Everybody's scared of the big bad Chinese wolf - but the wolf is running on illusory fuel. Not that China's world competitors are running on anything more high powered than smoke and mirrors. Not by a long shot. However, China is doing it far more recklessly, with far less regard for the consequences.
In short, in the worldwide illusory fiat money game, the Chinese are pulling out all of the stops. They have spent decades analyzing how the purely debt-driven would-be capitalism of the so-called "free world" works, figured it all out, and are now making an all-out bid at out gunning the West's banker foxes at their own rigged game.
What am I talking about?
Western civilization has been put on a pure paper diet by forces that have nothing better to do than to try and control every aspect of our lives via control over the value and volume of our medium of exchange and accounting units - our currencies.
Currency without gold redeemability means currency-issuance (i.e., inflation) without limits.
When what we think of as "money" was taken off its last connection to a real asset (gold) in 1971, it did a complete flip-flop and turned from an asset-based currency to a debt based currency.
Since then, money is created either by outright printing or by lending it into existence - out of nowhere. If you think banks give up anything at all when they loan you money for a home or a car, think again. They simply "credit" your account with the amount of the loan and simultaneously enter a "debit" in your name that says you have to "pay it back."
That's a misnomer, of course. You can't pay back what you never received. But modern day legislative tyranny makes it possible. Try not paying it back, and the bank will confiscate (uhhum, sorry, I meant "repossess") the real assets you bought with their illusory money. All you received in real terms is the right to "spend" something that doesn't really exist. And others are forced by law to accept it in payment of your debts. In short, it's a government-slash-banking racket played on you and everyone else.
The entire world has been forced to run on this less than meager diet (it's actually a negative diet, if there is such a thing) by default since the US as the last country with a gold-hinged currency severed that connection.
So, where does China come in?
In the West, there are still some limits on the banks' practices of lending nonexistent, ficititious money into being. To keep the illusion up, these banks insist that their borrowers actually pay back what the banks "loaned" them. (The borrowers naturally have to work and trade for the currency they feed back into their lenders' accounts - a situation much akin to forcing someone to work for nothing and then give up a large part of the proceeds of his labors. But we won't get into that.)
In China, defaults by businessmen on bank loans they have received are commonplace, to say the least. How do the banks react? Rather than call the loans and collect on the collateral available (which might bring about a deflationary recession via a massive credit contraction since the problem is so widespread) they loan them more money. Much, much more.
In its bid to join the rest of the world's "floating" currency regime, Chinese authorities have recently begun prosecuting a few of the most egregious banking nepotists who routinely paper their mistakes over with even more loans to undercollateralized - and often blood related - borrowers. But if the authorities were serious, they would have to indict the entire banking sector, and probably themselves as well.
Official figures state that the percentage of nonperforming loans lies in the 13 to 15 % neighborhood. Official Chinese figures, that is. Of course, there are no outside watchdog groups allowed in communist China. Father State is holy there. Heretics who dare to believe otherwise - whether Falun Gong or Christian - are viciously persecuted. According to an Asiaweek.com article, foreign analysts fear that as much as 40 % of China's 600 billion dollars in loans outstanding are non-performing.
Nobody knows where the truth really lies. It would be a safe guess, though, that reality exists somewhere far above the figures named by official Chinese sources. Here is a tidbit of that reality coming from a state run Chinese news outlet, www.china.org.cn. The article is only thee years old:
Dai Xianglong, governor of the central People's Bank of China, said earlier this year that 25.37 percent of the loans at the four biggest State-owned commercial banks were non-performing. (04-26-04)
Assuming these earlier figures were accurate, it is doubtful whether China was truly able to cut its NPL ratio in half since then. Current figures may simply be a publicity ploy.
Naturally, there is no liquidity crisis - yet. Father State will pump whatever financial fluids the patient requires through its state-controlled IV apparatus, but that only adds to the problem, rather than solving it.
Since the banks are virtually all state owned, this can easily be seen as a deliberate government policy. Whether deliberate to the point of being planned from the get-go, or only as a response to a crisis that has no other solution is up for debate of course, but a policy it is, nevertheless - official or not.
