Posted on 06/14/2006 12:55:28 PM PDT by fuyb
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.
But .. will Wal Mart's goods begin to become more expensive? Is this why I see my local Wal Mart re-arranging it's aisles in what appears to me .. wider aisles .. goods more spread out .. in short .. less merchandise?
Is this suppose to make me feel good or bad?
I don't think Japanese imports changed substantially back when they had the same problem in the late 80's.
No ... but when I looked up ..... they were gone.
Japan was supposed to take over the world (when I got my first transistor radio in .. I don't know .. maybe .. '58, '59, '60 ) ... but now ... all I see are cars.
Not that that isn't a pretty cool move ... forget the millions of different products and make just one good one.
I'm not an expert, so someone will correct me if I'm wrong. But it seems like there's every chance for a large economic crash in China one day -- similar to (or worse than) the depressions we've had in the past, when we were a developing country.
If that happens, it's hard to imagine all the harmful fallout -- wars, coups, refugees, a possible breakup in the country, not to mention all the other charming fallout from failed states like drug trafficking, human trafficking, rampant kidnapping, etc. Not a pretty picture.
I also see an economic collapse in China.
There is a very interesting documentary running on "The discovery times channel" called China rises, it's 3 or 4 1 hour programs. The numbers are staggering with regard to the changes taking place.
The Chinese are stuck between those that continue to believe in the socialist revolution and capitalism. The one thing we must keep in mind is that the Chinese government could care less about taking care of it's people.
I will be very surprised if this story stays buried very long. When western companies want to invest they will do their homework and we should start to see signs that those investments are not being made.
In most of the world, politics is just one branch of organized crime, and the collapses are inevitable. People who rely on the MSM will inevitably be surprised, and caught unprepared.
I predict the worst will happen in China -- within a few decades, maybe less. The mess won't be pretty.
I never understood this trade deficit thing and IOU's.
If our economy is growing wouldn't a trade deficit take cash out of the system by simply taking away from our growth GDP?
If we have a 60 billion dollar a month trade deficit, then if our economy is growing don't we just end up shedding our growth dollars to pay for their stuff?
If the government isn't running a deficit then if we are indeed running a deficit with other countries are the banks taking on that burden? Are they loaning money to you and me in which we then go spend on foreign goods?
If that's the case any car loan would be considered just thought. Loaned money to buy a foreign good.. but those goods are always paid off using U.S. dollars. So what's the big deal?
The banking issue is huge, and WalMart is peanuts, and anyone who constantly gets balled up in a corner about their pet issue of Antiwalmartism misses the big pictures.
The financial structure of China is a total house of cards, and many will be just as surprised if it collapsed tomorrow as the shocked pundits were when the USSR came tumbling down.
If and when that happens, everyone will wonder why they were focused on the width of WalMart's aisles, and didn't see the collapse of the entire chinese bank/state owned enterprise model beginning with the forced airing-out caused by WTO entrance/rules.
Oh. And if China evaporated this afternoon, WalMart would still be selling tires from Akron, Mexican flags from the Philippines, DVDs from Taiwan and cheap Weber barbecue grills made in Illinois.
Well, yes. Those loans are called US Treasury notes!
China has gone through this sort of things many,many, many times in its past. Its civil wars have shed as much rivers of blood as any notion on earth and with as much savagery.
The savings rate of Chinese citizens is extraordinarily high...Well, there go all those savings...! Amazing: essentially, the Chinese banks have been using depositors' money as collateral on all the loans.
If we have a 60 billion dollar a month trade deficit, then if our economy is growing don't we just end up shedding our growth dollars to pay for their stuff?
The idea is that, yes, you pay out $60B per month (to use your figure) to service that debt. But that money you borrowed that made that debt and that you invested returns $85B per month. So you are actually making money. Like this:
$85B monthly return on investment made with Loan #1234
-$60B monthly cost of servicing (paying back) Loan #1234
------
$25B in the clear.
The danger comes when the money you borrow doesn't go to something that will improve the way you do business and therefore give you a good return, i.e. dams, bridges, new machinery, etc.
When, instead, it goes to something that merely gets "eaten up", i.e. welfare payments, bureaucrats salaries, etc.
If the government isn't running a deficit then if we are indeed running a deficit with other countries are the banks taking on that burden?
If it is the government is running the deficit then the government is funding it by issuing Treasury bonds and Treasury notes. It uses the Federal Reserve as its "bank" -- it handles the paper work, the money, etc. etc. The Fed Rev. -- not your local bank(s)--take on the "burden".
Are they loaning money to you and me in which we then go spend on foreign goods?
By "they" do you mean the people (both foreign and Americans) that buy the T-bonds and T-bills? The answer is no. The investors are loaning their money to the government. Now your bank or credit union, on the other hand, will loan you money to buy foreign goods, like...well, like a new Accord.
If that's the case any car loan would be considered just thought. Loaned money to buy a foreign good.. but those goods are always paid off using U.S. dollars. So what's the big deal?
Loans are generally (but not always) paid off in US$ because that's what the borrower and lender agreed on. The lender wants to get paid back in Euros or postage stamps or whatever? So, that's the way it'll be if the borrower say "Sure. Okay." Besides nowadays money in these amounts at this levels are pretty much just numbers on a computer screen anyway.
So what's the big deal? In a nutshell: It's not so much how much money is borrowed as what it is borrowed for.
Sort of like borrowing $50K to buy a new widget maker for you business; or borrow $50K, take off from work for a couple of months and to go on an around-the-world cruise. Which would be better use of the money? Which would make it easier to pay back your loan?
On about a normal par with most countries. The abnormality is their extreme continuity of government and administration despite invasion, war, disease, occupation or warlordism.
China is pretty damn good at taking the long view as a result. The dangers of a large economic crash in China actually occurring are not significantly higher than anywhere else.
The dangers is that if one occurs, countries like Chinba and India are worse than elsewhere because 20% of the population angry and unemployed means several hundred million unstable angry people.
Yeah, I understand there was an internal war there in the early 20th century that had more casualties than WW1 -- hard to believe. And I'm afraid we haven't seen the last of this -- in fact, the upheavals may get worse due to the extra wealth being introduced into an already unstable environment.
I wish the Chinese people well -- like all people. But I'm afraid that a closed society is fundamentally incompatible with economic development, and they may be headed for a fall.
I agree completely. And the same thing happens with regard to wealth and poverty -- the MSM wants people to think that the "poor" in this country face hardships similar to the poor in places like rural India, rural China, and Africa.
In fact, those poor and our so-called poor have nothing in common -- and it's a real slander on this country and our capitalist system to say they do.
Our "poor" have income in the top quarter of the world's population -- that's "affluent" by any fair standard.
Unlikely. The domestic market in China is rising. It's important to realize that China is a huge country that is still for the most part agricultural. China has only unleashed 5% of its potential productivity. Even if the Chinese economy completely tanks tomorrow, the majority of the Chinese will not feel anything, so there will be very little of the horrors you described.
This article is just another extreme of the schizophrenic commentary over China (One common thesis: "China is going to take over the world in 20XX!" The other common thesis: "China is going to collapse TOMORROW!"). The reality will be somewhere in between. China will continue to lead the world's economic growth in the foreseeable future, but the Chinese growth rate will gradually decline to the Korean level toward the end of the next 20 years. Hopefully by then, China will be a freer country (as South Korea became by the late 1980s).
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