Chinese Corruption and Collapse

Chinese Corruption and Collapse

China's banking system is in a sad state of affairs. After years of high dollar rolling for their military build-up, Chinese banking and financial infrastructure, largely state owned, is on the verge of burning up. Plagued by massive corruption, greed, and narrow sightedness, the government has failed to understand the basic principals of new world finance. Then again, no one ever said it was easy to teach an old communist dog, a new democratic trick. It's hard to be a forward thinker when a line item on your annual budget is labeled: organs cut out of prisoners and sold. Ya, it's in the black too.

SEEKING ALPHA

The Inevitable Collapse of China's Banks

Chinese megabanks aren't even banks -- at least not the way we understand them. Carved out of the old Communist banking system just over 10 years ago, the state-owned banks' role has been to bankroll the government's massive infrastructure projects and to keep otherwise bankrupt state-owned enterprises [SOEs] afloat. As arms of the Communist government, Chinese banks have had no incentive to learn the disciplines of basic banking. Conversely, loan applicants never had to cobble together a business plan to get a loan -- or suffer the negative consequences of failure.

That's why it's no surprise that Chinese state-owned banks are a commercial disaster. The Chinese government has pumped over $434 billion to bail them out -- just since 1998. That's more than the GDP of banking giant Switzerland

Peek behind the Wizard of Oz's (or Shanghai's) curtain, and you'll see that China's double-digit percentage growth rates are an economic sleight of hand that have come at a price of escalating bad debt and non-performing loans. At the end of 2004, bank debt in China stood at $3.7 trillion -- about twice the size of its GDP. That's the highest proportion of any economy in the world. And that debt is lent almost entirely by state-owned banks -- and over half of it by the Big Four. Today, Chinese state-owned enterprises [SOEs] owe banks over $2 trillion -- about the size of the entire Chinese economy. And the amount of outstanding loans is growing by $500 billion each year.

Throw in China's cheap labor and you see why the Chinese are selling Honda knock-off motorcycles at the price of their weight in scrap metal in Vietnam. This may lead to impressive rates of "top-line" economic growth in the medium term. But it also leads to the kind of massive misallocation of resources that eventually brought the Soviet Empire to its knees.

This makes the coming collapse of Chinese banks inevitable. And it won't be the first time it will have happened. In the Asian crisis of 1997, two Guandong banks went belly up -- exposing the massive non-performing loans given to the Chinese red chips floated in Hong Kong.

Indeed, when Ernst & Young suggested in 2005 that banks' bad debts in China might amount to as much as $911 billion, the Chinese government quickly suppressed the report. That should be no surprise. Repressing the truth is what Communist governments are best at. But the next time you hear about China's $1 trillion of foreign reserves, remember that this world record stash is barely enough to pay off its bad banking debts. And with cheap loans financing a big chunk of China's 10%+ annual economic expansion, bad debts may approach $2 trillion before the bubble bursts.

Think of the Chinese economy like the bus in the movie "Speed." The Chinese economy is like the bus that has been rigged with explosives. If its speed drops to below 50 mph, it will explode. The Chinese authorities' challenge is to keep the bus going above 50 mph until the bomb can be (somehow) defused. If economic growth does slow, SOEs won't be able to service their debts and the entire banking system will collapse on itself. And even $1 trillion won't be enough to save it.

Here's what's worrisome. The Chinese bus will eventually run out of gas. And the Chinese economy plays a much bigger role in the global economy than it did during the Asian Crisis of 1997. China's troubles will have a much greater impact on the U.S. economy than the collapse of the Soviet Union -- an economy that accounted for less than 1% of U.S. trade in 1991.