China’s Economic Transformation and the risk for the Global Economy of a Financial crisis that would be thirty times bigger than the 2008 Crisis

Reorient is a financial services group in Hong Kong

Reorient provides a 62 page view of China’s economic transformation

Why does this matter ? Because China’s Banks are collectively over thirty times bigger than Lehman’s was.

It took the world a few years to recover from the worst of the 2008 financial crisis. A financial crisis that was 30 times larger could take about five to ten years for a world recovery.

Reorient Group argues, the old Chinese smokestack economy (dependent on low-value-added manufacturing exports and fixed-asset investments in infrastructure, mining, and real estate) is fading away and may drag somewhat on the banking sector; but nonperforming loans, even if the actual numbers are several times larger than officially reported figures, are still manageable; and accordingly, the banks may be undervalued instead of posing a systemic risk. John Maudlin in his China series, believe bad debts, if properly classified, could add up to nearly 20% of GDP.

Maudlin notes that China’s rapid credit expansion over the last five years puts it in the top five credit booms of the modern era. He argues it will be very difficult to make the transition without a great deal of pain.

Conventional wisdom suggests that China’s bank leverage ratios are more than manageable, whether they actually will be ultimately depends on whether China’s banks are reclassifying and rolling all but the worst loans.

Maudlin notes that the chinese will not forget what it took to build what the nation has today nor will they give up simply because things get difficult. The China that will emerge from the current problems, whether they are solved by a sharp correction or through a lengthier process accompanied by slower growth and a recession here and there, will be in far better shape than it is today.

Reorient argues that China’s transformation is unique

China‟s transformation is unique: forget the BRIC story and look at China as a special case

• Income growth by far the world‟s fastest
• Urbanization
• Agricultural productivity approaching US levels
• Tech capacity (twice as many science/engineering PhD‟s per year as the US) (74.8% in China vs. 34.0% in US)
• R and D spending as % of GDP at European levels
• Major high tech accomplishments (world leader in supercomputing and DNA sequencing, and a challenger in chip production, robotics and aerospace)

Nextbigfuture NOTE – India and a collective view of Africa have the population potential for a China scale transformation but they are not on that path. They are on a slower path that looks a bit more like Latin America in 2040.

China’s two Stage Economic Rocket

• Low-wage, export model
• State allocation of credit with enormous inefficiencies and corruption

• Consumption growth leads economy, not profits (reduces excess saving by corporate sector)
• Freeing of interest rates
• Two-way flow of investment leading to convertibility of yuan
• Defense and military high tech shift to private sector
• China creates its own new markets and sources of labor: Build-out of “New Silk Road” infrastructure (high-speed rail and high-speed broadband from Beijing to Istanbul in the west and to Bangkok, Singapore and Yangon in the south)

Reorient makes the case that China’s banks, real estate and local government debt are bad but manageable

Reorient also has detailed analysis of China’s strength in terms of technology transformation. They look at China’s internet and ecommerce and growth in PHD trained engineers and scientists. They also look at China’s real estate situation.

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