I have remarked before on my total lack of trust in Chinese financial and economic statistics. It is not because I am some sort of financial guru with access to inside information, it is simply the fact that the Chinese government controls, or thinks it controls, everything that happens in China. Certainly it wields huge power and that in itself is cause for cynicism and worry because when did politicians of any color ever run anything efficiently? Ever since the '08 crash the Chinese government has been allowing credit to let rip through the state-owned government banks. With all that loose credit sloshing around all sorts of dodgy deals have taken place. As Gordon G. Chang explains at Forbes.com:
In short, China’s growth since the end of 2008 has been dependent on ultra-loose credit first channeled through state banks, like ICBC and Construction Bank, and then through the WMPs, which permitted the state banks to avoid credit risk. Any disruption in the flow of cash from investors to dodgy borrowers through WMPs would rock China with sky-high interest rates or a precipitous plunge in credit, probably both. The result? The best outcome would be decades of misery, what we saw in Japan after its bubble burst in the early 1990s.
The news over the weekend is that just such a disruption is likely:
On Friday, Chinese state media reported that China Credit Trust Co. warned investors that they may not be repaid when one of its wealth management products matures on January 31, the first day of the Year of the Horse.
The Industrial and Commercial Bank of China sold the China Credit Trust product to its customers in inland Shanxi province. This bank, the world’s largest by assets, on Thursday suggested it will not compensate investors, stating in a phone interview with Reuters that “a situation completely does not exist in which ICBC ICBC will assume the main responsibility.”
When push comes to shove, of course, it may be that the Chinese government will lose its nerve and re-imburse the investers but this will simply be an illustration of the hopeless dilemma in which the Chinese politicians find themselves, as Mr. Chang explains succinctly - and it is worth following his well-reasoned argument [with my emphases]:
Most analysts don’t worry about a WMP default. Their argument is that the People’s Bank of China, the central bank, is encouraging a failure of the Zhenfu product to teach investors to appreciate risk and such lesson will improve the allocation of credit nationwide. Furthermore, they reason the central authorities would never allow a default to threaten the system.
Observers make the logical argument that “to have a market meltdown, you have to have a market” and China does not have one. Instead, Beijing technocrats dictate outcomes.
That’s correct, but that is also why China is now heading to catastrophic failure. Because Chinese leaders have the power to prevent corrections, they do so. Because they do so, the underlying imbalances become larger. Because the underlying imbalances become larger, the inevitable corrections are severe. Downturns, which Beijing hates, are essential, allowing adjustments to be made while they are still relatively minor. The last year-on-year contraction in China’s gross domestic product, according to the official National Bureau of Statistics, occurred in 1976, the year Mao Zedong died.
Why will China’s next correction be historic in its severity? Because Chinese leaders will prevent adjustments until they no longer have the ability to do so. When they no longer have that ability, their system will simply fail. Then, there will be nothing they can do to prevent the freefall.
What was it some Chinese chap said about living in interesting times?