a chinese banking crisis and the yukon

The Chinese economy has been toppling a lot of records recently, but even those worried about the rise of China should hope they don't snatch the trophy for "biggest banking crisis" from the Europeans and Americans.

The Chinese economy has been toppling a lot of records recently, but even those worried about the rise of China should hope they don’t snatch the trophy for “biggest banking crisis” from the Europeans and Americans.

For the Yukon, a Chinese banking crisis could be more worrying than implosions in Greece, Portugal or even the mayhem we’ve seen in the US over the last few years.

It’s useful to think about Chinese banks through the eyes of the Politburo in Beijing. The survival of the regime is the top priority, and this requires strong and steady economic growth. China’s rulers know that rulers from Gorbachev to Mubarak wouldn’t have fallen if their citizens had good jobs and rising incomes.

So when the global economy wobbled in 2008, the Politburo acted quickly. To head off the possibility of job losses as America and Europe imported fewer Chinese goods, Beijing directed the country’s big state-owned banks to go on a lending spree.

In the first half of 2009, lending in China was almost double the total for 2008 as a whole. Total credit in the economy ballooned an astonishing 31 per cent of Gross Domestic Product in 2009, about double the typical level China’s booming economy had seen over the previous years. Chinese regulators became worried and ratcheted up bank reserve requirements and other rules to clamp down on lending, but in 2010 credit boomed an additional 21 per cent of GDP.

The result has been a surge in asset prices. The usual bubble-era anecdotes began to appear. There were rumours of giant housing complexes being built on speculation, regional governments embarking on prestige infrastructure projects, manufacturing companies investing their spare cash in commercial real estate deals, the emergence of day traders and even villagers hoarding copper and other commodities.

Fitch, one of the big credit rating agencies that famously missed the last bubble, estimates a 60 per cent chance of a Chinese banking crisis by 2013. There are plenty of China Cassandras willing to go farther than that and predict total meltdown when this bubble, if that’s what it is, finally pops.

But there are some good reasons to be less pessimistic. First, Chinese banks are relatively deposit rich, have high lending margins guaranteed by the government and have capital adequacy ratios of over 11 per cent. This means they are relatively well placed compared to many banks to survive loan losses and liquidity scares (although if you are highly confident in Chinese bank statistics then I have some condos in Chongqing I’d like to sell you).

Secondly, the Chinese government desperately wants to prevent a banking crisis and effectively controls the banks and other major enterprises. It can tinker with interest rates and margins to make the banks more profitable, recapitalize wobbly banks with government money and even order other state enterprises to invest in bank shares (all things it did a decade ago in China’s last banking crisis).

But even if total meltdown is averted, any banking crisis is painful. You could write books about how the Chinese and global economies would be affected, but since this is the Yukon News, not the Chongqing Star, let’s look at how the Yukon would be affected.

There are three potential transmission mechanisms for Chinese economic pain to arrive here. The first is a general slowdown in global economic growth if China’s engine stalls. This mechanism is likely to be relatively weak. China is big but not that many countries are hugely reliant on it as an export market.

The second is much more serious: commodity prices. These have been buoyed to historically high levels by Chinese demand and, importantly, the expectation that this demand will continue in a new commodity “super-cycle.” But commodity markets are volatile, and even small drops in demand can provoke damaging downward spirals. The Yukon would look less attractive to mining investors if gold and copper prices were a lot lower.

The third transmission mechanism could also be serious for the Yukon: Chinese overseas investment. One reason why Chinese resource companies have been on a buying spree from Sudan to Watson Lake is their easy access to credit. If this dries up as a result of systemic banking troubles at home, Chinese companies will probably scale back their international investments first. They will be much less keen on long-term investments in the Yukon such as the ones they have made in Wolverine, Selwyn Chihong and Northern Cross. The next generation of resource properties, and even additional stages of the three properties above, would be affected.

There is, of course, not much we can do about a Chinese banking crisis except watch and wait. But if you are doing a deal with Chinese investors, you might want to sign sooner rather than later. And get the cash up front if you can.

Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels.