China Herald: Growing pains of China´s shadow banking

Michael Justin Lee

At the recent World Economic Forum in Davos, Switzerland, shadow banking loomed as a threat over China´s economic future. Financial analyst Michael Justin Lee does not agree, he writes in the ChinaUSFocus. Yes, the country has growing pains, but is not on the way to collapse.

Michael Justin Lee:

My agreement does not extend to the (Davos) conclusion. The majority conclusion seems to be that China will implode from the weight of the shadow banking system’s problems, taking down first Asia with it, and then the rest of the world. Even after making full allowance for probable hyperbole at such a media event, I think the Davos grandees went too far. The worst of the possible outcomes can be ameliorated with simple openness and transparency and I think the Chinese know this.

Market practitioners know that opacity and evasiveness about an economic problem makes it far worse. That’s a big no-no. Without open resources, the market has no chance to evaluate and discount the problem and therefore must assume the worst.

China’s shadow banking problem has a bit of parallel with another topic discussed in Davos, Bitcoin. Bitcoin is a private market currency. It is not backed by the good faith and credit of the U.S. Treasury or of any other central bank. It is backed only by the trust that the market accords it.

Actually, Bitcoin’s business model is not entirely new. Credit cards are also private market currencies. They are accepted for purchase because buying and selling parties trust their efficacy. The eventual success or failure of Bitcoin ultimately comes down to whether enough parties trust it, that is, accept it as a medium of exchange. The major credit card companies have earned that trust and therefore they are commonly accepted as currency despite not having been created by any sovereign authority.

The same goes for China’s shadow banking system. Its success or failure also substantially depends on whether the market trusts it. There are other factors as well, but without the trust of the market, all of those other factors could not sustain it. Consider a run on a bank. If I distrust a bank, I would withdraw my money immediately. If everyone else does similarly, a bank run results even if the distrust is unfounded.

China needs to earn trust that is clearly absent right now and the first step would be a simple transparent admission of the troubling situation. Sweeping problems under the rug accomplishes nothing. Hoping that overall economic growth accelerates to such extent as to trivialize the problem also accomplishes nothing. Less than twenty years ago, some other countries right in China’s backyard experienced very great pain from trying that. China must surely have been watching.

More in the ChinaUSFocus.

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