(image credit:  labourlist.org)

I am sorry I didn’t write.  I haven’t been able to use my right hand for the last month.  The truth is the worst possible answer, carpal tunnel.  A hunting accident would at least provoke feminine pity and the hope to bridle something untamed.  Instead, it looks like I am fast with my figures, but slow on my feet.

Which brings me to Europe.  The Eurozone has been pushing out press releases at a desperate pace.  Week in, week out, we get rumors of the ECB buying Italian bonds.  The Chinese buying Italian bonds.  Germany and France buying something with 3 trillion dollars.  Hope, perhaps.  But this is like playing defense in your kid soccer league- watch the torso not the feet.  The torso is economic growth; everything else is the feet.  Without economic growth, Europe can’t meet its debt obligations and interest rates will stay high and smother hope.  The arguments for economic growth in an environment with declining wages are stretched.  So I don’t want to spend much time on Europe.  We covered it; we know what is going to happen for the next 6-12 months.  The only hard part is not getting distracted from the truth.

What is really interesting is China, and I wish I could have written more about it earlier.  Yes, the stock market is down over there, but there is more to come.  Let’s look at what has happened in China to understand what will happen.  China’s economy has been rapidly growing, particularly after executing the largest stimulus in the world in 2009 on a not quite so large economy.  In order to pull back the reins, China has tried to curtail loan growth at the banks.  Unlike other economies, China controls how many loans are made by banks.  It is actually the best way to control monetary policy.  Except, that if banks can’t lend, then other entities in the economy will meet demand and start lending.  So what has happened in the last three years is that thousands of large and small enterprises have started to lend money out for projects that official banks could not lend to.  In other words, the least qualified lenders have been lending to the most marginal borrowers.  How much have they lent over the last two years?  One or two trillion dollars.  Between us, that is a lot of money.  For a five trillion dollar economy, that is a lot of money.

But no one knows for sure how much money has been lent out through informal channels, which is what makes it so interesting.  For all the attention that the subprime crisis got, it wasn’t that interesting.  You could go on Bloomberg, see all the securitizations and the underlying collateral mortgage-by-mortgage, know what was going to happen to home prices, then know what the impact of falling home prices would be on consumption and then know the impact of consumption on GDP.  In China, we just have no idea.  Analysts are publishing many numbers about the informal lending sector, but there are no official figures.  We simply do not know how big the problem is and China is also lacking dozens of econometric studies exploring the effects of leverage on real estate prices, real estate prices on consumption, consumption on GDP, and on and on.  They’ve had private property for 10 years, total.

However, there are a few things we can know about China.  First, it is highly likely that informal lending is at least 10% of Chinese GDP, which would make it double subprime at the peak.  Unlike subprime mortgages, the informal loans are working capital or property development loans, which means they are short duration, highly cyclical  and need to be constantly refinanced.  This means that, if we have a problem, we’ll experience it quickly.  Like, over the next 12 months, not 3 years as was the case in the subprime crisis.  We also know that the collateral (inventories and incomplete construction projects) is worse than that of the subprime mortgage market.  We also know that the Chinese government is taking steps to prevent informal lenders from foreclosing on projects, which is good in the short-term, but it means that fewer new informal loans will be made.  This is bad because if a whole portion of the economy exists because informal loans can be refinanced, then a meaningful portion of the economy will be stripped of its oxygen supply, shortly.

So what we can conclude is: that the up-and-to-the-right-line that China’s growth has tracked has had some support from an exponential growth in lending.  The trips to Macau, the handbags and empty condominiums were made possible by artificial growth in leverage.  So the correct growth trajectory for China is not 8%, but some number of degrees lower.  If M2 (money), doesn’t grow at 30% anymore, but instead grows at 10%, does the Chinese economy continue to grow at 7-8%?  Maybe, anything can happen.  But not ever before has a sharp downward change in M2 been accompanied with constant economic growth.  Nevertheless, for the moment, China and its strategists are sticking to the 7-8%, with the caveat that all bets are off if the US and Europe go into recession.  Great, so we know all bets are off.

The implications of a low-growth Chinese economy with a negative interest rate environment over the coming decade will have to wait until next time.  Sorry to hold you in suspense.