China, like Japan in the 1990s, Will Be Dominated by Huge Zombie Banks

-edited

Michael Pettis has some words of wisdom for those who believe China will soon overtake the US as the world leader.

"Having the smaller banks absorbed by the bigger ones, which seems to be Beijing's new strategy, will mean that China, like Japan in the 1990s, will be dominated by huge zombie banks," says Michael Pettis at China Financial Markets in a series of Tweets.

The Tweets were in reference to the Wall Street Journal article Why China’s Smaller Banks Are Wobbling.

China’s banks come in various flavors. There are a handful of giants, and a few more medium-size banks that can also operate nationally. Below that lies a bigger cohort of city commercial banks, and more than a thousand tiny rural commercial lenders. Both city and rural banks have their roots in local credit unions, and tend to have limited geographic reach. Cracks are emerging at some small and midsize banks after years of rapid growth.

Smaller banks lent liberally to local governments and businesses, and bad debts are rising as China’s economy sputters. Poor governance probably created problems at some banks, too, such as Hengfeng Bank. In late 2017, the official Xinhua News Agency, citing a company statement, said Hengfeng Chairman Cai Guohua was being investigated for “alleged serious violation of discipline and law.”

Possible state intervention depends on how large and important a bank is, and who is backing it. In May, national authorities seized Baoshang Bank, a lender in the northern province of Inner Mongolia that was linked to missing tycoon Xiao Jianhua, calling it a “severe credit risk.” This was the first such takeover in more than two decades. In contrast, a big bank and two bad-loan managers bought stakes in the struggling Bank of Jinzhou from existing shareholders. Industry-watchers expect capital injections to follow.

Many banks aren’t profitable enough to boost capital through retained earnings. And existing stockholders may be reluctant to buy new shares, given questions over reporting and ownership.

Zombification Four Point Synopsis

Forget the Yuan: King Dollar is Here to Stay

Many believe deficit spending will kill the US dollar as a reserve currency and the yuan will take over.

They are wrong. Forget the Yuan: King Dollar is Here to Stay for quite some time. I don't know what the replacement will be if any, but it won't be the Yuan.

The having the reserve currency is actually a curse that no one wants, especially China, but also Trump.

My "correct" is in reference to the first two sentences not the third about impeachment. There should not be a Fed.

Reserve Currency Curse

For further discussion, please see Nixon Shock, the Reserve Currency Curse, and a Pending Dollar Crisis

Meanwhile, negative interest rates are destroying the European banks as noted In Search of the Effective Lower Bound.

The Fed and Central Banks brought this on by refusing to let zombie banks and corporations go under and insisting on cramming more debt into a global financial system choking on debt.

The central banks want to stop "deflation"

Economic Challenge to Keynesians

Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.

My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

BIS Deflation Study

The BIS did a historical study and found routine deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Deflationary Outcome

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Mike "Mish" Shedlock

Comments (20)
No. 1-11
Sechel
Sechel

Doesn't have to end this way and I think Pettis may have suggested it. China could encourage the write-down of bad debt. China has the advantage of not being a democracy and beholden to special interests. It's not like they don't know what they should do they've clearly studied the problem.

My feeling is that this all comes down to whether China is willing to endure the short term pain for the medium and long term benefit. It sounds like an easy decision to make but it really isn't. Enduring short term pain is never an easy solution.

Stuki
Stuki

While the BOJs lunatic acts have prevented the zombie banks from defaulting publicly, it has not prevented them from being left to play a much lessened role in resource allocation now, than they did before they became recognized as zombies.

China, being a communist country, probably won't be content with that. Since, very much unlike Japan (but unfortunately very much like America by now....), its "elites" all owe their wealth, status and power almost exclusively to the government machinations that created and maintains the debt growth and inflation in the first place. Almost complete rule and ownership by abject incompetents, is just not very confidence inspiring as far as ability to solve even fairly simple problems go.

Even at the height of the Japanese bubble; world leading, competitive industrial and technology giants were still the primary source of wealth and influence there. Tokyo, for a brief period, had it's (increasing) share of wealthy FIRE sector clowns doing what clowns are intellectually limited to do, but not enough of them, nor for long enough, to dominate discourse nor resource (mis)allocation the way they can, in societies like China and the current US, where regime dependent clowns are pretty much all there is.

