Blogs & Comment

Chinese banking crisis on the way?

The (surprising) trouble with export-led growth.

An investor reacts as he looks at the stock price board at a private security company in Shanghai, China, Monday, May 16, 2011. Mainland Chinese shares lost ground Monday following the latest increase in the central bank’s reserve requirement for banks, which was announced late Friday (Photo: AP/CP)

Chinese banking regulators announced this week that approximately $400-billion (U.S.) in bad loans made by Chinese banks to local governments will be transferred to the central government. This bailout shows that the bad-debt picture in China may be “even worse than investors feared,” writes columnist Wei Gu.

There is, she adds, also a “moral hazard” in shielding bankers from the consequences of their actions. It creates incentives to embark on more lending binges.

CIBC World Markets strategist Peter Gibson has been expecting a banking crisis to hit China sometime by 2013. Could we be seeing the first tremors?

The trouble with export-led growth strategies is that they are not sustainable over the long run. Japan found that out in the 1990s, and China will likely discover the same this decade.

Suppressing one’s currency delivers a few years of dramatic growth but leads to problems with overheating, excess credit and inflation—as happened in Japan and is now happening in China.

When domestic prices and wages spiral upward, they cancel the competitive advantage of a low currency because domestic cost structures are ratcheted upward. The inflation can be reined in by letting the currency appreciate but that too, of course, sacrifices export-led growth. In short, the strategy is ultimately self-defeating.

Gibson believes China has the capacity to manage a banking crisis. But the adjustment path, which calls for replacing export-led growth with domestic sources of growth, will not likely be a smooth one.