There’s no free lunch. Not even for China.
The Beijing government has used its state-controlled banking system to provide much of the financial stimulus that has powered China to 8.9% economic growth in the third quarter of 2009.
And now the bill is coming due.
China’s big five lenders extended a huge $688 billion in loans in the first nine months of 2009. That dwarfs the government’s official stimulus program, announced in November 2008, of $586 billion in spending spread over two years.
Think about those numbers for a moment. Bank loans $688 billion in nine months. Government stimulus spending $586 billion in two years.
For months as the loans piled up, the worry has been that banks couldn’t possibly be lending at this speed and volume if they were paying any attention to the credit quality of the loans they were making. At $4.3 trillion (2008 estimate from CIA World Factbook) China’s economy is still just one-third the size of the U.S. economy (at $14.4 trillion 2008 estimate). No banking industry could throw $688 billion in loans at a $4.3 trillion economy in just nine months without making a ton of loans that will rapidly go into default. (Or would if China had a bankruptcy system.)
On November 24, the China Banking Regulatory Commission started to turn that worry into some sort-of real numbers.
The big five—Agricultural Bank of China, Bank of China (BACHY), Bank of Communications (BCMXY), China Construction Bank (CICHY), and Industrial & Commercial Bank of China (IDCBY)—have been ordered to estimate their potential capital deficits in 2010 based on their own forecasts for loans and loan losses, and to submit plans for raising any necessary capital.
Complicating the plan—and any attempt by outside investors to figure out how much capital the banks will need to raise—are uncertainties about what capital standard the China Banking Regulatory Commission intends that banks should meet. Last year the regulator raised the minimum capital ratio to 10% from 8%. Bloomberg has reported that the commission intends to raise capital requirements to 13% in 2010, but on November 23 the commission denied the Bloomberg story. However, he Wall Street Journal has also quoted an unnamed official at China Construction Bank saying the commission will raised capital rations in 2010. As of September 30, capital ratios at the five banks range from 12.6% at Industrial & Commercial to below 9% at Bank of Communications.
So how much capital will the big five banks need to raise in 2010? Estimates I’ve seen range from $15 billion to $5 billion. That’s on top of the $24 billion that these banks have already raised in 2009 by selling subordinated debt.
Of course, if the quality of the loans that these banks rushed to make to fulfill the government’s plan for economic recovery are as bad as I think they are, this $15 billion to $45 billion will be just a down payment on the final bill.
Unless the Chinese government does what it did in the aftermath of the 1997 Asian currency crisis and lets the banks sell off their bad loans at full value to specially created entities. By the way, those non-performing loans from 20 years ago are by and large still sitting on the books of those bailout vehicles.
Jimineer and Pat: It’s a question of time periods. In he near term China will continue to boom while it builds up problems. Those problems couild produce a correction (or worse) in say 2011 or 2012. But China’s extraordinary growth then resumes by say 2013-2015. And stretches until 2030 or so before hitting demographic constraints. It’s like the U.S. in 1870-1915 (although faster). Do you not invest because ther economy blew up regularly with a panic every 5 years or so? By avoiding the volatility you would have avoided the great growth story of the period. China is much the same. You’ve got to find a way to live with the volatility so you can stay on board. (Or get on board/move off/get onboard again.)
Something can be good AND bad depending on the time and space of the observer. And when I say this, I do not even factor in the effect of the observation on that thing.
The Asian 0f 1997 Chrisis put China and other countries in the “toilet”. Our memory is very short. Th be overweight on an economy that’s risin so mych and run by the 5% Elite Communist party is somewhat like investing in a 20,000 sQ’ house built on quick sand. Sooner or later, the 2nd floor will be the new first floor. The huge commercial construction there is currently experiencing up to 50% vacency. And the Govt. is financing these “White Elephants”. Is this a safe haven-not!
China, Brazil, India, Indonesia, etc. deserve a prominent place in your portfolio. (I have been heavily over-weighted foreign stocks since 2004 and very grateful.) But that doesn’t mean that every aspect of those economies is perfect or profitable all the time. One item of concern for Jim is the excessive loans from major Chinese banks. It’s not going to tank the Chinese economy. Jim mentioned that in the past, the government helped these banks deal with bad loans. Even if that doesn’t happen this time, the overall Chinese economy is still likely to outperform most western countries.
Will their market crash like the US did? Well, like most major markets, they already did. FXI dropped from the 70s Oct 2007 down to the 20s March 2009, and is now back up to 45. Jim’s advice to hold more foreign equities is sound, but large Chinese banks may not be the best place to start.
How about all the countries that we helped out in the past 70 years? Could they help us out just a little? Oh pardon me, it only works when their buts are in a sling.
I think the best part of reading your articles is kind like sit in a global economic class of Harvard. Your analysis is a great lecture for me (Engineering major) to get a picture of this world’s economic changing. Thank you! (even though, sometimes, you pick the wrong stock)
I guess there’s a fine line. Profit from China’s supposed boom as long as you can and get out once loans come due.
im w/ Jimineer…is it put $$ in China or Chinas toast???? I get the overall point which is that the US no longer dominates the markets and that as you might expect almost nobody saw it coming… but now I was all set to follow Jim and start looking for dips and places to get into Asia and China specifically and BOOM this news…well I guess when they go bad that will b the opp to jump in and wait for the Gov’t to “take the loans off the books” and keep pretending that everything is cool again…China is a proped up ,subsidized ticking time bomb of false reality…but they are cool as long as they buy our debt…right??
Jim, at 8:30am your article “How to escape the next lost decade” said to me that China, among others, is the place to invest in the future. Then at 1pm you post this article about Chinese Banks and bad loans. So if Chinese banks have he same type problems we experienced in the US, then wouldn’t most of the Chinese economy and stocks crash as well at some point in time similar to here in the US? I’m sure I’m just missing on the finer points but to me you seem to send contradicting signals – e.g. here is where the growth is, but oh the banks have all these bad loans…….
Can you perhaps tie these two articles together for numbskulls like me.
If China has financial problems, will they sell their investment in US bonds to pay these debts?
YX – We cannot ask India becuase they will not.
BillO, we should diversify our debt by asking India to buy more. Since the Indians are eager to be taken “importantly” by America or be treated as a “priority” of America, why don’t we just ask India to buy more US Treasury!
How long will the Chinese be able to buy our debt given their banking problems and social spending?
I hate to have such a morbid sense of humor, but consider this; who ever defaults on a loan in China could experience repercussions! They could be “caned” or worse. Not paying back the Chinese government is not an option. Unlike here in the US, debtors go into bankruptcy court with “finger extended” at the creditors. Who knows, there could be some missing Chinese executives in the coming months.
range from $15 billion to $5 billion.
think you meant: range from $15 billion to $45 billion…as you elude to in the next para.