The Chinese economy is “very credit dependent”, warn GMO analysts Edward Chancellor and Mike Monnelly. Not long ago, cities like Wenzhou would see bad debts surge, and small business owners and property developers would default in droves throwing a spanner in the great Chinese economic growth story.
Credit cooled off, but only temporarily.
With the economy beginning to recover and property prices picking, credit growth is accelerating once again.
But Chancellor and Monnelly argue that there are still at least 10 indicators of “acute financial fragility” in China’s credit system. Here they are verbatim:
- Excessive credit growth (combined with an epic real estate boom)
- Moral hazard (i.e., the very widespread belief that Beijing has underwritten all bank risk)
- Related-party lending (to local government infrastructure projects)
- Loan forbearance (aka “evergreening” of local government loans)
- De facto financial liberalization (which has accompanied the growth of the shadow banking system)
- Ponzi finance (i.e., the need for rising asset prices to validate wealth management products and trust loans)
- An increase in bank off-balance-sheet exposures (masking a rise in leverage)
- Duration mismatches and roll-over risk (owing to short wealth management product maturities)
- Contagion risk (posed by credit guarantee networks)
- Widespread financial fraud and corruption (from fake valuations on collateral to mis-selling of financial products)
“Not only does financial fragility look to be on the rise, Beijing seems to be on the verge of losing control over the credit system,” they write.