How close is China to a financial crisis, and is the banking system of the world's second
largest economy really at risk?
Listen up!
Over the last four decades, the Chinese economy has undergone one of the greatest growth and
development processes in history.
During this time, and with an annual growth rate of almost 10%, China has gone from being
a country of impoverished peasants to becoming an industrial superpower, full of large companies
and modern metropolises.
Along the way, according to World Bank data, more than 700 million people left poverty
behind.
To give you an idea, this is more than the entire population of Latin America, Spain
and Portugal combined.
We are talking about one of the processes that has most influenced the global economy
over the last 40 years.
There is no doubt: China has been one of the great drivers of the planet.
However, this situation could now be at risk.
VisualPolitik community, in a past video, we already told you how the Chinese model
could be about to face a deep economic crisis.
We talked about the first major crisis since at least 1976.
However, in that video, we left one issue pending: the possible contagion of the crisis
to the entire Chinese banking system.
In case you don't know, China is a very unusual economy: since almost 2008 its productivity
levels have stagnated, so that today they are very low.
Therefore, in order to try to reach the growth targets set by the government, they have to
invest a lot of resources, investment that is financed with debt.
And since the returns are low, this has caused the debt of families, companies and the government
combined to soar above what is usual, for example, in Europe and even in the United
States.
Remember this chart?
Well, that’s what we are talking about.
But that's just the beginning.
Pay close attention to this other graph.
In it you can see how, during recent months, the delinquency rate of Chinese high yield
credits has multiplied...
Which is the highest risk debt.
This increase in non-performing loans coincides with the bad period the Chinese economy is
going through.
Keep in mind, for instance, that during the second quarter of 2022, China recorded its
worst growth figure in 30 years, with the exception of the coronavirus.
And remember also that youth unemployment is already close to 20% while the real estate
sector is imploding.
We talked about all this in the previous video.
However, perhaps the most worrying of all are the signals coming from the Chinese banking
system.
And above all the effect that the bursting of the real estate bubble may have on it.
But let's start at the beginning.
During April 2022, four rural banks in Henan province were forced to freeze nearly $6 billion
in deposits overnight.
The official reason given by the government was that the activity of these banks had been
suspended because, apparently, they had taken deposits from other provinces through online
intermediaries.
This is something that Chinese regional banks are strictly prohibited from doing.
However, there were several reasons that fueled the suspicion:
i) the fact that all deposits were frozen and not only those collected abroad;
ii) the fact that the government tried to silence the affected customers, even by sending
thugs to attack them;
And iii) the fact that the process dragged on for months caused suspicion and fear to
multiply rapidly.
And so, suddenly a question spread throughout the land: did the real estate crisis have
something to do with these banks suddenly having to suspend operations?
The Henan crisis began to be resolved on July 12, when financial regulators began to order
partial payments to affected clients.
However, despite this, doubts have not disappeared.
And the question is: Could the real estate pinch trigger a financial crisis in China
as it did in the great crisis of 2008?
Well, let's take a look.
(THE FINANCIAL EXPLOSIVE)
The bursting of the real estate bubble, the fall in housing prices and the bankruptcy
of many developers have triggered uncertainty.
For example, in mid-July, a group of homebuyers with properties under construction known as
"WeNeedHome" threatened to stop paying their mortgages if the government did not guarantee
that construction would be completed.
By the end of that same month, according to data gathered by Bloomberg, there were already
more than 320 projects affected by this boycott.
And for a country like China, where the government has enormous social control...
That's a lot.
But let's start at the beginning.
China's banking system is largely state-owned and represents a key part of the government's
economic policy.
As we have already told you on several occasions here on VisualPolitik, China is a very unusual
country.
Here the government plays a very important role in economic planning.
This means that when the government sets a target for economic growth, everyone has to
work to achieve it.
In the case of banks, this means giving more or less credit.
For years this did not cause any problems.
However, as growth rates slowed, especially after the 2008 crisis, banks were pressured
to offer more.
The idea was that the more cheap credit they provided, the more projects could be implemented,
which in turn would increase economic growth and allow the government's objectives to be
met.
The problem as we saw before is that this policy has multiplied the debt in circulation
in China...
To levels much higher than those of Western countries.
And that's not the end of it.
Over the years this policy has made many of the projects financed by the banks unprofitable.
And the question is, why would anyone want to build projects of dubious profitability?
Well, basically for the same reasons why banks are forced to lend their money:
Local governments and public companies have to meet the targets set by the government.
If the growth of the economy slows down, then they have to spend more money.
For example, by building infrastructure that is not needed.
The problem is that if a project is not very productive, there is a risk that it will not
generate sufficient resources to repay the debt incurred to carry it out.
In other words, over the years Chinese banks have been forced to grant more risky loans
to meet the targets set by the government.
