbright Bank couldn’t come up with the cash to repay a loan on time.
These are warning signs, in the same way that the failure of various sub-prime lending vehicles in 2007 was a warning sign of the looming credit crisis. If it follows the same path China’s economy will have a very hard landing and Australia will feel the full brunt of it.
For better or worse, we’ve hitched our iron ore wagon onto the tail of the red dragon. What happens in China’s economy will matter here…big time.
That’s not fear-mongering. That’s reality. If you think China can manage the fallout you’re not thinking. The US, with the most sophisticated capital markets in the world and a huge amount of self-interested parties trying to save the system, only just managed to pull it off. How is it that China will avert a similar fate?
We don’t know how events will pan out from here. We just know it’s better to have your eyes wide open than eyes wide shut. Ignorance is bliss while the going is good…but it can be a wealth destroyer when things change.
Greg Canavan+
Editor, The Daily Reckoning Australia
[Ed Note: To read more of Greg’s in depth macro-economic analysis, click here to subscribe to the free daily e-letter The Daily Reckoning.]
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