China's Veiled Economy

To most of the world China's economy remains veiled behind a shroud and is far from transparent. Not only because China is far away from our shores, but because their economy is very controlled by a government that acts as its puppet master we often have a difficult time getting real information on what is happening. An all growth is good mentality that always included "building more and expanding more" has been China's mantra for years. The combination of these factors has lead to the massive credit trap that China now finds itself in. The lack of clean and precise numbers remains a problem because of political tinkering when it comes to economic data, this situation is magnified because the same government also extends its control over the media and even the internet. It often seems the only way the world would know the wheels had fallen off the economy would be if millions of Chinese hit the streets in protest and that is highly unlikely because China has heavily discouraged such actions for decades.

Money Supply Grew From $10 To $24 Trillion Since 2008

Over the years corruption has flourished in China and growth of credit has gone unchecked. It is the nature of political systems to mask their flaws and is the case of China years of rapid growth have made this easy. It is important to remember that much of the growth in China after 2008 came from a massive 6.6 trillion dollar stimulus program that expanded credit and poured massive amounts of money into the system. This encouraged expansion and construction with little regard as to real demand or need. When critics and those who see the economy of China as containing major defects have made efforts to voice their concerns and point out weaknesses in the system they often have a hard time being heard over the noise of those touting the message of China being a case of potential unleashed.

Even today while many people concede that growth has slowed they still refuse to recognize just how much of past growth has been constructed on a foundation of sand. This is written not to diminish the accomplishments of China or to question their progress, but to point out much of what we have witnessed is the result of one time factors that have largely played out. Several factors have drastically changed politically, socially and from a military perspective since the days when America fueled China's growth. Recently what many Americans viewed as a beneficial relationship has morphed into something akin to fear or resentment. The new military swagger from Beijing coupled with a massive loss of American manufacturing jobs and the theft of intellectual knowledge has left many Americans unenthusiastic over the massive trade deficit with China. I contend China is in far dire straights than most people imagine and the reason it has gone unnoticed is because of the control their government has over the economy which makes it impossible to get accurate or specifically detailed numbers and information.

We must remember Beijing has been hit by the perfect financial storm as forces from a closed capital account, independent monetary policy, and a tightly managed exchange rate all have decided to plummet the economy at the same time. The lack of clean numbers combined with an intentional transparency issue has created a "guessathon" where we are forced to scan the latest pricing on what cargo ships are charging and how busy ports across the world appear to be in an effort to determine what is really happening. A big problem is that an "economy" by its nature can easily trick, hide, or mislead us as to what is occurring off stage or festering in the wings. Reality is often obscured without effort, but when a government is in full propaganda mode in an effort to reassure its people that all is well it can become impossible to see through the fog. China has become a huge player in the game of world finance and merits far more attention than a country like Greece, but this means going to a lot of work to get the truth.

China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. For years credit expanded rapidly in China, and now much of the country is mired in debt. As Beijing pursued a strong yuan policy pegged to the U.S. dollar. Since 2005 the yuan has appreciated about 30%, this profited those who put money in China, but now that the economy of China has become very shaky a lot of investors are questioning the risk of holding yuan assets. Now the country is experiencing massive capital outflows as several events and the the pain of attempting to hold its currency peg to the U.S. dollar finally became unbearable.  The  PBOC is under tremendous pressure as the responsibility of holding this mess together rest solidly on their shoulders. A massive scheme for the state to buy stock shares to halt a falling market while dealing with near bankrupt municipal authorities is only part of the woes they face.

Total Debt Is Soaring

Four big state-owned commercial banks and other mainly state-controlled banks account for nearly all official lending in China and their customers are largely state-owned firms. This has left little room for private banks and this means informal lending in China has grown rapidly over the past five years and even local governments borrow from the shadow banks. No one really knows how big the shadow banking sector has become, but shadow loans are estimated to make up 20% of all loans. This is only one of the problems that has developed and skewed China's development as the government controlled the economy from behind the curtain. For years the people of China have had the habit of saving much of what they earn but the low interest rates paid at banks has not rewarded savers, this is reflected by growth in the shadow banks and the fact much of their money has drifted into a bizarre housing market where prices are sky high. 

It is understood that China’s current-account surpluses have fueled its huge money-supply growth within a largely pegged currency over the years. As foreign exchange piled up, the People’s Bank of China continued to print more yuan. According to some estimates, China’s banking system has grown from $10 trillion to $24 trillion since 2008, but now the reverse may happen, if the yuan weakens, the central bank will effectively have to buy its own currency using foreign reserves to maintain its peg. This could mean the external trade position would now cause the central bank to shrink domestic money supply. Beijing will need to get used to the market forced deleveraging and slower growth. It is clear the economic efficiency of credit has started to collapse in China and the unwinding of its giant credit spree looks to be very painful.  All this plays into the view we all going to witness an overall deterioration that makes it logical for investors to get out of both the yuan and China. Expect to see a continuation of wealth leaving China and fleeing towards safety.


  Footnote; Please feel free to explore the blog archives and as always you comments are encouraged. For more on China see any of the post below,
              http://brucewilds.blogspot.com/2014/03/china-and-great-credit-trap.html
              http://brucewilds.blogspot.com/2013/11/china-land-of-overcapacity-and-debt.html
              http://brucewilds.blogspot.com/2013/04/china-and-corruption.html
              http://brucewilds.blogspot.com/2013/02/china-bubble-yes-it-is.html
              http://brucewilds.blogspot.com/2012/09/china-made-by-america.html