Many have predicted a crash in China that will occur at any moment. This has been going on regularly since the early 1990s when the Economist started the tradition. China hasn’t crashed though. Why? It’s because they have found a way to end the business cycle.
In a western economy, the business cycle starts off with lowering interest rates spurring lending increases and further lending increases via the money multiplier effect. The money supply grows, capital is built and eventually a shortage of good investments happens. More and more marginal investments are invested in. When you think of marginal investments, think McMansions in remote parts of California’s central valley. The price of the investments is driven up by the increasingly available capital. Eventually capital stops growing and capital built in anticipation of further credit growth cannot sustain itself or find a buyer and this causes loans to default. This causes the money multiplier to work in reverse and crash the system. The banks foreclose on home owners. Eventually there is a banking crisis and the government must borrow money to bail out the banks. In the U.S, taxpayers get stuck with the bill for this.
In China, the same thing happens, but when the loans start defaulting, the government prints up the money and buys the bad debts. Thus, in China, nobody gets stuck with the bill except for Yuan holders and there is upward pressure on the Yuan because they are net exporters. The Japanese are net exporters, but they weaken the Yuan by buying treasuries. China does this to some extent, but lately they haven’t been increasing their treasury position as much as they used to.
There are problems with the Chinese approach. The main one is moral hazard. If banks are not allowed to fail they will make insanely risky bests. This is why China makes sure that the banks follow strict lending guidelines. For instance, China will issue a decree that since the housing market is overbuilt that no loans will go to new cement production plants. In this way, in China, banks are partially privatized central planning. What about politicians using their influence to benefit themselves? The Chinese have found a way to prevent corruption such that it undermines the financial system. The death penalty is regularly given out for financial crimes, while nobody went to prison for the 2008 fraud except for one or two small lenders. That’s not to say that there’s no corruption in China, it’s just managed well enough that it doesn’t undermine the system.
What does this say about our banking system though? Why do we do this boom/bust cycle to ourselves? I think generally it’s a clever little game that the bankers use to get other people to create assets that they then take from them and resell to their friends with newly created money after the bank bailout and business cycle reset. It’s a power consolidation mechanism for the economy that regularly transfers property from those who get access to credit later to those who get access to credit earlier in the business cycle. A lot of people have discovered how the whole thing works throughout the last 100 years and it hasn’t really changed much. In the west, it’s the bankers world and we only live in it, so it’s good to understand it and master business cycles to be a better investor. Nevertheless, China has a different model and until western analysts recognize this reality, they’ll never be able to predict anything about China’s economy. Doing so would acknowledge that there is some fundamental oddness about how things work in the west and this is too big of a red pill for most of them to swallow.