China’s problems

China’s problems in a nutshell, From Niels C. Jensen’s Absolute Return newsletter:

China’s problems….. It is faced with a decapitated banking industry, which has been far too willing to lend to all kinds of investment projects – good and bad. At the same time, the Chinese growth model has been driven by investments and exports, whereas the growth in consumer spending has been relatively modest. A few numbers to support that statement: As recently as 10 years ago, exports and investments constituted 34% and 42% respectively of Chinese GDP, i.e. less than a ¼ of Chinese GDP came from the combination of consumer spending and government spending. By comparison, consumer spending accounts for over 70% of U.S. GDP.

By 2014, investments had grown to 46% of GDP, whilst exports had fallen to 23%. The further growth in investments has been funded by rapid credit expansion in China’s banking industry, which has grown from $3 trillion in 2006 to $34 trillion in 2015. That is a shocking amount of credit in a $10 trillion economy. Now, the Chinese leadership face a big challenge. They must restructure the banking industry whilst at the same time seek to change the growth model. I can think of quite a few things that can go wrong in that process…..

The outcome is likely to be similar to Japan in the 1990s: zombie banks.
From FT lexicon:

Beginning in 1990, Japan suffered a collapse in real estate and stock market prices that pushed major banks into insolvency. Rather than follow America’s tough recommendation – and close or recapitalise these banks – Japan kept banks marginally functional through explicit or implicit guarantees and piecemeal government bail-outs. The resulting “zombie banks” – neither alive nor dead – could not support economic growth.

A period of weak economic performance called Japan’s “lost decade” resulted. Scores of companies were cast into an “undead” state – in the sense of being too weak to flourish, but too complex and costly for their lenders to shut down. Hence they remained half-alive, poisoning the corporate world by silently spreading a sense of stagnation and fear.

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