China today is not the Lehman Brothers of 2008. It was the collapse of Lehman that triggered Wall Street’s giant margin call. Global selling ensued. Equity markets crashed.
My old friend in Australia, Greg Canavan, shows why the problem with China in 2016 is not the same as the problem with Lehman in 2008. Greg writes that:
“The problem with China is that its banking sector expanded way too quickly. According to fund manager Kyle Bass, China’s “banking system used to be ¥41trn only eight years ago and now it’s ¥184trn. They have $31trn of assets in their banking system. Their economy is $10trn”. If Bass’s numbers are accurate, that represents a 350% expansion in bank assets in just eight years. That’s a compound annual growth rate of 20%! No banking system can allocate capital productively at such a growth rate. That means there is a huge amount of bad debt in China’s banking system. The turmoil you’re seeing in China now is an early symptom of this.”
Why is it not Lehman? At the peak of the debt bubble in the US (in 2008) bank assets were about the same size in US GDP. China’s debt is nearly three times the size of its economy. That means the productive part of the economy has to grow and produce income in order to service the debt. If it can’t, Greg says you’ll get rising defaults, credit contraction, and intervention by the government to prop up bank balance sheets.
Is all this a problem for the rest of the world? Well yes, but not in the same way Lehman triggered a global sell off. The problem here is more long-term. China’s credit expansion and GDP growth drove commodities demand. Its trade surpluses drove down US interest rates and contributed to the bond bull market. In one way or another, everything that happened in China contributed to growth in global trade, cheaper credit, and demand for commodities.
Now that it’s burdened with massive debt, and now that its central planners have been exposed, it’s beginning to dawn on investors that there is no obvious replacement. If China isn’t the engine of global growth, what is? Europe? America? Technology? Netflix?
The alternative is that there is no obvious or immediate successor. QE won’t do it. Lower energy prices haven’t done it. Maybe what you get after a global debt binge is a global hangover. The economic symptoms of that are lower growth and debt deflation.
The investment argument for that world? Normally it would be bonds. But with low rates, the only real non-growth alternative left is… cash. And you wonder why there’s a war on it.
Category: Economics