Three weeks ago, George Soros observed that there are “eerie resemblances” between the global financial crisis of 2008 and China’s credit markets. In a blog post on the 20th, I warned of the dangers of China’s local debt crisis, particularly the “shadow banking” element. Today, a Chinese trust investment worth USD 496 million (RMB 3 billion) went bad and will likely default by the 31st. The company, China Credit Trust & Co., made opaque loans to the Shanxi Zhenfu Energy Group, a coal miner, which collapsed in 2012 after a leading shareholder was arraigned for illegal deposit-taking. If it defaults, the company will be the first of some 10000 shady non-bank creditors to do so. The ICBC (Industrial and Commercial Bank of China, the largest bank in the world) has preemptively declined bailing out holders of the financing, despite allegedly guaranteeing the project to investors.
Also today, a hacker broke into CNN’s Twitter and Facebook accounts, taking the opportunity to declare that China had put all its US treasury bonds on the open market and proclaimed the South China Sea a “closed-zone.” The announcements were quickly deleted, and despite markets apparently not taking them seriously, they brought to mind Former Prime Minister of Japan Ryutaro Hashimoto’s statement at Columbia University in June 1997 that “several times in the past, we have been tempted to sell large lots of US Treasuries.” Within seconds, the dollar plunged and yields surged. Contrarily to the US, more than 90% of Japan’s debt is held domestically, reducing the risk of this kind of capital flight.
China has steadily built up a currency stockpile worth USD 3.8 trillion (RMB 23 trillion) since Asia’s 1997 crisis, but according to William Pesek over at Bloomberg View, China would be better served investing at least some–and probably most–of this wealth in clean energy, public services, infrastructure, and education. Therein lies the paradox: to unload any significant portion of these treasury bonds, China would have to absorb massive capital losses. US interest rates would soar. And China’s biggest export market would disappear.
Perhaps if China fails to reign in local debt and divert capital away from construction, resulting in a real crisis, this mountain of bonds will come in handy. Excluding this increasingly plausible scenario, they are only a weakness (or according to Pesek, a pyramid scheme).