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Is China's bubble bursting?

As bankruptcy-driven disappearances and suicides haunt Wenzhou, we check in with leading China debt expert Victor Shih.

in the foreseeable future.

Which will essentially erode their wealth through inflation.


Many of loans — on the order of $1 trillion, you’ve estimated — have been made informally, essentially by loan sharks or by the "shadow banking" industry. Why is this so prevalent in China?

It's prevalent because the banking system basically rations credit, channeling the vast majority of it to state-owned enterprises. That said, there's still a large and quite vibrant private sector in China. They're forced to seek financing some other way.

Now fortunately, the state owned enterprises have strong incentives to re-loan some of the money they receive to private businesses. In normal times, like last year, a state-owned enterprise could borrow from the banks at about 5 percent, and lend it to underground banks at 10 to 15 percent. So state-owned enterprises can get an upside of 5 to 10 percent a year on money they borrow.

In the U.S. when debtors can't pay, they go to debtors court, declare bankruptcy, and they can got on with life. How are things different in China? Why are people jumping out of buildings?

People jump out of buildings when they've borrowed so much more than their assets, and they have borrowed from some very unsavory people. Or they've borrowed from mainly their immediate friends and family, and they have too much shame to go on living.

But usually, they don't jump out of buildings. They go through the courts, as they do in the U.S. — of course, the courts are more corrupt, but the legal procedure is not that different from in the U.S.

Are there places other than Wenzhou where debt has become a problem?

A sizable informal debt bubble appears to be bursting right now in Ordos, Inner Mongolia. They've built a vast amount of housing there, even though the population is actually quite small. There were coal mines there that made a lot of local people rich. They didn't know where to invest the money, so they first invested it in real estate, then in underground bank loans, and there have been a wave of defaults of these underground bank loans, which are causing problems.

Will this affect the US economy and the rest of the world?

The slow down in local government borrowing has led to a slow down in Chinese imports of construction materials. That mainly effects Australia, Brazil and other countries that export raw materials to China.

On the contrary, the U.S. has really benefited from food inflation in China. Farmers have been driven off their land, when it is converted into real estate. Chinese dependence on imported food, especially from North and South America, has increased quite substantially in recent years. I don't see that trend reversing any time soon. So farmers in the U.S. have really benefited from Chinese growth and from rapid and artificially-driven pace of urbanization.

This week, French President Nicolas Sarkozy appealed to his Chinese counterpart, Hu Jintao, for financing to support the euro zone's bailout. Does China have the money to do this? There are, after all, a lot of poor people in China, and development has a long way to go. And what are the risks of such financing for Europe and China?

China has the world's largest foreign exchange reserves, and so strictly speaking they have the money to invest in whatever sort of bailout scheme Europe comes up with. At the same time, I think Chinese leaders are very careful not to publicly claim credit for saving Europe. That's because, although in the short-term there could be some pay-off, there are still risks and we don't know what really is going to happen to Europe down the road. If this bailout has to be followed by subsequent bailouts, then it's not going to look very good for the Chinese decision makers. So I think they'll go about it in a careful way, and it will largely go unseen by the public.

In an op-ed in today's New York Times, Arvind Subramian of the Peterson Institute argues for a shift in voting status for loans that the International Monetary Fund makes to countries in trouble. He contends that China should gain the kind of veto power that the U.S. has, but that Europe should lose its veto given that it is now a debtor rather than a creditor. Do you agree, and what would this mean for the global order?

If China does indeed contribute a substantial amount of money to the IMF, it should probably get a higher voting share.

Sure, that would impact the way the IMF goes about its business, because China — just like the U.S. and Europe — has its own strategic priorities. The U.S. and to some extent Europe have used the IMF to further their own strategic goals, so if China were to gain influence in the IMF it would probably use it to further its own strategic goals.

Follow China debt expert Victor Shih on Twitter: @vshih2

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