Zeev how are you? I hope fine.
An interesting thing from Yahoo today...
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CHINA
Financial meltdown looms if confidence fails
By DAVID LAGUE, Herald Correspondent in Hong Kong
Packed in tightly behind its towering city walls, the ancient city of Pingyao has been mummified in the dusty poverty of the Chinese agricultural heartland.
Its wealth long drained away, the interlocking networks of Qing Dynasty courtyards and lanes which once housed 22 thriving banks, nearly half the national total in the late 19th century, remain remarkably preserved in the Shanxi countryside, south-west of Beijing.
The local tourist office official, Mr Zhao Jianwen, guides visitors through the former headquarters of the Ri Sheng Chang, once China's biggest bank, which now serves as a museum to lost prosperity.
He explains that the banks here had branches all over China and even overseas but they suffered from their close links to the Beijing authorities early this century as the corrupt Qing Dynasty sank into terminal decline.
"In those years, there was a lot of lending to the government but they were not able to pay it back," he said.
"Eventually, the banks were bankrupt."
Pingyao's failed bankers would find much in common with their Chinese counterparts today, as the Beijing Government orders the big state-owned banks to pour yet more funds into loss-making, state-owned enterprises in a desperate bid to head off soaring unemployment and keep a promise to maintain 8 per cent economic growth.
This surge in lending, part of a proposed $US1.2 trillion ($1.98 trillion) government spending splurge over three years, is threatening a banking system already buried under a mountain of bad debt and there are growing fears that China is now increasingly vulnerable to a South East Asian-style financial meltdown.
A leading expert on China's financial system, Mr Nicholas Lardy, from the Washington-based Brookings Institution, says the Chinese economy has appeared robust and immune from crisis, but it was an illusion.
"Once you look under the surface, there is fragility," he said. "All the conditions exist in China for a financial crisis and have existed for several years, but a triggering event hasn't happened."
The triggering event that would be fatal for the banks and probably the ruling Communist Party would be a run on the four major state-owned banks if millions of ordinary Chinese realised that a big chunk of their savings - perhaps 30 per cent or even much more - has evaporated through unrecoverable loans to state-owned enterprises, speculative real estate lending, graft and inefficiency.
The new surge in lending, up 17 per cent over the first nine months of this year according to official figures, has alarmed many analysts who had been reassured last year that the leadership had been attempting to reform state-owned enterprise and nurse the hemorrhaging banking system back to health.
In a memorable editorial, the Asian Wall Street Journal described the burgeoning government spending as having a "levitating effect" on the Chinese economy.
"The economy is like a cartoon figure who runs off the edge of cliff," the paper said recently.
"He keeps running forward through thin air until he looks down.
"In fact, China is providing an object lesson in how a closed financial system allows a statist government to defy economic gravity just long enough to make the inevitable crash more painful."
One of the main reasons the Chinese Government has defied economic gravity for so long is that a tightly controlled media and an almost total lack of transparency in the workings of its banks and financial institutions means most people are unaware of the extent of the danger.
It is true that in major cities like Beijing some better-informed people sense the risk and have begun buying consumer durables or switching some of their funds to foreign currency bought on the black market, but most Chinese continue to deposit their savings in the state-owned banks, confident that the Government will bail them out if disaster strikes.
Only insiders know the truth.
"If China allowed banks to go bankrupt, the country's banks would be bankrupt several times over," says an employee of a major government financial company.
"The bad loans are so huge, every time I see people still putting their savings in the bank I feel sorry for them.
"The whole banking system is based on people's confidence and on the promise of no devaluation and 8 per cent growth, but what will happen if people eventually find out and [this causes] a run on the banks?"
The fate of Pingyao is probably a guide to what might happen.
A combination of lending to the Government - even the Dowager Empress Cixi visited Pingyao after the Boxer Uprising to borrow silver - competition from foreign banks at the height of colonial dominance and the rise of Shanghai as a rival financial centre was fatal for the city's banks.
A museum notice on the wall of the Ri Sheng Chang bank headquarters describes how the Pingyao banks were unable to recover many of their loans.
"Many of the banks were unable to handle a bank-run crisis and were eventually closed down," it says.
There were high hopes that China's banks would take steps to minimise the danger of a collapse after Premier Zhu Rongji took personal responsibility in March for a government pledge to reform an estimated 300,000 state-owned enterprises over three years, which was widely interpreted as an undertaking to close or overhaul many of the biggest loss-makers.
At the same time, Mr Zhu said the banks must begin operating as normal commercial lenders, with an emphasis on secure loans and profitability.
Some analysts expected the banks to switch some of their lending to the thriving private sector.
This would have allowed the banks to cap the mountain of bad debt that some experts estimate accounts for 40 per cent or more of all loans.
However, a dangerous surge in unemployment from collapsing state-owned enterprises has clearly panicked the authorities as worker protests and strikes spread all through the decaying industrial heartland.
At the same time, China's economic growth began to slow sharply as the Asian financial crisis eroded export markets, foreign investment began to fall and domestic demand slumped.
The Government reports that economic growth is still approaching 8 per cent but this figure is viewed with increasing scepticism as prices fall all over China and massive stockpiles of unsold goods - from cars to frozen chicken - accumulate in warehouses.
In their desperation to keep the economy growing fast enough to absorb the millions of unemployed, the authorities are now spending heavily on what is officially described as "infrastructure" but a big proportion of these outlays is believed to be new loans to state-owned enterprises to pay for salaries and raw materials.
Caught between a threat to social stability and survival of the Communist Party, and the danger of a financial collapse, the authorities have clearly decided to buy time with more subsidies for the state sector, but this strategy seems likely to make the day of reckoning worse for the banks.
In the meantime, the party has turned to propaganda in a bid to patch up the financial system.
The official media has begun to hail the exploits of a model banker, the incorruptible Mr Rao Caifu, the manager of a small-town branch of the Agricultural Bank of China, who lent more than $US26 million ($41 million) since 1981 without one dud loan.
"In recognition of his good deeds, the Communist Party's Central Financial Work Committee has decided to launch a movement to emulate comrade Rao Caifu throughout the entire financial system," said a party exhortation published last month in the official Financial News newspaper.
Unfortunately for the party, few Chinese bankers and investment company managers can boast of a record like comrade Rao's.
While domestic bad debts continue to pile up, foreign lenders are now increasingly worried that China's overall financial position is far less robust than they had assumed.
The catalyst for this sudden frisson of fear among international bankers was the collapse last month of the Guangdong International Trust and Investment Corporation (Gitic), the investment arm of the Guangdong Provincial government with reported foreign debt of about $US2.4 billion.
A handful of other investment companies have also since defaulted on foreign debts but the realisation that the investment arm of China's wealthiest province had failed did the most serious damage to the confidence of Western and Japanese banks.
Foreign bankers had assumed that lending to China's state-backed finance companies was safe, but the Beijing authorities have so far only promised to cover debts that had been properly approved.
Mr Lardy says it is impossible to predict when a financial meltdown might strike while China's "unsophisticated" depositors continue to have faith in the banking system.
"I'm not confident there won't be a crisis," he says. "Maybe they can carry it off for another year or two.
"As soon as depositors lose confidence, the game is up."
Best to you,
Clark
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