China Is Suffering A Major Financial Crisis

China’s financial crisis is getting worse. In this latest phase, Chinese banks, anticipating huge loan losses, have taken dramatic steps to enhance their loan loss reserves, tapping China’s bond markets for some 30 percent more funds than they did last year. The banks’ problems are hardly a surprise. They are in fact just another step in the metastasizing crisis that began over a year ago when the huge property developer, Evergrande, announced that it could no longer support some $300 billion in liabilities. Back then, Beijing clearly failed to comprehend what was going to happen and refused to act promptly or completely enough to stop the spreading series of failures that has since characterized Chinese finance. These failures and the crisis in general will continue to spread until Beijing acts more decisively.

What China is experiencing is a text-book illustration of how a financial crisis unfolds. Failures in one place led to failures elsewhere and the associated fears and lack of confidence make their system unable to function effectively or support economic growth at all.

The spread of trouble began the moment Evergrande announced its failure. Immediately, any firm or financial institution that counted on Evergrande’s ability to fulfill its obligations became vulnerable to loss. And, in the nature of finance, all those who counted on these others also immediately became vulnerable. It mattered not that the vulnerability was direct to Evergrande or secondary or even tertiary, all lenders and potential business partners had questions about the viability of everyone else, questions that became still more intense as other developers followed Evergrande with similar announcements.

This suspicion about others spread still further to Chinese mortgage lenders when Chinese borrowers, worried that these developers would never complete the contracted projects, threatened to stop paying on their mortgages. Since most banks were involved, this threat made Chinese depositors worry about the security of their funds, a fear that became especially acute when the Bank of China unilaterally limited withdrawals.

The financial problems have had clear economic effects. Weakness is already evident in China’s economy, which, despite still more government infrastructure spending, threatens to come in well below this year’s already reduced real growth target of 5.5 percent. Many blame the economic shortfall on the severe lockdowns and quarantines imposed by Beijing in response to Covid outbreaks. No doubt these have played a role. But the financial crisis, although underplayed by both Beijing and western media, has had a profound effect. When people fear for the security of their bank deposits, they slow down or stop spending. When lenders fear the viability of business and individual borrowers, they stop the provision of capital to otherwise promising projects. When those involved in business arrangements fear the viability of their associates, projects stop. As has become increasingly evident, all this slows the wheels of commerce and development.

The fate of Chinese steel is a perfect illustration. Because real estate developers have stopped their projects and because of a lack of credit, some 29 percent of the industry has announced that it is near bankruptcy. This is a steep decline from last year when the Chinese steel industry profitably sold billions of tons, about half the world’s output, in fact. According to Li Ganpo, founder and chairman of the Hebei Jingye Steel Group, “The whole sector is losing money, and I can’t see a turning point for now.” And these problems are naturally spreading. Iron ore prices have fallen 36 percent since March. Steel is just one example. China will continue to see these kinds of shortfalls until Beijing acts to stop the spread of failure.

Beijing could have avoided much of this economic pain if it had acted as soon as Evergrande announced. Authorities may have lent directly to short circuit what has become an inexorable spread, not to the failing developers but to others in the financial system to mitigate their vulnerability to the developers’ failures. That would have helped restore confidence and ensured that lending would continue to spin the wheels of commerce. Alternatively or additionally, the People’s Bank of China (PBOC) might have increased the system’s flow of loanable funds so that private lenders and state-owned banks would have the means to lend more aggressively and also have enough of a financial cushion to reassure customer fears about the security of their deposits. But Beijing failed to act and so financial failures and the fears of them progressed, text-book fashion, across China’s entire financial system. That progression, with its ill effects on the economy promises to become increasingly severe unless Beijing implements such policies.

Sadly, there is little sign that Beijing has fully awakened to this need. So far, the Politburo, China’s chief policy-making body, insists that local and provincial governments take the lead in dealing with financial strains. Passing responsibility in this way suggests that China’s leadership has studied Washington more thoroughly than previously thought. Cynical joking aside, this buck-passing and lack of action does China’s economy no good. In the best of circumstances, local and provincial governments would have been incapable of dealing with the scale demanded by the financial crisis. But after years in which Beijing has forced local and provincial governments to finance infrastructure projects ordained by central planners, these government entities lack the financial resources to cope with local matters, much less the needs of the nation’s financial system. Beijing is the only actor who can fill that role, and so far, it has refused to act beyond a few marginal interest rate cuts.


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