Is China About to Cause the Next Asian Economic Crisis?
Last week, the Chinese yuan depreciated further and broke through the very closely watched level of seven yuan per dollar. This depreciation sent global equity markets into a tailspin, with the Dow Jones Industrial Average declining almost 3%.
Many market economists view the Chinese currency breach of the long-held seven-yuan level as a sign that trade negotiations with the U.S. are going poorly, resulting in the global markets selling off.
However, it may be a sign of a much more troubling problem. China has some issues eerily similar to what other Asian countries had just prior to the 1997 Asian financial crisis. That event two decades ago has been analyzed in great detail. It was triggered by a debt default of two companies: Somprasong Land (a major Thai property developer) and Finance One (one of Thailand’s largest finance companies). Currency traders began to short the Thai currency, and eventually it broke its peg to the U.S. dollar, resulting in a 40% collapse in value. This steep drop made paying back dollar-denominated loans impossible. Currency weakness spread to South Korea, Indonesia, Malaysia, and the Philippines. All their currencies declined dramatically --between 34% and 83% against the dollar. Equity markets around the world, including the U.S., experienced significant declines.
While the trigger was a debt default as financial conditions shifted, the underlying factors had long been in place – these were export-driven economies that had close government co-operation with preferred manufacturers, subsidies, favorable financial deals, massive debt-financed growth and a currency pegged to the U.S dollar. Sound familiar?
Almost all financial crises have the same underlying problem -- too much debt. China has a massive debt load. The domestic credit to the private sector banks is 161% of GDP. The 1997 crisis started in Thailand when its level was 166% of GDP. China’s total debt, which includes corporate, household, and government debt, has doubled since 2008 and is now 303% of GDP or over $40 trillion.
Another worrisome change in the Chinese financial system is its current account balance. The balance has dropped dramatically over the past 10 years and is on the verge of going negative. If it becomes a deficit, China would have to borrow foreign funds for future growth. As recently as 2007, it had a current account surplus of $420 billion, an amount equal to 10% of GDP.
The South China Morning Post reported in November 2018 that Chinese property developers face “surging refinancing demands,” as $51 billion matures in 2019. China now has $3 trillion in U.S. denominated debt. The market has started buying credit default insurance against Chinese debt, as default risk spiked this past week to its highest level in six years.
The People’s Bank of China seized the failed Baoshang Bank early this year. This was the first bank seizure in 20 years. In July, the Bank of Jinzhou had to be bailed out by three state-owned entities. And if bank failures were not causing enough pressure, in June a federal court in Washington, D.C., held Shanghai Pudong Development Bank and two other Chinese banks in contempt. The banks refuse to comply with a U.S. subpoena for bank records of a Hong Kong company linked to North Korea sanctions violations. The contempt order enables the U.S. Treasury secretary to terminate the banks’ U.S. correspondent accounts, which effectively shuts them down on the world economy.
All of this is happening as China’s economy slows to the lowest growth rate in almost 30 years and the U.S. is imposing tariffs on its exports. There is unrest in Hong Kong as protesters are marching in the streets and the wealthy are quietly moving assets and fleeing to the West.
China is clearly waiting President Trump out in the hope that he loses the 2020 election. But the Chinese economy may be in a much more vulnerable position than markets realize, and that could massively destabilize the world economy.