The last time we had strong signals from the Chinese central government regarding a link between banking and stock markets, we sold our China ETF and then watched the Chinese stock market lose 60% of its value. That was 2007-2008. What’s got the Chinese spooked now is a warning for banks to tighten their lending practices further.

Data

• Chinese banks have sprayed money around their economy in unparalleled fashion.
• An amount of money equivalent to half of annual Chinese GDP was leant by banks this year. Versus we’re seeing hundreds of billions of dollars LESS lending in the US (if not trillions).  See colorful chart below for the Wall St Journal.
• This understandably has many concerned about bad debt. It is highly likely that bankers in China leant a lot of money this year to individuals and businesses that may not have had the best credit and best plans for the use of the loans. Boatloads of Chinese spending is ending up in Macau (China’s Vegas). This is what happens when governments become involved in banking. It generates inefficient capital allocation and bad loans.
• We are ptimistic that we will not see an economic bust in China from bad loans because Chinese banks have several provisions that make them less risky than US banks:
  • Their capital ratios are much higher: 10% vs 4-5-6% here in the USA.
  • Chinese banks must keep reserves equivalent to 150% of estimated bad loans.
  • Chinese bankers that lose a lot of money and embarrass the central government are apt to be included in China’s world-leading statistics on death sentences. Even more than Texas.  OK, this point is tongue-in-cheek. But it makes you wonder how much damage a person has to do to the US economy in order to be considered worthy of a capital crime. 

Of course to rely on the judgment of Chinese bankers, and to rely on the data coming from China may be problematic. We are viewing corrections in the Chinese stock market as buying opportunities in the near term.