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Sunday, July 02, 2006

The Chinese Economy : Clear Warning Bells

Gary D. Halbert sees a disaster about to explode in the Chinese economy. In a well researched article, he highlights:

While it has become an article of faith that China's economy is booming & the economy is seen as growing rapidly- he points out that growth and size alone don't tell you how healthy an economic entity is. Chinese numbers are a paradox: Most analysts believe China's GDP is running at a 9-10% annual rate or higher. Industrial output in China surged 17.9% in the 12 months ended May. China's exports mushroomed by 25.1% in the 12 months ended May. Domestic retail sales soared 14.2% in the last year. Meanwhile, China's M-2 money supply exploded by 19.1% over the same period. In short, China's economy is out of control!
He adds,perhaps worse, China is facing the threat of an enormous banking crisis. As the economy has exploded, Chinese banks have made mountains of loans to borrowers of all shapes and sizes, and today many of those loans are non-performing and will have to be written off at some point. The irony is that virtually all of the major banks around the world are heavily invested in China and have non-performing loans on their books as well. The problem is the massive overhang of debt, and in particular, troubled loans. Looked at from the standpoint of Chinese corporations, servicing this debt is a tremendous burden. Looked at from the standpoint of Chinese banks, the loans threaten the banks' viability if they become nonperforming. The solution of Chinese companies is to sell more products to generate cash to pay off the loans. It is difficult to sell into the Chinese economy because of high savings rates, driven by government policies and economic insecurity. The Chinese government needs a high savings rate to help stabilize the banks; dramatically increasing domestic consumption would undermine the savings rate, threatening the banking system just as surely as defaulting loans would. The solution for these companies, therefore, is to increase exports. In a world already saturated with Chinese exports, the only way to increase cash flow is to cut already low prices. That increases cash flow but does nothing for profitability. In other words, companies already saddled by debt burdens cut into (or below) profit margins to service the debt. Banks not wanting to declare bad portfolios arrange to lend more money to troubled enterprises. This allows some repayment of old debts, but simply puts off the day of reckoning on all sides (and increases the magnitude of reckoning when it arrives). Substantial portion of the loans disbursed by the Chinese banks this year is said to have gone to keep bad loans floating, like using one credit card to pay the monthly payment on another. You can do that for a while, but you can't do it forever.Thus, bank lending accelerates at a breakneck pace - not going into market-driven opportunities, but maintaining essentially failed enterprises for a while longer. Production surges at lower prices and the entire process moves faster and faster. For the Chinese government, Slowing down is dangerous and speeding up disastrous.
China may be an economic and financial disaster waiting to happen. Virtually every economic indicator we see -- with allowances given for uncertainties in Chinese statistical methodology, to put it politely - is surging out of control.

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