(This is Part 6 in a series. Go back to Part 5.)
If we blow up a balloon with air and just keep on going, beyond a certain point the balloon becomes over-inflated. In this over-inflated state the balloon is extremely fragile and can be busted by landing on virtually anything.
What the balloon lands on is not the cause of its bursting, however, but only the trigger of it. The real cause of the balloon's bursting is the previous over-inflation.
The same is true of a Credit Bubble. Beyond a certain point an over-inflated Finance Bubble becomes extremely fragile, and in this state the bursting of the bubble can be triggered by all manner of things.
Of course, the trigger is then invariably blamed as the "cause" of the bust that follows. Meanwhile, the real cause—unrelenting creation of credit, with its attendant distortions and excesses—is usually ignored.
As readers of the previous five articles will be aware, our financial and economic system has reached a milestone of extreme over-inflation. In this fragile state it is vulnerable to various triggers that could initiate the process of its collapse. Let's look at three of them:
The first potential trigger: Unrelentingly EZ money and credit in the United States has created a tremendous and increasing trade deficit with the rest of the world, which in turn fuels global inflation. It works like this:
A growing mountain of U.S. liquidity creates
Huge demand for imported goods which fuels
A huge and growing trade deficit which causes
Excess dollars flowing into the world.
As this wall of dollar liquidity flows into the world and is converted into local currencies it creates excess liquidity everywhere—which, along with ubiquitous easy-money policies, further inflates the Global Credit Bubble.
As a result, asset inflation has been showing up around the world too—in stock markets (again), bonds, housing, commodities, emerging market paper, gold and so on.
The leading edge of this trend is China. Soybean prices in China rose by a third last year. Rice rose 21%. Peanut oil rose 24%. Steel rose 74%. Hong Kong property prices rose 34% in one year.
China is awash in easy credit. The Chinese M2 was up over 20% in the last 12 months. Chinese banks loans rose a blistering 56% last year. Construction along the coast is on steroids. Business is booming.
But there is an interesting underbelly to all this. In their feverish competition to make loans, the Chinese banks have funded many wasteful and uneconomical enterprises. As a result, non-performing loans are estimated to make up one-third of all the loans at Chinese banks, and total bank loans are at 145% of GDP.
In fact, the four major Chinese banks, which account for 76% of all deposits in China, are all considered to be technically bankrupt. The banking system is extremely fragile at the moment and the government is busy trying to figure out a way to bail them out before it's too late.
Meanwhile, the Chinese central bank is busy recycling dollars back into the U.S. in order to hold down the value of their currency, the yuan.
Why do the Chinese want to hold down the value of the yuan? So that they can keep exporting—upon which their economy critically depends—in vast quantities to the rest of the world and especially the U.S.
So the Chinese bank is feverishly buying U.S. Treasury securities. In fact, the Chinese central bank now has some $403 billion of foreign currency reserves, mostly in dollars.
And the Chinese are not alone. The Japenese spent $182 billion last year buying dollars and selling yen in order to keep the yen from rising, so Japan could continue to export, upon which their economy depends. The Japanese central bank now has $777 billion in foreign currency reserves, mostly in dollars.
Global central banks are now holding $2 trillion in U.S. paper. Asian central banks alone are holding $1 trillion.
The U.S. government and economy are now heavily dependent upon massive and continuing loans from the rest of the world, especially Asia, to keep going.
This Asian trigger to the Great Global Credit Bubble could show up in a couple of different ways:
One possibility is that intense inflationary pressures in China could put a severe squeeze on business profits and bring the economy to a halt. This would precipitate a collapse in the Chinese credit bubble and most likely bring about the failure of the Chinese banks.
Such a scenario would be similar to the failure of the major Latin American economies in the early 1980's, though much larger. The Chinese authorities are well aware of this possibility and are now trying gingerly to bring the economy down to a "soft landing" that will not implode the banking system.
Secondly, if Asian central banks get concerned about holding so many falling dollars they could lessen their prodigious buying of U.S. government paper or even begin to sell their massive holdings. This would have grave consequences for the dollar, interest rates and global stock, bond and housing markets.
(This is the end of Part 6. Go to Part 7.)
—jim sloman, 3.30.04 for Jul 30
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