Posted on 06/10/2006 5:36:20 PM PDT by RWR8189
EARLY LAST MONTH, the accounting firm of Ernst and Young released a report concluding that the "nonperforming" loans of China's banks totaled $911 billion (40 percent of China's GDP)--a figure that far exceeds the Chinese government's own estimate of $164 billion. Beijing's response to the report was not subtle: "The report not only seriously distorts the actual assets quality of the Chinese banking sector," but "its conclusions are absurd and incomprehensible." Ernst and Young withdrew the report the next day, citing fundamental errors in the analysis.
But was the report really that flawed? Or was the firm's report more right than wrong, and retracted only because doing business in China these days requires pulling one's punches?
Certainly, Ernst and Young's position as auditor for the state-owned Industrial and Commercial Bank of China, the country's largest bank, would give it insight into China's banking problems--and also the incentive to think twice about making the Chinese government angry. The report's timing could not have been worse, as several Chinese banks are gearing up this year for initial public offerings on the Hong Kong exchange that should bring in tens of billions of dollars in new capital. (Ernst and Young will earn millions when, as expected, the Industrial and Commercial Bank launches its IPO effort this coming September.) The last thing China's banks wanted to see was a sour report on their great volume of bad loans and their underlying financial condition.
Of course, China's problem with nonperforming loans (NPLs) is not new. In 1999, according to the "official" tally, NPLs accounted for 25 percent of the total amount of money loaned--a huge amount by international banking standards. The pace at which new loans increased was so great that even after the government moved many of the worst loans off the books to "asset management companies"--created expressly to deal with this mounting problem--and infused the banks with hundreds of billions in new capital, the official ratio still remained at 25 percent.
Moreover, NPL totals are expected to rise as a result of a flood of new lending by Chinese banks between 2002 and 2004 and "another credit surge" recently reported in the Economist. In the first four months of this year, Chinese banks lent 60 percent of the amount of credit they issued for the whole of 2005. This is bound to give rise to future bad loans.
In fact, the Ernst and Young report was not unique. Very few financial analysts believe China's "official" figure for NPLs. Most think the ratio of bad loans is considerably higher, maybe as high as 50 percent, according to Frank Song, director of Hong Kong University's China Financial Research Center. When suspected NPL figures are combined with prospective NPL estimates, the Ernst and Young report's figure of $900 billion is probably not wildly off the mark. In fact, previous estimates by Standard and Poor's and PricewaterhouseCoopers indicated that Chinese NPLs could very well top $800 billion; and Fitch Ratings has just put the number at close to $700 billion. Like any such assessment, it's possible that the Ernst and Young report was based on assumptions and analysis that could be called into question. But it's just as likely that the report's inconvenient timing was the reason it was retracted.
The reality is that China's leaders simply haven't been that interested in telling banks to stop throwing good money after bad. Loose credit has become a way of life not only for China's bankers but also for its bureaucrats and party officials. China's banks have an immense amount of cash to play with. The savings rate of Chinese citizens is extraordinarily high: Pensions are uncertain and demographic trends indicate that China's aging population of parents and grandparents can increasingly expect less and less help from their children. The largest banks are also state-controlled and have personal and institutional incentives to give loans to state-owned enterprises, which still make up a surprisingly large segment of the Chinese economy and typically bleed money. With party officials and their relatives sitting on corporate bank boards or managing one of the tens of thousands of largely independent local branches, the banks have become the world's largest ATMs for China's political and business elite. Add to this the fact that China's banks have, at best, rudimentary internal audit systems.
So, the question is, will the banks be fixed? Those in China who want it fixed are hoping that, by bringing in Western financial partners, they can raise additional funds and, through a coupling of management techniques, begin to bring better practices to mainland banks. But they are running headlong against a well-established and well-connected system of elite corruption. And to protect that system, the Chinese are only allowing their non-Chinese partners minority ownership positions which, in turn, only give them a limited say over banking practices.
Moreover, the nearly 170,000 state-owned enterprises being supported by the banks cannot, Beijing believes, be allowed to go out of business. China's leaders are increasingly worried about rising unemployment and the social unrest that might follow. In addition, Beijing rightly suspects that allowing Chinese citizens to place more savings and profits in markets outside of China would result in a run on deposits that the state banks could not survive.
The buildup in domestic liquidity--savings, plus massive foreign investment--has led to an inflated domestic real estate market and massive spending on infrastructure and manufacturing capacity, investments that now account for nearly half of China's economic output. The bubble in real estate may, of course, burst, and it's an open question whether the world's consumers will, against rising protectionist sentiments in industrial nations, continue to support the ever expanding capacity of Chinese manufacturing or, for that matter, buy all its products.
Plenty of analysts have seen these problems and have predicted China's economic downfall for some years now--and it hasn't happened. At least, not yet. The laws of economics may be complex, but they do, in the end, punish those who ignore their most rudimentary precepts.
However, that's the point. Western financial experts keep looking at China as though it simply wants to be another Western-style, economic force. And while undoubtedly some in China do, others don't. The Communist party sees the banks as too important, in allocating resources and ensuring political support, to turn them over to independent actors. As Minxin Pei notes in his fine new book China's Trapped Transition, "Few authoritarian regimes can rely on coercion to maintain power. Most autocracies mix coercion with patronage to secure support from key constituencies, such as the bureaucracy, the military, and business groups."
China is no different, and its banks remain a critical element in the regime's strategy for self-preservation.
Gary Schmitt is a resident scholar and Jared Feiger is a researcher at the American Enterprise Institute.
