In the global economy these days, there are known unknowns, unknown unknowns, and then there’s the Chinese credit market.
On the heels of Federal Reserve Chairman Ben Bernanke’s announcement Wednesday that the Fed is set to ease its program of large-scale bond purchases, global markets have been in turmoil, which has only been exacerbated by a sudden spike in the Shanghai interbank offer rate. That rate indicates the willingness of banks to lend to one another, and its surprising rise on Thursday has reinvigorated fears that the Chinese banking system is far more rickety than Beijing would like to let on.
The problem is that very little is known about just how much debt Chinese banks have taken on amid that country’s infrastructure-fueled growth. This has resulted in fears that a massive credit bubble may be about to pop. If that’s true, the results could be catastrophic.
The questions regarding the health of the Chinese banking system turn on whether its financial institutions have taken on too much debt too quickly and whether a slight slowdown in the country’s economy could prevent debtors from making good on their loans. Much of China’s economic growth at the municipal level has been underwritten by rising real estate prices, and if the torrid growth of those prices begin to taper, bank collapses are not out of the question, a scenario not unlike the 2008 financial crisis in the United States.
Just have a look at this chart of the rate in question, the Shanghai Interbank Offer Rate, or SHIBOR, from Barclay’s:
Charlene Chu, a senior China analyst at Fitch, has emerged as a leading Cassandra on the Chinese economy, and on Friday she released a report estimating that over the course of the last 10 days of June, Chinese banks will face nearly $250 billion in obligations related to wealth management products. The unwillingness of Chinese banks to lend to each other, she argues, may leave them struggling to meet those obligations. Chu estimates that these wealth management products may total as much as $2 trillion, and because they include short-term payouts may result in Chinese banks facing severe short-term capital shortfalls, a scenario that calls to mind the bankruptcy of Bear Stearns in 2008. Earlier this week, Chu released a report describing the Chinese credit bubble as unprecedented in world history.
But the pressures on the Chinese economy are not occurring in isolation. Bernanke’s decision to begin to scale back the Fed’s massive stimulus program means that the global economy will soon be deprived of an enormous amount of liquidity. Following the Fed’s so-called quantitative easing program, developing economies were flooded with cash, fueling recent economic booms in Brazil and Turkey. The program’s end may herald a giant sucking noise of capital leaving these developing economies and returning to recovering Western economies. It should come as no surprise that both the Turkish and Brazilian markets were hammered this week.
This may spell bad news for Chinese banks. For years, skeptics of the Chinese economic growth miracle have argued that the country’s municipalities have taken on enormous debt and placed it investment vehicles off the official books. As a result, no one really knows how much debt China has taken on in the process of achieving astounding economic growth rates over the past decade. Though Bernanke is stepping off the gas pedal because he believes the U.S. economy is finally beginning to recover, Chinese leaders are trying to figure out how to keep the economy growing, a problem with no obvious solution.
The news that China’s banks may have grown reluctant to lend to each other only adds to the storm clouds on the horizon.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University and a senior editor at The National Interest. Prior to Fletcher, he taught at the University of Chicago and the University of Colorado at Boulder. Drezner has received fellowships from the German Marshall Fund of the United States, the Council on Foreign Relations, and Harvard University. He has previously held positions with Civic Education Project, the RAND Corporation, and the Treasury Department.| Daniel W. Drezner |