Forget Greece — the bigger financial crisis is in China
WHILE all Western eyes remain firmly focused on Greece, a potentially much more significant financial crisis is developing on the other side of the world.
In some quarters, it’s already being called China’s 1929 — the year of the most infamous stock market crash in history and the start of the economic catastrophe of the Great Depression.
In any normal summer, a 30% fall in the Chinese stock market after an ascent which had seen share prices more than double within the space of a year would have been front-page news across the globe.
The dramatic series of government interventions to stem the panic would similarly have been up there at the top of the news agenda.
Yet the pantomime of the Greek debt talks, together with the tragicomedy of will they, won’t they leave the euro, has relegated the story to little more than a footnote.
The parallels with 1929 are, on the face of it, uncanny. After more than a decade of frantic growth, extraordinary wealth creation and excess, both economies — the US in 1929 and China today — are at roughly similar stages of economic development. Both these booms, moreover, are in part explained by rapid credit growth. Borrowed money, or margin investing, played a major role in both these outbreaks of speculative excess.
True, the Chinese stock market bubble is only a one-year wonder, whereas the build-up to the Wall Street crash of 1929 was more sustained. Even so, the comparison still holds.
As noted by JK Galbraith in his classic account, The Great Crash 1929, even as late as 1927 it was possible to argue that American stocks represented fair value. It was only in the final year that the “escape into make-believe” happened in earnest, when the stock market rose by nearly 50%. This applies to the Shanghai Composite, too. Stripping out the lowly rated banking sector, valuations for just about everything else have rocketed.
Nor do the similarities end there. As in 1920s America, China’s stock market boom has ridden in tandem with an equally speculative real estate bubble. The macroeconomic backdrop is also surprisingly similar. Then, as now in China, rural workers had migrated to the cities in vast numbers in the hope of finding a more prosperous life in fast-growing industrial sectors. In 1920s America, virtually all these sectors — from steel to automobiles — grew like Topsy, inspiring households to invest in them and chase the apparently bountiful profits they were generating.
A similar explosion in industrial activity has taken place in China, only more so. It has packed more development into a few short decades than any country in recorded history before, creating a worldwide glut in industrial capacity that even global demand, let alone domestic Chinese demand, is struggling to accommodate.
Already, there are warning signs of a slowdown, similar to those that front-ran the 1929 crash — depressed commodity prices and a virtual hiatus in global trade growth. The Chinese economy is like one of those cartoon characters that manages to keep running long after leaving the edge of the cliff, only belatedly to look down and plunge into the abyss.
Naturally, there are many dissimilarities too, not least that China is still essentially a planned and centrally controlled economy which has so far managed to defy the usual rules of economics. The consensus is that this time will be no different, that even if the stock market does continue to crash, the impact will be no worse than 2007-08, when the Shanghai Composite fell by two-thirds. Yet after a massive fiscal and monetary stimulus, the wider economy barely lost a beat. Have no fear, the Chinese authorities have it all under control.
I don’t buy it. Indeed, I can see very little evidence for China’s technocratic elite having things under control. The firebreaks that China put in place last weekend to mitigate the panic are, in practice, not much different from those applied during the Great Crash of 1929, only this time it’s public rather than private money that promises to quell the fire.
They failed spectacularly in 1929. This time around, they’ve thrown the kitchen sink at the problem, but so far it has produced only a mild and wholly unconvincing rebound.
Besides, China cannot keep answering each successive bubble by creating another. First it was gold, then housing, and when cooling measures threatened an all-out bust in the property and construction markets, the taps were turned on afresh, producing a further flood of money into the stock market.
The authorities were happy to tolerate the bull market at first, hoping it might encourage a switch from debt to equity financing, but there seems little chance of that now. The stock market boom has only succeeded in adding to the debt.
Whether any of this turns into a calamitous economic meltdown obviously depends on the rest of the response. Policymakers have learnt a thing or two since 1929; we now know that the real damage in financial crises is done not by the crash itself, but by a collapsing banking sector. Stock markets are only a signal of credit contraction to come.
Even so, I doubt China has as much of a handle on its banks, and more particularly its shadow banking sector, as it pretends. — © The Daily Telegraph, London