China doesn’t get much coverage on Weakonomics because it’s not really my specialty. But the country is also so big and vast that it’s hard to pin down a story simple enough for the few words I commit to a post. But China may be experiencing something similar to what we were dealing with a few years ago. The Washington Post has a pretty good article explaining the country’s potential troubles; you’ll need to read it to understand how this could impact the US. Here are the main points on China compared to what the US went through:

It’s not the people borrowing crazily so much as it is local governments: In China, there’s little worry about people borrowing too much. There is a cultural aversion to debt. But, local governments have been taking on debt like crazy. This is being used for all types of projects, infrastructure and housing being the easiest examples. These smaller and localized governments need people and economic activity to develop the tax revenue that pays off the debt. It’s not happening.

The people are actually lending crazily: Part of the problem is China’s massive savings rate. The Chinese save money like an American couldn’t believe. But interest rates on those savings are practically nothing. So banks have begun offering more complex financial products to attract deposits. Those deposits are then invested with longer-term and riskier loans. The banks need a continued flow of deposits to keep up the pace of activity. If and when it slips, or if and when the loans default, there will be trouble.

Cheap economic growth is harder to find: For decades the Chinese have been expanding and modernizing their economy. Farmers and rural people have moved to the cities to find work in factories. Infrastructure and housing were built, and the return on investment was quite good. But now most of the low hanging fruit has already been developed. So each incremental project is more expensive and provides less value. There’s a tipping point at which it’s no longer worth the effort to continue building.

The moral hazard is different: Remember moral hazard? It was the buzzword of 2010. And it partially explains the financial crisis. It’s basically the idea that investors and bankers alike both pretty much knew that if something happened to the banks that the government would step in and either save them or keep the industry afloat. It’s a little different in China though, because the government already owns the banks. So the banks may be engaging in reckless behavior, but the government already owns them. How this relationship plays out in a crisis isn’t yet known.

A bubble pop might push China towards the next step in economic development: China’s economy is one based on investment and capital spending. The US’s economy is based on consumption. The difference is supply and demand. In the US, when we have demand for goods or services the supply will adjust to reach it. In China, they’ve been building all the supply and then waiting for demand to follow. Neither method is perfect, but gauging investment decisions based on the prevailing demand of the economy is probably the more stable method. China recognizes this and the powers that be are trying to shift the economy towards more consumption. A financial crisis, while not desired, might shift them in that direction faster.

Read: China’s economic slowdown emerges as risk to U.S. economy (Washington Post)

Image: Chen Qu

Be Sociable, Share!
categories: banking