Beijing and Its Bubble

Encouraging economic growth in a recession is a touchy business. Tax cuts can work if they trigger consumption and investment (assuming that consumers are not too shell-shocked). Lowering interest rates is another good tactic — it should drop the cost of getting a loan or using a credit card, making it easier for consumers to make and finance a purchase. But what if you are in a state that doesn't have a well-developed tax base? Or where interest rates are already below the rate of inflation? This is the problem that China faces. Social stability and national unity are considered such high priorities in China that Beijing essentially bribes the population and the regions with subsidized credit to keep them in line. Nearly anyone can get a loan for nearly any reason, so long as they employ people. Tools that Western states use in recession are used in China all the time. So when recession hits, there are no "emergency" tools to be broken out — they are already in use. China has squared this circle by force-feeding credit into the system, and more than $1 trillion in loans has been pumped out thus far in 2009. But in this flood there has been negligible regard for the quality of the loans — meaning the recipients’ ability to repay them. In a system that glorifies subsidized credit, there were never many checks in the first place, save the ability to employ workers over the medium term. Now, there are no meaningful controls whatsoever. Social stability and national unity are considered such high priorities in China that Beijing essentially bribes the population and regions with subsidized credit to keep them in line. And the Chinese know it. STRATFOR sources in the Chinese financial world — private and public both — estimate that about half of this flood of lending has gone not into normal economic activity, but into speculation in real estate and in the stock market. Whenever there is a virtually unlimited amount of cash being put toward something that exists in limited quantities — such as land and stocks — bidding wars ensue and prices explode. The Shanghai Composite Index has already risen more than 50 percent since its March lows, a bull market completely divorced from any semblance of market fundamentals — and most likely as a direct result of the government's lending policy. People (ranging from small businessmen to managers of the large state-owned enterprises) take out loans with few controls, sink the cash into the stock market and watch prices rise impressively. But this works in reverse as well. Since there is nothing but speculation holding the market up, any number of things — for example, a loan payment coming due — can cause someone to pull their investment out, resulting in a price crash that has the ability to gather speed and size like a snowball rolling downhill. On Monday, the Shanghai Composite Index plunged by 5.8 percent. This probably can be explained by a combination of local factors and does not necessarily herald a stock crash — much less a broader, systemic crash. But the fact remains that, regardless of how stable one believes the Chinese financial network to be, injecting half a trillion dollars in loan-based investments into it in a few months is precisely the sort of activity that would trigger a bubble were one not there already. And the events seen Monday are precisely how it could all start to fall apart.