And, of course, something very similar has happened with the real estate market.
Thanks in large part to the banks' policies, housing demand and prices skyrocketed.
For years, this policy spurred the construction of tens and tens of millions of homes across
the country, creating millions of jobs.
In addition, thanks to steadily rising home prices, family wealth continued to grow.
China was getting richer and real estate had a lot to do with the whole process.
It was, so to speak, one of the great economic engines of the country.
And behind it were the banks.
The problem, as always, is debt.
Families and real estate developers alone have accumulated bank debts of $7.5 trillion
dollars.
An amount of money to which we have to add what companies have also invested in the real
estate sector.
We could easily be talking about more than $11 trillion dollars.
And maybe even much more.
And that...
That's a lot of cash.
But what if you want to look at it from another perspective?
Well, look at this graph, for example.
Here you can see how the amount of household debt relative to income has tripled in just
a few years.
So far, more than 26 real estate developers have gone bankrupt and according to estimates
by the British consulting firm Capital Economics, there are more than 100 million empty homes
in China.
So it is very likely that housing prices will continue to fall for some time and that construction
will slow down.
This may lead to an increase in unemployment, which in turn may worsen the Chinese crisis
and increase delinquencies.
Under such a scenario, the question is: Who would be most affected by this situation?
Precisely the banks.
(China Banks May Face $350 Billion in Losses From Property Crisis.
Bloomberg)
According to estimates by Standard & Poor's and Deutsche Bank, between 6.4% and 7% of
all Chinese mortgages may be at risk of default.
A situation that, if it occurs, could spread to many other sectors.
Now, the question is, faced with such a risk, what exactly does the government intend to
do?
Well, let's take a look.
(REFERRING TO THE MANUAL)
The Chinese banking system is enormous.
Perhaps too large for the State to rescue it easily if necessary.
To give you an idea of what we are talking about, at the end of July, loans in the Chinese
banking system amounted to more than $30 trillion.
Approximately 175% of GDP.
What’s more, we must bear in mind that in China, public revenues account for little
more than one-fifth of GDP.
And to top it off, an important source of public revenue is precisely the sale of land
and real estate activity itself.
So, if it comes to that, any bank bailout could put the Chinese government in a very
difficult situation.
And that is why Beijing is very clear that the number one priority is to prevent a financial
crisis from occurring.
They have to make sure that things don't get out of control at all costs.
And to do that they need to force a soft landing in an industry that has a lot of problems.
And that is precisely what explains news like this;
(China surprises with a rate cut to combat the economic slowdown.
El Economista)
The Chinese authorities want to prevent the crisis from deepening, so they are implementing
expansionary monetary and fiscal policies, as well as all kinds of regulatory changes.
On the one hand, they are reducing interest rates and increasing financing for companies,
including real estate developers.
The idea is to stabilize this sector and allow banks to gradually divest themselves of riskier
assets while boosting investment in other sectors.
Then, on the fiscal side, the government has asked large public companies to increase their
hiring levels.
And it is also launching a huge infrastructure plan to help offset the slowdown in the real
estate industry.
(China Readies $1.1 Trillion to Support Xi's Infrastructure Push.
Bloomberg)
("We have entered a new cycle of infrastructure development.
That will be the new normal."
Yu Xiangrong, Citigroup's chief China economist)
And if that were not enough, if necessary, the government itself could even buy some
of the most problematic real estate assets from the banks.
(China plans real estate fund worth up to $44 billion for distressed sector, source
says.
Reuters)
And the truth is that China has many strengths in this area: for example, it has some of
the largest sovereign wealth funds and pension funds in the world.
Funds that could be mobilized to buy real estate assets in order to try to stabilize
things.
However, just a moment, because as you have seen, we are talking about a real estate sector
and a financial system that are too large for the State to be able to easily control
this process.
If the crisis deepens we could see holes of hundreds of billions of dollars in the Chinese
banking system, which by themselves would be capable of putting Xi Jinping's government
on the ropes.
In addition, as we have already mentioned, it is not at all clear that the old formula
will work this time.
China already has too much debt and too much infrastructure for monetary and fiscal stimulus
to work.
In other words, if it is not brought under control, we could be facing the first phase
of something like the great Chinese crisis of 2008.
Obviously the future is not written and we have already talked about the Chinese fortresses
in past videos.
But be that as it may, this is a real risk today.
And it is to a large extent what explains why capital outflows from the country have
accelerated and also why Chinese stocks have plummeted.
The good news, perhaps, is that the Chinese government seems to be well aware of the risks.
But at this point, it's your turn: Will the Chinese government manage to stabilize the
situation and avoid a financial crisis?
What do you think they should do to prevent things from getting even worse?
As always, leave us your impressions below in the comments and let's open a debate.
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Thank you very much for watching.
All the best and see you next time.