Brad Pyles
The Global View

Ghosts of Panics Past

By, 05/13/2010

Some worry China's fast loan growth and rising property market will result in disaster. It's only natural. People see ghosts around every corner after bear markets—the ghosts of panics past. But even if you buy this crisis was primarily due to real estate (it wasn't), the next crisis will little resemble this one. And once you understand China's economic system, you'll realize there's likely little to fear in the near term in any case.

It's true China's loan growth has been rapid over the last two years as the government used its banking system to stimulate the economy. (An estimated 90% of corporate funding in China comes through bank lending.) Likely this will lead to a large number of bad loans. In fact, China will probably have more bad loans than most countries would under such conditions—the vast majority of the banking sector is government-owned and thus inherently worse at allocating capital.

However, most of the rest of China's economy is also government-owned—a whopping 70% (it is still a communist country after all). Therefore, the government doesn't need its banks to remain profitable. As long as they keep capital flowing through the economy and allow that 70% to profit overall—the government can always bail out the banks.

There simply isn't the same stigma around bailouts as you've got here in the US. In China, bailouts are routine and don't necessarily draw on tax money for funding—not when the government has so many other lucrative investments (that 70% again) to draw upon. And those investments are lucrative—the Chinese economy is growing at a blistering pace of 11.9% (Q1 2010) and recently assumed the mantle of third largest in the world. This fast growth has allowed China to recapitalize portions of its banking system four times since 1998—$200 billion in 1998 and 1999, $80 billion in 2003, $49 billion in 2008 and 2009, and has announced plans for $26 billion so far in 2010. There's no reason to believe bank recapitalization can't continue as long as growth does.

Further, the fast pace of loan growth isn't being completely ignored. Bad loan levels and recapitalizations can cause earnings dilution for bank shareholders. Too much money supply growth and you could get inflation. Not to mention China's government would prefer not to have to bail out its banks, and certainly not more than necessary. This is why the government has recently announced steps to crack down on the Chinese property market (along with some other measured monetary tightening) by imposing higher minimum down payments and restricting bank loans in high inflation regions. (Want to buy a third home? You better be prepared to pay all cash.)

Is all this hands-on fiddling the most efficient way to go about fostering growth? Probably not. The Chinese financial system is far from perfect—even clunky. At some point, one could imagine the merry-go-round creaking to a halt. But remember—China has a simply huge amount of free capacity to fill. An estimated 54% of the population is still rural and agrarian. As the population becomes more urbanized, massive gains in productivity should continue driving economic growth. And China's financial system could modernize right along with the rest of the economy—there are already some signs of this as the stock market tests advanced financial instruments, like options and futures. If the financial system doesn't eventually improve, the piper will likely have to be paid when the country has industrialized and productivity growth slows down. At that point, it'll be harder to paste over all of the system's creaky joints. But that's years away.

Is China's financial system clunky and inefficient? Yes. Show stopping? Likely not. If you're worried a collapse of China's real estate market will fuel the next global catastrophe, you're barking up the wrong tree.


*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

Click here to rate this article:

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


Get a weekly roundup of our market insights.Sign up for the MarketMinder email newsletter. Learn more.