Whether you are already invested in China, thinking of investing in China, competing with China or just wondering if you'll have a job in six months, the possibility of an economic meltdown in China should probably be on your radar screen. The $164,000 question is: Just how real is the possibility of a crisis in China?
The irony is that while some predict crisis in China sparked by a banking collapse that would surely lead to a devaluation of the currency as incoming investment dries up and domestic savings flees in search of security, others are calling for a revaluation of the currency to restrain China's over-zealous export growth that is supposedly wreaking such havoc in labor markets overseas. With so much noise centered on the possibility of both a Chinese currency revaluation and devaluation, could it be that the likely outcome is in the middle? That's what I'm betting on. Let's look at the pros and cons.
Other lending in China is driven by an "if you build it they will come" approach to economics, which assumes that money invested will eventually lead to money made without much regard for details such as actual supply, demand and capacity in any particular field. In other words, every village, town and province wants to build its own steel mill using OPM (other people's money) from the state, which results in massive over-investment that leads to massive oversupply and a whole bunch of failing companies that can't repay their loans. (By the way, it doesn't help that the best way to get one of these loans is to be a cousin of the mayor and a friend of the president of the local branch of a major bank and to be so generous as to be willing to share the wealth with your family and friends. Unfortunately, I have no such cousins.)
Chinese banks are in a similar situation. Their solvency depends on a growing economy coupled with continued economic and financial reform in China, including decreasing subsidies for failing state-owned enterprises and increasing fiduciary discipline and economic realism with regard to credit decisions. The former is underway and ongoing. The support system for China's SOEs is being whittled away, and SOEs are increasingly being forced to sink or swim. The latter, reform of the banking system to introduce real market forces, is behind schedule and in need of a shot in the arm. But that's not all bad. Because the government still heavily controls China's banks, it can reach out, as it recently did, grab the banks by the neck and force them to behave, at least for a while. Over the long run, real reform must occur to root out corruption, drastically reduce OPM-related over-investment, and put China's financial system on the solid footing it needs to sustain growth.
By the way, for those of you who think a Chinese financial collapse would be a good thing for America, think again. A lower Chinese currency would only add fuel to the fire of the Chinese export engine-i.e., Chinese competitiveness would increase, not decrease. Additionally, many major multinationals already derive substantial profit from China. Less profit in China means less investment and employment everywhere. The largest impact would be on Chinese imports, which, believe it or not, have been increasing at 40% per year and are our best bet to reduce our trade imbalance with China.
Make no mistake about it: A healthy Chinese economy is good for America, and vice versa. That's the beauty of the world economy. We all work together-one for all and all for one. It sure beats the heck out of what is going on in other parts of the world.