Great Depression Online Archive Issue:

China's Speculative Bubble and Government Mischief

Great Depression Online
Long Beach, CA
August 18, 2009

Inside This Issue You Will Discover…

*** A Tell Tale Sign
*** Poisoning the Banks to Death
*** China’s Speculative Bubble and Government Mischief
*** And More

A Tell Tale Sign

One tell tale sign that the economy’s still in trouble is the fact that banks are still failing like unreinforced brick masonry buildings in a Mexico City earthquake.  Just last week, for instance, five banks went bust…bringing the tally of failed banks for the year up to 77. 

Colonial BancGroup Inc. was the most notable of last week’s causalities, particularly since it’s the biggest bank failure since Washington Mutual collapsed last year.

By our rough calculations, about 2.5 banks are failing per week…or about 130 per year.

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This may not seem like much compared with the approximately 9,000 banks that failed during the 1930s, but things are quite different now than then.  For example, we don’t know if branch banks were around back then.  If they were, we imagine they weren’t as prevalent as they are now.  In this regard, Washington Mutual had 2,239 branch offices when they went bust. 

How many banks in the context of the 1930s would 2,239 bank branches be equivalent to?

We don’t know, but we suspect it would be more than just one.

Poisoning the Banks to Death

Of course, back then, when a bank went bust, it had an immediate impact on depositors.  Suddenly, overnight, their lifesavings vanished.  Nowadays the FDIC covers deposits up to $250,000.  Still, it’s possible, with enough failures, FDIC could fail too.

“The failure [Colonial BancGroup Inc.] will deplete the FDIC’s deposit insurance fund by $2.8 billion,” reported Bloomberg.

Ultimately, as explained by the FDIC website, “FDIC deposit insurance is backed by the full faith and credit of the United States government.”  In other words, FDIC deposits are backed by government debt, the taxpayer, and lastly, Federal Reserve issued paper money.

Predictably, the same rot that caused a fatal bellyache for Washington Mutual ended up in Colonial BancGroup’s gut too.  In both cases soured real-estate loans poisoned the banks to death.

China’s Speculative Bubble and Government Mischief

Apparently Chinese banks are now guzzling what may one day turn to a book of soured loans.  In fact, they are attempting to postpone the inevitable by lending out lots of money.

“Chinese banks are like enthusiastic runners on an accelerating treadmill, explains Wei Gu for Reuters.  “The weakening economy means poor lending decisions are threatening to catch up with them, but the banks are sprinting ahead by expanding their loan books ever faster.  They cannot keep this up for ever.”

Still, it seems China has more than just bad bank loans to worry about. 

From what we gather, with the U.S. consumer – China’s number one customer -- saving rather than spending, the Chinese government has embarked on a $586 billion stimulus program. While nominally smaller than the U.S. government’s $787 billion stimulus program, in terms of each nation’s GDP, China’s stimulus program is nearly two and a half times larger. 

What’s more it’s creating what appears to be the origin of a massive stock market and real-estate speculative bubble.

The Shanghai Index is up over 80-percent in the last nine months.  And real-estate is blasting off too…

“Chinese real estate, already at lofty levels, has risen alarmingly fast lately,” reported the Wall Street Journal on August 7th.  “According to Frank Chen, a Hong Kong-based analyst with brokerage Yuanta Securities, average home prices in some cities on the mainland, such as Shanghai and Shenzhen, may have risen by more than a quarter since the start of the year.  That may leave average prices in relation to household incomes higher than they are in New York, London, San Francisco and Sydney.”

Sounds like a bubble to us, but “the run may have further to go, because bubbles frequently last longer than observers expect they will.”

With the potent combination of enthusiastic government and bank mischief going on this could become quite an exciting spectacle.  For the participant it’ll eventually end in ruin and regret.  For the observer it’ll eventually end with wonder and awe.

Enjoy it one way or another…however you may choose.

Sincerely,

M.N. Gordon
Great Depression Online

P.S.  For whatever reason, the Shanghai Index got hammered on Monday…crashing nearly 6 percent in a single trading session.  Perhaps the bubble will be pricked sooner rather than later.  If so, this may be for the best.

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