Brad Setser, who should be a daily read for everyone who enjoys economics, has posted an excellent summary of an RGM Monitor item on China’s coming economic crisis, and how it will differ from other emerging-market crises. AsiaPundit has no disagreements.:

One thing is clear: the trigger for financial crisis in China will differ from the trigger for the last Asian crisis. China simply is not vulnerable to sudden pullback of international bank credit. China’s reserves exceed China’s short-term debts by factor of six to seven and its total external debt by a factor of almost three.

The core question, of course, is whether China’s external strength will protect it from a domestic banking crisis. My answer is no.

Crisis though is an imprecise term. Bank crises can happen if bank depositors - or a bank’s short-term external creditors - pull their funds out of the bank. Or they can happen if a large share of the banks’ loans go bad, leading to large losses for the banks equity investors and even its depositors (if the government does not step in). The two types of crises are of course related - depositors are more likely to run if they worry that the banks are bad. But the link is not perfect. So long as a bank is backed by a credible government guarantee, for example, depositors may be happy to keep their funds in a rotten bank. China’s banks, for example, still carry tons of bad loans from their lending to state owned enterprises in the 1990s. But those bad loans have not stood in the way of a vast increase in the bank’s deposit base - or a lending surge.

Lending booms often are followed by a surge in bad loans. That happened in the Asian tigers after their boom. Chinese banks do not have quite the same vulnerabilities: they are not as exposed to a large currency move, for example. Most of the deposits and loans of the banks are denominated in RMB, not in dollars. That limits the banks’ “balance sheet risks” from a hidden currency mismatch. And it is hard to see how the RMB would depreciate significantly in any case.

The triggers for a surge in bad loans are more likely to come from the real economy. And the longer China continues on its current path of export and investment led growth, the bigger the risks. And if a slowdown in investment or exports is not offset by a surge in consumption, China’s growth could slow sharply.

That in turn would lead to a surge in bad loans, and a surge in bad loans might make the banks more reluctant to lend - and make depositors more reluctant to keep piling their savings into the banking system. Both developments in turn would lead to slump in new lending - aggravating the cyclical slowdown. Boom would turn to bust.

AsiaPundit has always intended on reviving the China Economic Roundup feature. Time constraints have prevented that from happening yet, and AP regretfully admits to withholding great economic posts for roundups that had not been forthcoming. That will cease.

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