China's financial sector has been shaken by the insolvency of a major nonbank trust company. Moreover, Xi Jinping's government has no means to prevent this crisis from escalating. In the worst case, it could lead to a global financial crisis comparable to that of 2008. That crisis was triggered by the failure of Lehman Brothers in the United States.
China's central bank, the People's Bank of China, classifies investments and loans by all Chinese financial institutions as "total social financing." In Japanese yen, the value of China's nonbank financial institutions' loans amounts to some ￥2,700 trillion JPY ($184 trillion USD).
This far exceeds ¥2,121 trillion JPY ($144.8 trillion USD) in Japan's broadly defined liquidity covering cash and deposits, bonds, trusts, and other financial instruments (as of the end of July).
At the core of the nonbank financial sector are trust companies. Beijing-based Zhongzhi Enterprise Group is one of the largest trust companies. Its affiliate Zhongrong International Trust Co, is based in Harbin. Both institutions failed to make payments due in June and July.
'Time Bomb' That Could Cause a Chain of Explosions
The Xi government has restricted media coverage about Zhongzhi and Zhongrong. However, three companies listed as investors disclosed the failure on August 11. That was in compliance with Chinese regulations.
On the previous day, US President Joe Biden described China's economy as a "ticking time bomb" at a rally of his supporters.
"That's not good because when bad folks have problems, they do bad things," he warned.
The White House should have known the Chinese situation in advance through some route. In US dollars, China's domestic financial size totaled $38 trillion USD in 2022, overwhelming the US financial sector at $21 trillion USD.
Turbulence in such a financial superpower will spill over to the United States and the rest of the world. Moreover, KPMG, a major US accounting consultancy, was suddenly hired in mid-July. Their job is to review the balance sheet of Zhongzhi Enterprise Group including Zhongrong.
The 'ticking time bomb" may represent a perfect description. Even a relatively small explosion within the huge Chinese financial world could cause a chain of explosions. In turn, that could lead to a large-scale financial crisis.
Comparison to Lehman Brothers
The 2008 global financial crisis that was caused by the bankruptcy of Lehman Brothers in September was sparked by the bankruptcy of a mid-sized US investment fund in March of that year. That China's burst housing bubble was behind Zhongzhi's financial trouble also reminds us of the similarity with the 2008 crisis.
Potential Prolonged Deflation
The Xi government seems unable to stop the progress of the burst bubble that underlies the current crisis. Measures such as a massive increase in funds by the People's Bank of China could be decisive.
Meanwhile, there is a limit. Inflowing foreign currency as the source for the issuance of central bank funds has declined dramatically. Consequently, any massive central bank issuance could trigger the Chinese yuan's free fall.
Without an increase in central bank fund issuance, the government may also have difficulty issuing bonds for fiscal stimulus. Meanwhile, the Xi government's supervision of the financial sector is very lax.
The National Financial Regulatory Administration (NAFR) has left Zhongzhi Enterprise Group to resolve the trouble. In the midst of government inaction, only the financial crisis will make progress.
China may thus plunge into a long-term deflationary recession, as did Japan in the wake of the burst of asset bubbles in the early 1990s.
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Author: Hideo Tamura
Hideo Tamura is a Planning Committee member at the Japan Institute for National Fundamentals and a columnist for the Sankei Shimbun newspaper.