How Bad Is The Chinese Economy?

Earlier this year I wrote a piece on the potential for a Chinese banking collapse along the lines of the Japanese recession of the 1990s. Now, The Australian reports that China has over 1 trillion in non-performing loans (NPLs):

According to Ernst & Young, the accounting firm, bad loans in the Chinese financial system have reached a staggering $US911 billion ($1.18 trillion), including $US225 billion in potential future NPLs in the four largest state-owned banks.

This equals 40 per cent of gross domestic product and China has already spent the equivalent of 25-30 per cent of GDP in previous bank bail-outs.

The revelation shows that half-hearted reforms have addressed merely the symptoms of China’s financial fragility. Poor business practices are blamed for NPLs but the real source is political. As long as the communist party relies on state-controlled banks to maintain an unreformed core of a command economy, Chinese banks will make more bad loans.

Systemic economic waste, bank lending practices, political patronage and the survival of a one-party state are inseparably intertwined in China. The party can no longer secure the loyalty of its 70 million members through ideological indoctrination; instead, it uses material perks and careers in government and state-owned enterprises (SOEs). That is why, after nearly 30 years of economic reform, the state still owns 56 per cent of the fixed capital stock. The unreformed core of the economy is the base of political patronage.

China’s transition from communism to crony capitalism hasn’t done all that much to diminish the centralization of the Chinese economy – the Politburo and other government officials are still the main economic movers and shakers in the country. China’s nomenklatura basically can rob the system blind, and no one bats an eyelash. This sort of endemic cronyism and corruption is one of the major factors that caused the Japanese banking crash. If such a thing were to happen to China, it would have major repercussions across the world economy.

China’s rapid industrialization has come at the expense of financial transparency and accountability – which means sooner or later China’s meteoric rise could be followed by a precipitous fall. The Chinese government needs to get the lending practices of Chinese banks under control – which will require some rather deep structural revisions to the way the Chinese economy is run. A banking collapse in China would quickly spread, leaving havoc in its wake. Ultimately Beijing must reform or sooner or later the foundations upon which China’s economy is based will collapse right out from under them.

2 thoughts on “How Bad Is The Chinese Economy?

  1. Several major American and European banks have already purchased shares in China’s four national banks that are large enough to get them automatic seats on the board- the goal is to put western banking knowhow to work in reforming the Chinese system in order to avert such a crash. (I hope it works, but my fingers are crossed pretty tightly.)

  2. India’s long-term economic prospects are infinitely stronger than China’s for a number of reasons. I’m not anticipating 1% growth rates for the Chinese economy anytime soon, but I’d be surprised if five years from now it’s still generating the headlines for blistering ascendancy that it is today.

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