Is China about to have its own Bear Stearns moment? I have been thinking a lot about this after reading a smart report released today by BofA Merrill Lynch Chinese economist Bin Gao, which looks at the recent debt restructuring at the China Credit Trust Co., a major Chinese financial institution. Just a few days ago, the Beijing based company was in danger of defaulting on a high risk, complex debt product. Then, suddenly, it managed to get its hands on enough money to restructure the half a billion-dollar deal and prevent the debt from going bad. Nobody knows who the investor was—the central government? a state owned bank? a worried Chinese billionaire? As if that wasn’t bad enough, the secret bailout comes at a time when intra-bank lending rates in China are rising (which means banks don’t trust each other), market volatility is increasing, and the value of risky debt products is plunging.
Sound familiar? That’s exactly what happened in the run up to the 2008 collapse of Bear Stearns in the U.S. Indeed, says Gao, “the bailout looks very much like the Bear Stearns moment.” The CCT problem isn’t the only red flag out there–over the last few months, there have been a number of investment projects that have gone bad in China, including debt issued by a coal mining company, and a provincial government real estate project. The risk of infrastructure projects going wrong and creating a domino effect of exploding debt, just as the subprime mortgage crisis did in the U.S., is something that TIME warned about over two years ago, in a cover story by Ken Miller entitled The China Bubble.
Are we at that moment now? Economic secrecy in China means it’s impossible to know for sure, but Ruchir Sharma’s column in the Financial Times today makes it clear that he thinks the Middle Kingdom is already in trouble. I’ve talked many times with Sharma, who heads up global macroeconomics for Morgan Stanley about the issues in China, and his metrics tell it best. The most reliable indicator of financial crisis is the pace of growth in debt (not the size, but the pace). Over the last five years, debt levels in China have increased by 71 percentage points. Looking back over the past 50 years, there are about 33 cases of countries with similar debt run-ups—22 of them plunged into a credit crisis, and all suffered a major economic slowdown. Needless to say, I’ll be watching this space very carefully.