In the West, there is a government/central bank mandated loans-to-asset ratio that must be maintained. In China, such requirements exist - if they do at all - only on paper. Just like the US Fed is forced to crank out ever vaster sums in "money supply" to keep the illusion of a sound economy going and to prevent any politically sensitive economic backsliding, so the Chinese government is forced to feed its own dragon with ever larger sums of loans to cover up unbelievable imbalances in their state owned banks' loan portfolios.
Is that illegal? No. It seems good policy. The world bank and IMF routinely "forgive" poor countries' debts because there's no chance in hell they could pay back their loans anyway - and then they loan them more money. So, the Chinese figured, why not do this on a purely domestic scale as well? Obviously, they saw no reason why not.
Now that the world is leaning on China to open up and "float" the yuan against other international currencies and release its almost decade-long rigid currency peg to the US dollar, the fecal matter that has risen and risen as a result of the communist government's concerted hurling efforts is about to hit the proverbial fan.
The amount of money in circulation inside China as a result of the above described lending practices is way out of proportion to China's actual economic activity. Add to that the PBoC's persistent need to print huge amounts of yuan to buy up US dollars floating around its domain to keep their currency peg in place, plus the amount of foreign speculative funds entering the country in expectation of the beginnings of a huge rise in the yuan when the currency peg is loosened, and you have somewhat of a problem on your hands if you are a Chinese communist party leader.
This embarrassing little problem is going to hit the rest of the world in a major way.
It is very possible that the Chinese currency will actually crash completely when the world realizes the moral and economic bankruptcy of the communist party's ways. Could this be the reason the ChiComs are playing "chicken" with the world over when they will begin the revaluation process? Are they scared of this contingency?
It is also very possible that the rest of the world will come to the conclusion that the yuan is rather disproportionately overvalued instead of undervalued, as so many now believe! If the wolrd does, the yuan will crash and burn.
With a total crash of the yuan worldwide, and foreign currencies gradually trading with less and less restrictions against the yuan, how would China continue to feed its voracious appetite for commodities from abroad? The suddenly increased expense would instantly throw the Chinese economic miracle into reverse gear.
The currently prodigious demand for oil would cease virtually overnight. Steel, copper, you name it, would no longer flow into China. Private Chinese companies would suffer serious downgrades of their creditworthiness. The government would, too. Foreign investors would cease buying Chinese government and corporate debt - which would saddle the then already reeling economy with humongous interest payment burdens.
Most certainly, foreign creditors would demand much more collateral before even thinking about lending to Chinese companies. What would China offer? Debt? Worthless, by then. Stock in its companies? Worthless by then as well. Promises to do better in the future? ...
How about gold?
The Chinese government is the only government in the non-Muslim world that officially advises its citizens to hoard physical gold. Now you know why. They see gold as the only possible cushion to absorb the kind of blow such currency mayhem will unleash on its citizen's personal balance sheets. They know that the stuff they print to buy worthless dollars is itself worthless. They also know they have no chance on earth to "fix" they banking disaster by year-end - or whenever they will have to finally start loosening their dollar peg.
Could gold be the only thing China can offer in that situation?
Wouldn't that be a killer? All of a sudden, the same governments and entities that worked to diligently and so hard over decades to make gold the pariah of the international investment and financing world may be forced to demand gold in order to preserve any semblance of economic viability to the world system. China's share in world trade is far too large to just let it fall by the wayside the way Malaysia and other southeast Asian countries were treated during the "Asian Contagion" of the late nineties.
Could the IMF simply loan China what it needs to right itself, like it did to the other countries back then? Fat chance! China is far too big a player for that. Doesn't seem like there are too many options open for avoiding this disaster, does it?
Well, actually, there is a way out.
Why not turn a vice into a virtue and increase foreign demand for the yuan by making the yuan the next world reserve currency? That would be a fitting finale for a world currency system turned upside down. Pick the most worthless of all worthless fiats and make it the standard for the rest of the world. It wouldn't be the first time something like this happened. Just look at how the world gobbled up dollars after they were totally debased in 1971.
A new era in international finance is surely dawning. It just may not be what you're looking forward to. Could this really happen, then?
It is happening.
There are effective ways for investors to protect themselves from the fallout of this situation, but they are extremely limited.