We noted in 2009, in a piece titled “China 2009 = America 2001 = Rome 11 BC [10]“:
One of the top experts on China’s economy – [economics professor] Michael Pettis – has a very long but interesting essay [11] arguing that China is blowing a giant credit bubble to avoid the global downturn.
Pettis documents reports and statistics from modern China, of course. But he ends with a must-read comparison to ancient Rome:
Let me post here a portion of Chapter 15 from Will Durant’s History of Roman Civilization and of Christianity from their beginnings to AD 325
The famous “panic” of A.D. 33 illustrates the development and complex interdependence of banks and commerce in the Empire. Augustus had coined and spent money lavishly, on the theory that its increased circulation, low interest rates, and rising prices would stimulate business. They did; but as the process could not go on forever, a reaction set in as early as 10 B.C., when this flush minting ceased. Tiberius rebounded to the opposite theory that the most economical economy is the best. He severely limited the governmental expenditures, sharply restricted new issues of currency, and hoarded 2,700,000,000 sesterces in the Treasury.
The resulting dearth of circulating medium was made worse by the drain of money eastward in exchange for luxuries. Prices fell, interest rates rose, creditors foreclosed on debtors, debtors sued usurers, and money-lending almost ceased. The Senate tried to check the export of capital by requiring a high percentage of every senator’s fortune to be invested in Italian land; senators thereupon called in loans and foreclosed mortgages to raise cash, and the crisis rose. When the senator Publius Spinther notified the bank of Balbus and Ollius that he must withdraw 30,000,000 sesterces to comply with the new law, the firm announced its bankruptcy.
At the same time the failure of an Alexandrian firm, Seuthes and Son due to their loss of three ships laden with costly spices and the collapse of the great dyeing concern of Malchus at Tyre, led to rumors that the Roman banking house of Maximus and Vibo would be broken by their extensive loans to these firms. When its depositors began a “run” on this bank it shut its doors, and later on that day a larger bank, of the Brothers Pettius, also suspended payment. Almost simultaneously came news that great banking establishments had failed in Lyons, Carthage, Corinth, and Byzantium. One after another the banks of Rome closed. Money could be borrowed only at rates far above the legal limit. Tiberius finally met the crisis by suspending the land-investment act and distributing 100,000,000 sesterces to the banks, to be lent without interest for three years on the security of realty. Private lenders were thereby constrained to lower their interest rates, money came out of hiding, and confidence slowly re-turned.
Except for the exotic names … and the spice-bearing ships, this story has a remarkably contemporary ring to it, as do nearly all historical accounts of financial crisis, by the way. This story is not totally relevant to China today except to the extent that it indicates how difficult it is for banking systems flush with cash to avoid speculative lending, and how the very fact of their speculative lending then creates the conditions that can bring the whole thing crashing down. Hyman Minsky told us all about this kind of thing. There has never been a political or economic system in history that has been able to avoid the consequences of excessive liquidity within the banking system. Even the Romans learned this, and they learned it the hard way, as we always do.
America’s easy credit bubble started in 2001. Rome’s prior to 10 BC. We know the results of both.
Is China now blowing a huge credit bubble which will lead to a giant crash down the line?
Pettis thinks so …
Last week, economics professor Steve Keen explained [12]:
[During the 2008 crash] private debt [in China] was effectively constant at 100% of GDP.
All that changed after the financial crisis. In just 6 years, private debt grew by over 80% of GDP—and that’s using official figures as submitted to the Bank of International [13] Settlements (see Figure 2) when there’s every reason to expect that this particular figure is likely to understate the actual level.
Figure 2: Private debt in China exploded as it sidestepped the Global Financial Crisis
Why does the level of private debt in China matter? If you believe conventional economics and finance theory [14], it doesn’t—which is why I find myself having to repeat the (expletive deleted) obvious so often that it does. [Background [15].]
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From 2009 on, growth in private credit went into hyperdrive as a deliberate government policy to boost the economy.
Figure 3: China avoided the Global Financial Crisis by boosting credit growth
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In 2010, the increase in private debt in China was equivalent to 35% of GDP. That dwarfs the rate of growth of credit in both Japan and the USA prior to their crises: Japan topped out at just over 25% per year, and the USA reached a “mere” 15% of GDP per year—see Figure 4.
Figure 4: China’s credit bubble is the biggest ever
As I have argued for a decade now, crises begin when the rate of growth of credit slows down in heavily indebted countries. China was not heavily indebted in 2008, which is why it could take the credit growth path out of the Global Financial Crisis. But now it is more heavily indebted than America was when its crisis began—even relying on official statistics which undoubtedly understate the real situation—and the momentum of debt may well carry it past the peak level reached by Japan after its Bubble Economy collapsed in the early 1990s (see Figure 5).
Figure 5: China is on course to reach Japan’s Private Debt to GDP peak
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So China is having its first fully-fledged capitalist crisis. To date its response to it has been to try to sustain the unsustainable: to transfer the bubble from housing to the stockmarket, and to keep the stockmarket rising like some production target for wheat from the bad old days before the fall of the Gang of Four [16]. It can’t be done. At some point, the Chinese government is going to have to make the transition from generating a credit bubble to trying to contain its aftermath.
And economics professor Michael Hudson notes [17]:
Most of the Chinese stocks went down because small Chinese investors were borrowing from, let’s say, the equivalent of payday loan lenders to buy stocks. There was a lot of small speculation in Chinese stocks pushing it up.
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In China, it’s largely small borrowers who borrowed from intermediate lenders, that have borrowed from the big banks. So a lot of individuals in China that tried to get rich fast by riding the stock market all of a sudden find out that they have a lot of debt to intermediate, you know, non-bank lenders, insiders, people who banks will lend to. It’s like the British banks lending to real estate speculators to lend out to homebuyers. So this is essentially the attempt to get rich by riding the stock market in China went way overboard. Chinese stocks are still above what they were at the beginning of the year. This is not a crisis. This is not very much. It’s just that the artificial increase in the market has now ended some of the artificial push-up. And it’s still artificial, and it will still go down some more.
For confirmation that individual Chinese investors borrowed too much to buy stocks – leading to a bubble which inevitably had to burst – see this [18], this [19], this [20] and this [21].