China’s annual GDP growth of 9.1 per cent in the third quarter remains the envy of the developed world. But, the lowest rate in two years shows the era of double-digit increases is at an end. China can no longer rely on using economic growth to smooth over the damage done by a financial system run amok.
Growth helped China out of a financial hole in the late 1990s, when bad loans were 30 per cent of bank assets. Lenders got new equity, and their toxic assets were popped into special, bond-funded vehicles. The $300 billion injected in three waves represented around 20 per cent of 2004 GDP. Those special vehicles probably never recovered money. However, because China’s economy has quadrupled in dollar terms since then, the missing billions have become a mere accounting footnote.
Now, the losses are bigger and more complicated. Credit Suisse estimates 12 per cent of bank loans could go bad, equivalent to 17 per cent of GDP. But, the financial system has burst its banks. The so-called “shadow banking”, including sketchy underground lending, could be 15 trillion yuan, equivalent to a third of this year’s GDP, says Societe Generale. No one knows how much of that will go bad, or in what form the government may have to plug the hole, but the bill will be high.
In the 1990s, finance provided a solution, but now it looks like the problem. The US subprime mortgage dilemma provides a grim precedent. An explosion of cheap financing helped push up growth rates. But, eventually, financing got too top-heavy. Lenders floundered and the property sector collapsed, knocking out the engine that might have helped the US grow itself back to health.
In China, the shadow system has kept property developers and small companies in business, creating jobs, houses, wages and prosperity when banks wouldn’t lend. But, if the developers run out of money, the economy will be deprived of the best way to grow out of a rut. China is in danger of following the US into a toxic financial-economic interaction.