Well, the sooner they implode, the better [for later they'll only become bigger and more powerful]. The least we could do to hasten it is to boycott everything made there.
Stratfor has been reporting on this issue for about a year. Finally people are starting to see what's going on, and it's being publicly said that there are serious issues within Chinese banking sector. Earnst and Young were not the only ones - their report was followed by a number of other reports that also placed the numbers of bad loans between 500B and 1T. Some have said that it may be even worse, due to lack of transparency in the Chinese banking system.
They're headed the same place Japan went to when its economy collapsed in the 90s. Except China is far less prepared to deal with that fallout.
Read or watch "The Commanding Heights", a book and a program done surprisingly well by PBS, that is available on DVD. It is 6 hours long, and shows all the economies and governments of the world during the 1900s. It is mesmerizing.
And maybe a clue as to why big capital is not rushing off to develop alternative petroleum sources like there's no tomorrow. The ripple effects of a collapse of the Chinese economy would drop energy prices like a rock.
Is there a plan already drawn up for that or like somewhere that lists everything made in china and all the companies.
Well, I'm doing it on disorganized basis - just by checking the labels on what I am buying.
Yea, I kindof do that already. on a sadder note, even though I love my HP Pavilion ZV6000, if I had known that it was made in china I would never have gotten it. :-( Even though I love it.
Let's help them implode faster:
Remove "Permanent" MFN status from China, and 30 seconds before the ink dries, the Chinese "economy" will begin to slowly circle the bowl. Then add insult to injury and start investing heavily in India.
“Loose credit has become a way of life not only for China's bankers but also for its bureaucrats and party officials.”
This is bad news for the Chinese economy; rudimentary Austrian-school economic analysis shows that government-induced artificial easy credit policies create unsustainable short-term economic booms that are bound to come crashing down as the expansion consumes the capital stock necessary to keep production going. Unless the banks’ reckless behavior is fixed, the Chinese economy may soon enter the bust portion of the boom-bust cycle.
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A la Japan in the 80's and 90's.
Japan was a bit different: there the boom was financed by actual assets in the form of American real estate. The problem was caused when the same real estate was used as collateral for multiple loans and the real estate market busted.
For example, remember when the Japanese bought Rockefeller Plaza for something like 80 million bucks, and then sold it a few years later (after the real estate market went soft) and they could only get 30 mil?
How many loans do you think were based upon the "nod-and-a-handshake-they have-Rockefeller-center-in-their-portfolio" way? Probably half a dozen, at least. When all that real estate went south, so did the Japanese markets.
Chinese credit, however, probably works in a much different way, since the banking system depends on a wink and a nod from the ostensibly-Communist government (It only exists for the same reason). Many of those loans are probably in the name of a bevy of high government officials and their cronies (and therefore they will never be paid back), not in the name of some rice farmer or rickshaw driver who actually works for a living, nor are they probably backed up by any physical asset (land, mineral rights, buillon, etc).
In other words, when China goes, it'll really go?
Straight through the floor, the earth's crust and straight into the molten mass at the center of the planet, right out the other side.
Remember when you were a kid and they told you about digging a hole to China? This time China is digging it's own hole.
Start looking at Indian stocks and bonds.
P.S. which is something that I always found funny about the "We should nuke China RIGHT NOW" crowd out here:
We already have a weapon in our arsenal far more effective against the Chinese than a nuclear weapon; it's called the Yankee dollar. Remove the prop of American funding (i.e. the trade deficit with China), and China will fall faster than a prom dress in a darkened room.
I hope (and bet) you're right.
It's a sure thing, actually. Heck, I'm not an economist or even a trader (I did spend 20 years on Wall Street, but that was a system's programmer.Now I'm working on my PhD in history), but it should be obvious to even a democrat what's going on here.
China's sudden transformation into a "capitalist" country which retains a "communist" government is nothing of the sort. The words "communist" and "economy" don't even belong in the same sentence. All this business being carried on is the result of politics; the Chinese saw what glastnost did to Russia and are determined to not let it happen to them. In that case, what happened is that the Russians actually did try to modernize and free up their markets -- they just couldn't control a process that took off like a runaway train (human nature took over and, according to Mao, "there is no such thing as human nature").
That led to Gorbechev being shown the door, the fall of the Berlin Wall, and Yeltsin getting his fifteen minutes of fame by standing on a tank outside the Kremlin.
The Chinese government KNOWS in it's heart of hearts that communism doesn't work, but it cannot come out and say so because of the chaos that would ensue (see Russia). So, the idea is to:
1. Modernize the Chinese economy at Western expense by allowing foreign investment (letting the barberians do the work for them)and then keeping that money at home by barring certain key markets to those same foreigners, or hedging them in with rigid regulations (i.e. heavy bribes for the privlege of getting screwed by the CCCP)
2. Allow the great mass of the population to make some money (it's not a lot in real terms, but a doubling of Chinese wages, etc would appear to people who barely have indoor plumbing that they are getting rich), and
3. Keep the old guard in power. With the people under the illusion that they are being given economic freedom (how free is a free market in which the government gets it's cut and directs every aspect of every tansaction?), which you HOPE will cause them to forget all about POLITICAL freedom. It's simplepolitics; why should you care about political freedom when you're rich, you ungrateful bastards?
It will fail because you cannot have people getting rich without them clamoring for political and legal rights to safeguard that wealth (especially from the government!), and because the whole thing is ultimately a sham which will collpase on it's own when it reaches a critical mass (you can't keep handing out free money to people who will not or cannot pay it back).
The question is not WILL it happen, but WHEN will it happen.
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