Harvard University economics professor and chess grand master, Ken Rogoff, has estimated that China’s banks are carrying bad debts of around four to five times the official numbers of 1.5% (of bank assets). Speaking at the World Economic Forum in Davos, Professor Rogoff said China’s financial stability was at risk and that China could be the last big domino to fall as the “global debt super cycle” unwinds. He believes that bad debts are running between 6% and 8% and the banks are disguising the problem by rolling over bad loans with some “collusion” from regulators.
Bad debt levels of this magnitude would effectively wipe out the capital base of many Chinese banks and create a massive problem for banks and investors around the world with Chinese bank exposures.
China’s problems are a major topic of discussion amongst investors as it also fights hard to defend its currency, spending the hundreds of billions of US dollars of its foreign reserves in the process. Foreign reserves are understood to have dropped from around USD$4 trillion to around USD$3.3 trillion as it battles a huge currency flight from the country.
There are large forces at play with China’s yuan now a part of the elite IMF reserve currency regime, the communist party desperate to maintain economic growth to retain control of the country and manage the shift from being an investment based economy to being a domestic consumption based economy. In addition the global currency wars where countries are devaluing their currencies in order to generate export growth are playing havoc with stability in the global economy.
The authorities in China have been accused on mismanaging the signals on their economy and massaging the key economic numbers. This has manifested itself in volatile share and exchange rate markets, leading to nervousness about the ability of China’s inexperienced administrators to handle such challenges.
2016 has begun with historic levels of volatility in global markets. China is a key cog in how this volatility plays out and investors will scrutinise every piece of news regarding China for signs that the situation remains under control. Investors should hope that the Chinese authorities pull the right economic levers as the alternative would likely export deflation around the world.