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Brewing a Chinese Banking Collapse

Written By Brian Hicks

Posted October 26, 2011

Everyone whines about the Chinese “doing unto us,” what with the artificially depressed yuan and all that…

But these days, we are doing unto the Chinese — and right nicely.

Unfortunately, that pain may also flow both ways. And I’m not just talking about Washington’s threats to slap on a billion or two in new tariffs.

Let’s start our rundown in that grand old port city, Hong Kong.

We have all become quite accustomed to Chinese double-digit growth year in and year out. Indeed, the Chinese are so sanguine, they have structured their entire financial system around the care and feeding of such astonishing gains.

In a recent Bloomberg economists’ survey, the median estimate for September was for 6.5% growth. And not a one of the bean counters would guestimate a decline.

Hong Kong Freak-Out

So one can understand why they are freaking out when September sales to the United States and Mainland China fell 8.9% and 7.3% respectively. Shipments of electronics are off 16%, while outflow of T-shirts, undies, and the like fell 8%.

The HK government has described the situation as “bleak.”

Asian apparatchiks are not famed for their free use of hyperbole. They prefer vanilla words like “moderate” or “restrained.” The last time I heard “bleak” was when the Korean Chaebol were collapsing back in 1997; it was usually followed up by an abject apology to coworkers and family and a quick dive out an upper-story window.

The folks at Morgan Stanley and Daiwa Capital Markets fret that Hong Kong has already tipped into recession in the third quarter, seeing as how it saw its GDP fall 0.5% in Q2.

China Runs Out of Gas

Let’s follow this thread back across to the Chinese mainland…

As mentioned a moment ago, the Chinese are literally banking their financial lives on permanent growth.

According to the number crunchers at BlackRock Investment Institute, in 2002, a yuan of GDP growth required roughly 0.17 yuan in credit. A decade later, that figure has doubled.

It now takes 0.3 yuan in loans to generate the same amount of biz.

To give you a sense of these things, that’s like discovering your daily commuter car’s gas mileage has dropped from a fair 30 mpg highway to an awful 17 mpg. Certainly takes a chunk out of your bottom line, eh?

BlackRock’s Neeraj Seth puts it succinctly: “China has become a less profitable place to invest” when “growth requires an ever-increasing quantity of inputs.”

No wonder, then, that China’s bottom line growth is shrinking…

Screaming Bloody Murder
WD 102611 Chinese Inflation
This decrease in banking profits has all sorts of causes. 

On the one side is the immense increase the Chinese are paying for goods.

The most recent reading for Chinese inflation is September’s 6.1% per annum — down a whisker from August’s 6.2%, but certainly terrifying nonetheless as, once again, we see Chinese industry getting less bang for buck (or rather, yuan).

Beijing did make a show at slowing cost growth. A recent report out of the People’s Bank of China has aggregate financing — including bank lending, off-balance sheet loans, and bond and stock sales — dropping 11.4% to 9.8 trillion yuan ($1.5 trillion) in the first three quarters of 2011.

Can you imagine how loud Wall Street would scream if it lost 12% of its borrowing power and 6% of its purchase power? Well, that’s exactly what’s happening in China…

In the end, Premier Wen Jiabao was forced to loosen lending curbs. And China’s banking regulator announced this week it will allow a higher bad-loan ratio for small companies threatened by the lending slowdown.

Diseased Loans

Finally, let’s take a closer look at those bad loans.

Fitch Ratings estimates as much as 30% of China’s banking system loans — some $2.46 trillion all told — could go all “nonperforming” on them.

This brewing collapse harkens us back to the breakdown of the Keiretsu and Chaebol back in the 1990s. While the West’s attention was focused primarily on the well-established corrupt cronyism in Japan and South Korea, Beijing was quietly bailing out its four biggest banks to the tune of more than $650 billion.WD 102611 MCSI CFI

I’m not the only analyst around who can smell the coffee. International investors have been quietly sliding out the back door on Chinese banks for over a year now.

As of early October, the MSCI China Financials Index had lost more than half of its value!

The New Asian Contagion

Why, when we have so many troubles here in the West, do we give a rat’s behind about our chief competitor’s banking breakdown?

Over the past four years, China has created 40% of the planet’s GDP growth. Four of the world’s biggest banks by market capitalization are Chinese, and the country holds 31% of all foreign reserves.

To paraphrase JFK from way back in the dawn of the global age, when Beijing eats that big bullet, we will be Beijingers.

The Play

It’s not all doom and gloom, mind you…

While the investor in me is terrified that China’s slo-mo banking crisis will plow directly into an already-weakened Wall Street, the option trading half of my brain sees this as an opportunity to rake in put contract gains.

The Asian collapse of 1998 cost the Dow some 21% of its value in a matter of months.

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