So, just as is the case for the US, Argentina pre Corralito is likely a better model for China, than Japan. Argentina was also once wealthy, fast growing and competitive. But had fallen prey to the idiotic delusion that successive Dear Leaders can do beneficial things if you only cheer for the right one (with the right bimbo by his side). Which, as always, allowed those Dear Leaders to take advantage, by burning every seedcorn prior generations had built up. Leaving nothing but a hollow shell propped up by a confidence trick.

China may be different (Obvious competence at something useful in organizations like Huawei, is definitely more than Argentina had by 2000...), but I seriously doubt there is enough of that, to counterweigh the sheer size of the privilege and patronage network which have grown up around The Party's rather unconstrained theft-by-inflation policies.

Casual_Observer
Casual_Observer

This is a joke. There are bad loans in all modern banking systems. The real joke is that it takes so many words to state the obvious. The banking system is backstopped by central governments and debt will be monetized as needed.

Bam_Man
Bam_Man

China had better get its act together with respect to Quality and Intellectual Property Rights, or they will lose customers (which is already happening) and then entire markets. In that scenario, Zombie Banks would be infinitely preferable to what they will actually wind up with.

JonSellers
JonSellers

"It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results."

You'll be happy to know, Mish, that this is also the exact kind of deflation John Maynard-Keynes was concerned about. He had little concern for the day to day deflation created by increased efficiencies. So you and Keynes are like twins here.

Where you differ is probably in how to approach mass debt deflation. I'm guessing in Mish-world it would be to let the debt deflationary spiral find its bottom through bankruptcy and unemployment. Keynes solution was to have the government pay workers to bury jars full of cash and others to dig them up, until as such a time as the spiral finds a bottom. Knowing that the workers income would keep them afloat and adjust the bottom a bit higher.

I prefer to just shoot the bankers, take their wealth and women.

Tony Bennett
Tony Bennett

"Having the smaller banks absorbed by the bigger ones, which seems to be Beijing's new strategy, will mean that China, like Japan in the 1990s, will be dominated by huge zombie banks,"

...

And?!? ... "and" like water is wet.

Naturally, the US is/will follow the path of these trailblazers.

I had to laugh back in 2008/2009 on the machinations of the Obama Administration to keep our zombies on life support. One of the head honchos was Larry Summers ... the very same Larry Summers who in the 90's (as Clinton assistant Sec of Treas) chastised Japan for allowing its banks to become zombies ... and how the US banks were envy of the world.

My my, how things change when shoe on other foot makes an appearance.

Country Bob
Country Bob

There is only one bank in China now.

Sure, some of the branches have different names. But they are all part of the Communist Party. That is the law in China, and its also the practical reality.

Lawyers will bicker over corporate licenses and logos and other nonsense -- but in practical terms its always really been one single bank.

And yes, the Bank of China is mostly living dead.... but I suspect China's bank has more life in it (percent of total) than the zombies of Europe. Actually, that is more than a suspicion -- Europe is mostly dead already.

All the big banks of Europe are really wards of their respective states now. And they move at the speed of government bureaucracy, they don't matter in global affairs.

China has a lot of dead / zombie parts, but they still matter -- a lot more than Europe does.

Knight
Knight

The entire banking system is Zombie—that’s true everywhere. One only needs to look at the current state of interest rates and QE, or “non-QE” as it is now being called. China’s problem is China. It’s version of corruption and property rights, for example, come at the expense of the rest of the corrupt players around the world. That version of corruption is not a long term strategy. 100 years from now, Goldman Sachs will still be cutting deals, I’m not so certain about China.

KidHorn
KidHorn

Japan had/has a lot of banks with bad loans on the books. But that's now what killed their economy. The economy died because the ordinary citizens were up to their eyeballs in debt and realized they needed to start paying it back instead of borrowing more. Many had 100 year mortgages on domiciles that were seriously under water.

The same thing will happen in China. And eventually in the US.

Ivorin
Ivorin

Mish wrote, "It’s asset bubble deflation that is damaging."

I contend that even before an asset bubble deflates, the damage has already been done. The very rise of bubbles permanently misallocates capital and wastes resources. Such resources are gone forever, like spilled milk or water under the bridge.

The various extend-and-pretend games played by government fiscal, regulatory and monetary machinations just compound the errors and increase the waste.