[LINK] "China Can't Postpone the Pain Forever"

[rfmcdonald]

Bloomberg View's Michael Schuman suggests that, looking at similar situations elsewhere in Asia, China is primed for a financial crisis. Is it ready?

First of all, China would have to defy decades of history to avoid being crushed by its mountain of debt. Research firm Capital Economics analyzed 30 years of emerging-market crises and concluded that “no country has experienced an increase in its private debt-to-GDP ratio of 30 [percentage points] within the space of a decade and not experienced problems.” At best such countries endured significant, and often protracted, slowdowns in growth. China has seen an 80 percentage point jump in that ratio over the past decade, to more than 200 percent. A reckoning seems inevitable.

And the chances of that debt bomb exploding are rising, since the government, rather than defusing it, is throwing on extra TNT. Terrified of the political fallout from a slowing economy, the central bank has been loosening money; credit growth is accelerating. Meanwhile, the stimulating effect from this renewed flood of lending appears muted, a sure sign that the new cash is being used unproductively. That means the weight of China’s debt burden will continue to increase and the inevitable damage will be even greater.

Nor does it seem possible for China to avoid a monstrous downsizing of industry. Chinese companies simply churn out too much steel, coal, cement and other stuff, no matter how many roads and railways the government builds at home and abroad. That reality is slowly sinking in. The State Council announced in late January it would speed up the elimination of steel capacity, a step analysts consider necessary to repair the sector. But the cost will be heavy. The China Metallurgical Industry Planning and Research Institute has estimated that the cuts could cause as many as 400,000 steel workers to lose their jobs. Now imagine those layoffs repeated across old-line manufacturing industries.

All of these problems will eventually show up on banks’ balance sheets. Officially, the government claims that the slowdown has barely dented the stability of Chinese banks, with nonperforming loans at a mere 1.6 percent of the total. If you believe that, I’ve got some subprime mortgages to sell you. Private estimates place the potential NPL ratio somewhere between the high single-digits and as much as 20 percent.

That doesn’t necessarily mean the banks will pancake Lehman-style. Backed by the state, they'd almost certainly be rescued. But policymakers should prepare for sticker shock. By one estimate, the price tag to support the banks could reach $7.7 trillion -- or the equivalent of three-fourths of China’s 2014 gross domestic product.

Such figures may seem outrageous, but history tells us they’re not. Indonesia’s bank bailout cost the government nearly 57 percent of the nation’s GDP, while Korea spent 31 percent. If we extrapolate from Korea's experience -- which isn't unreasonable, since the country had adopted a similar investment-led growth model -- China would end up spending some $3 trillion rebuilding its banking system.