The Race to the Bottom - Update, Will China Take the Lead?

As of this point in time the international “Race To the Bottom” is still quite close, and I for one am on the edge of my seat!

Europe took the lead recently with many of its auxiliary engines missing badly as fuel flow diminished. North Africa and the Middle East optioned to take a pit stop and dismantle and rebuild their machinery, Japan decided to experiment with high octane fuel, while the USA is attempting to fuel as they race, running a fuel truck alongside their thirsty dragster. China meanwhile added additional engines, transmissions and wheels to their economic racer, deciding cost is no object, but which strategy will prevail? With many laps to go it is anyones guess as to who will completely self-destruct first.

For the last few laps, business and investors have had their eyes riveted on the Federal Reserve and the European Union as they both aggressively elbowed for swiftest descent, largely ignoring the Chinese entry.

This week we will take a closer look at the Chinese entry and attempt to analyze performance and strategy.

The unprecedented level of credit expansion in China has gotten to the point where it dwarfs anything we’ve seen before with overall credit now at about $23 trillion, making a severe banking crisis a very real possibility.

Is it possible China could indeed out-credit the USA?

If so, this could give them a decided edge in the “free fall” section of the race so we cannot count them out.

With a “credit-driven growth model [that] is clearly falling apart” and facing the specter of “Japanese-style deflation,” the risks have definitely increased,

Since most of the credit is furnished through “shadow” banks, establishing a clear concise estimate of credit expansion is difficult, however, the rise of bundling of assets and securitization, and an acceleration of policy tightening, over-indebted local governments and institutions will feel the pain of a rising cost of capital, prompting ratings agencies to raise red flags about the future growth prospects of the Chinese economy.

The Chinese financial sector is definitely sending out some dangerous signals.  

Overall credit has grown from $9 trillion to $23 trillion in five years, while the ratio of credit to GDP has surged 75 percentage points to about 200% in that time; this compares with an expansion of 40 percentage points in the five years to the implosion of the U.S. banking system in 2008, and about the same in the build up to Japan’s Nikkei bubble in 1990.

This alone makes China a serious contender.

Some think China has a plan to strew debris across the track once they nudge ahead of the field, but this view is mostly wild eyed conspiracy talk.

The share of new credit coming from “shadow channels” is rising, which suggests not only that more credit is going to weaker borrowers that can’t afford bank lending, but also that institutions with shoddy risk assessment and limited loss-absorption capacity.

Credit is now twice as large as GDP and growing twice as fast… a certain sign that China is about to make a move on the next turn.

To make sure… policy tightening has been applied starting the process of final collapse.

China is the world’s second largest economy and one of the major holders of U.S. debt.  It is also a regional power and one of the most important producer and consumer of goods and services.

Although these recent moves have good theoretical economic implosion potential it seems likely the Chinese will run out of track before one of the other contenders flies apart completely, in the mean time the smart money is on Europe who seem to have the edge on inspiring socio-economic collapse with most pain for the pit crew.

USA seems to have chosen an edless lap philosophy which could hamper their chances for the final collapse cup, although they may squeeze a “best in show” accolade. Japan cannot seem to muster the disintegration factor needed while North Africa and Middle East are likely not going to make it back onto the track before the chequered flag. Russia seems content to remain as is… lacklustre and relient on past track record.

China: Massive Credit Bubble Fueled By Shadow Banking And Securitization Could Collapse Banks

Like the headline says… “Could”, but can they? Perhaps, but is it enough soon enough?

Stay tuned…