When will China's government banks need a bailout so the economists that have been forecasting this for years will finally be right? When will China's housing market finally collapse? The answer is, nobody knows because China is a closed economy and will not tell the market anything it doesn't want the market to know. For every article about non-performing loans, there is another quoting a government officials saying they'd pay the bills themselves if the debt become toxic. For every article about the housing market looking like it's heading the way of Las Vegas real estate, there is a string of data from China showing that housing prices are still higher than they were a year ago. There is no free fall in China. There is no crash. But everyone is wondering if China is the next EU. The den of China bears has roared back to life this week after being quiet for a few weeks.
In The New York Times, Paul Krugman wrote on Monday that China is possibly on the verge of becoming the next world crisis. Why? Because "there was rapid growth in credit - with much of that growth taking place not through traditional banking but rather through unregulated 'shadow banking' neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting - and there are real reasons to fear financial and economic crisis."
Americans heard the same thing in 2007 and 2008, that a shadow derivatives market was going to destroy the U.S. economy. The thing is, there is no shadow derivatives market. Derivatives exist. Self-regulatory agencies exist to make the laws of trading them. There was, and is, no shadow. The only shadow would be a black market, which is criminal, and maybe akin to watching the Medellin drug cartel go bankrupt. It won't take down Columbia. It won't take down the investment banks where that money was held. (Maybe I'm misunderstanding something here, which is probably the case.)
Also on Monday, Nouriel Roubini said that his firm, Roubini Global Economics (RGE), increased the probability of their “crash and burn” scenario. They lowered their expectations for a soft landing, though this remains their base case scenario.
There are a few reasons for these forecasts, and none of them have to do with the crisis in Europe. In 2008, China sent over $700 billion to states to invest in things like roads, trains, bridges, housing and entire cities. Some of these projects were bridges to nowhere. Although the government estimates that public debt as a percentage of GDP is just 17%, Bloomberg estimates that it is at 80% because of fixed investment.
The findings also suggest China is failing to curb borrowing even with interest rates rising. One central bank official told Bloomberg will slow growth in the world’s second-largest economy if not controlled. But by how much? Is 8% China GDP hard to live with in China? Is it a downer for countries like Brazil, that have come to rely on China for export growth? Earlier this year, China's premier Wen Jiabao said he wanted the economy to grow at just 7%. Nobody worried then, but that was because the market still believed Europe could save Greece and the IMF could save Portugal.
There's also the issue of sales prices dropping in China’s real estate market. Economists warn that developers won’t be able to repay their debt to the states and therefore those same municipalities won't be able to pay back their loans either because of poor cash flow and falling revenue from declining land sales that they relied on for much of their income.
In China, fixed assets account for nearly 50% of GDP compared to around 25% in the U.S. and an average of 30% in the emerging markets, said Ira Kalish, director of global economics at Deloitte in Los Angeles.
Is China that bad? One ex-China banker doesn't think so.
"The banks in China are in better shape than people outside the country realize," Frank Newman told me earlier this month. Newman is a former deputy Treasury Secretary under the Clinton Administration. But more impressive than that, Newman is the only American to ever run a Chinese bank. He was the Chairman and CEO of Shenzhen Development Bank up until 2010.
"Most of the fixed investment China did in 2009 were good projects. And let's not forget that this is still China and the government doesn't want a banking crisis. So if the government doesn't want a banking crisis, no matter what people say to the contrary, it's not going to get one," he said.
The last time the country's big four state-owned banks went through a crisis, the government created a troubled assets management firm. The debt just gets rolled over and will never be fully paid, but the banks non-performing loans declined as a result.
No outsider knows the percentages of non-performing loans at the big four banks of China, including the Industrial and Commercial Bank of China and China Construction Bank. From Newman's point of view, non-performing loans are stable and in the private banking sector are even coming down.
Still, he said, banks have something to worry about.
The commercial real estate bubble is deflating, but China is not one big Florida where housing values are collapsing 10% a year. Housing prices are down in the tier 1 and tier 2 cities over the last several months, but still higher than they were a year ago. Real estate prices are expected to decline again in 2012. Some Central Bankers in China have said that the major banks and developers could survive a 30% correction. Others disagree and expect many developers to fold, many shopping malls to remain vacant. Unemployment in China will rise from current official levels of around 4%.
Construction has played a big role in the country's full employment and urbanization strategies. "The people you see climbing bamboo scaffolding in Shanghai all came from the interior of China and they are now moving back," said Kalish. "It happened in 2008 when the country lost about 20 million manufacturing jobs because export markets were basically closed off because of the credit crisis. About half of them moved out of the coastal cities and the rest were laid off. The stimulus package got most of them back to work quickly, but a lot of those migrant workers stayed in the interior cities because wages had improved along with working conditions. China is changing and with it come a host of new problems. I do think the government manages it, at least short-term," Kalish said.
China's economy is slowing and likely to end the year with 9.1% growth, down from over 10% for the last 10 years. State-owned-enterprises registered profits of just under 4% in the first 11 months of the year, according to government numbers. That's down from 50.1% in the first 11 months of 2010 when compared to 2009.
Despite concern over China's crash and burn, China's stock market has outperformed the MSCI Emerging Markets index and is the best performing big emerging market year-to-date. If the U.S. stock market is doing poor because of Europe, then one can argue that China's economy is also slowing, in part, because of Europe. Europe is China's top trading partner. When Europe's bad news is out of the picture, the world will turn to U.S. elections. China will remain on the back burner.
China has its fair share of economic problems. No one wants to see the world's No. 2 economy break, including Krugman and Roubini. Like the U.S., people are getting older and the country doesn't have the social safety net that Americans enjoy. They have to build it. That cost money. Demographics do not necessarily favor China. Moreover, the growth over the last several decades has led to rabid inequality. For much of China's east coast, it's the Upper West Side meets South Bronx. Income inequality is one of the main concerns of the Chinese government, a government that so far has been able to avoid national political protests against its leaders not necessarily because it is not a democracy, but because the Chinese have seen their lives improve since the last uprising in Tienanmen Square in 1989.
"There is some good news in the demographic shift as well," said Kalish. "China is going to have less workers, so the government will not need to worry as much about full employment as it does now. That will allow China to move up the value chain and redeploy its labor force away from assembling high tech products and sewing fabric together. China is not going to be the world's factory. China's problems are long term. The spending spree of the last two years at the municipal level will see an increase in non-performing loans. You have high speed rail that is too expensive to use. You have empty office buildings. But China is not the U.S. or Europe. A crisis there is not going to impact the rest of the world," Kalish said.
See: China Debt Dwarfs Official Data--Bloomberg
Will China Break?--Paul Krugman, The New York Times
