Everything is BIG in China - their population, their growth, their corporations, everything!
Turns out their banks are big too.
Or too big?
The four largest banks in the world are all Chinese. The country has total banking assets worth more than 285 trillion Yuan (which is 3.1 times its GDP). In 2008, this number was just 40 trillion Yuan. That’s roughly 7X growth in 12 years.
Take a look:
Well, how did that happen?
When we talk about banking assets, more than two-thirds of it consists of loans granted to individuals and corporates.
China has lent money like a madman in the previous decade (read our coverage on China's mounting debt problem here).
Therefore, it makes sense that their banks are the biggest in terms of asset size.
And yes, too big.
Chinese banks are known to lend to lousy companies mass-producing a bunch of lousy stuff.
Given China’s debt issues, the shadow banking system, and the possibility of bank runs, you realize that it’s only a matter of time until these banks collapse. Or, as people like to call it - “the bubble bursts.”
Having said that, you might be wondering what would happen to the world economy if the Chinese banks collapse?
We’ve already seen how their eating habits have affected the world.
Can their banking habits take down the world economy at a similar scale? Or would it be worse?
Let’s see.
Although the Chinese banks are controlled by the Chinese government (who would move heaven and hell to prevent its banks from failing), let us still try and understand what could happen if they actually fail.
To understand this, we first have to figure out the extent to which the world economy depends on China.
Understanding the World’s Dependence on China
Apart from the fact that China owns 20% of global GDP as of 2020, let’s look at the extent to which the world depends on China:
How much does China import from other countries? - Indicating the extent to which countries depend on demand from China.
How much do countries depend on China for money (loans)?
How much does China export to other countries? - Indicating the extent to which countries depend on the products produced by China for raw materials/consumption.
How much does China import from other countries?
Look at the data.
Source: World Bank
China is second only to the US in terms of imports.
On top of that, China consumes more than 50% of the global copper and aluminium production, more than 14% of global oil production and… You know what?
Let data talk for itself. Take a look at the chart below:
Source: World Bank
This is deep. Imagine what would happen if China stops purchasing these commodities. What would happen to the companies or countries that rely on exports of these products?
Let’s take a refresher on the law of demand and supply.
When demand falls, the price falls. Keep in mind the percentage share of China in terms of demand for these goods. Fall in demand from China would cause madness all over. Basically, because of China’s huge demand for these commodities, it has a large impact on the pricing of these goods.
Any rise or fall in China’s consumption will affect the global prices of these commodities. Because, if China stops importing these, the global prices will come crashing down, and this will directly impact those nations which were producing and exporting these commodities.
There are around 33 countries (as of 2018) that depend on China for more than 25% of their exports. If not for the entire world, then think what would happen to these countries if China were to stop purchasing their products.
How much do countries depend on China for money (loans)?
Heard of the term ‘Debt trap Diplomacy’?
Debt trap diplomacy - when a country tries to gain power over poor countries by lending money to them under harsh conditions, often with an intent to gain power over such countries.
Turns out Chinese Banks are not just lending out to Chinese companies, but to other countries too.
Often, developing nations are lured by China’s offer of cheap loans for infrastructure projects, which require heavy investment.
Why would China offer cheap loans to other countries?
Well, what happens is, these developing nations, which are primarily low or middle-income countries, would not be able to keep up with loan and interest repayments. Hence, they would approach China for debt relief. China then pounces on this opportunity to DEMAND advantages in exchange for debt relief. For example, Sri Lanka was forced to hand over control of the Hambantota port project to China for 99 years, after it found itself under massive debt owed to China.
It’s just a well thought, strategic plan by the Chinese government!
China has invested lots of money this way in smaller countries like Pakistan, Angola, and various other sub-Saharan countries. These countries are already under a huge debt crisis (and they primarily owe their debt to China).
China has granted loans of more than $146 bn to Africa. If Africa is a school, China is the trustee on whose money the school runs. If the trustee loses all his money, the school faces a jolt.
7 countries in the world owe more than 25% of their GDP to China. 3 of these countries are in Africa and 4 in Asia. The following chart shows how much the countries are indebted to China:
In case the Chinese economy falls, these countries would also apparently fail.
Now you realize why we keep saying everything is connected?
How much does China export to other countries?
China is one country that is heavily dependent on the income generated by exporting to other countries. After all, it's the world’s largest manufacturer and exporter of goods. Other countries, on the other hand, are also heavily dependent on Chinese exports. Well, simply because Chinese products are dirt cheap.
Many countries are now trying to ban the import of Chinese goods, because of China’s trade practices, border conflicts with India, tensions at the South China Sea, pandemics, etc.
Assuming that does happen, who will Chinese companies sell their products to? Where would China get money from? Yeah, it would be selling its products to its citizens. But that just means that these Chinese companies would be producing much more than they can sell (excess capacity).
Mind you, China is already operating at excess capacity (recall: ghost towns).
But what about the world economy? Can it afford to ban Chinese goods?
Not really.
The level of production capacity/infrastructure that China has built over the years (again, in it’s race to become the largest economy in the world), making use of its cheap labour, land, and other resources, cannot be achieved by any other country so quickly.
Truth is that China has other countries right where it wants them to be. If countries decide to ban Chinese products, they’ll have to set up domestic industries, which entail huge costs. The price of the goods, which earlier used to be imported, will then increase in the domestic market which would ultimately lead to a rise in the general price level of goods, hence, inflation.
This entire web of imports, exports and loans place China in a position of prominence. If this intricate web collapses, what will happen?
Will the world economy crash?
China is known for its ability to save its banks from going under. It is a country where everyone and everything is controlled by the Government. And China can very well do it again.
To be honest, the possibilities of a 2008-like crisis is remote. The Chinese government can technically keep on printing money and bailing out businesses. What would happen is the growth of the economy would slow down, unemployment would increase, per capita income would go down and restlessness would go up.
The smaller countries that are indebted to China would suffer. The larger countries that relied on China for cheap imports would suffer. Commodity prices would crash.
The other two biggest markets are the USA and the Eurozone. But over the past decade, these two economies were not even close to the growth rate of China. If China collapses, there’s no other country left that can prevent a global stagnation.
Hence, even if the banking institutions in China fail, it won’t be as bad as 2008. But yeah, one cannot shut one’s eyes to reality. The cost of China’s failure cannot be ignored.
“When China sneezes, the whole world catches a cold.”
Quite literally.
Now, let us wait and watch what course the Chinese economy takes and what the future holds for us.
Till then, keep healthy, keep safe and … ReadOn.
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