Last week, the Chinese yuan weakened further, breaking through the very closely monitored level of seven yuan per dollar. This weakening sent global stock markets into a spin, with the Dow Jones Industrial Average falling almost 3%.
Many market economists view the Chinese currency breach at the long-held seven yuan level as a sign that trade negotiations with the United States are going bad, resulting in global markets selling.
However, it may be a sign of a much more troubled problem. China has some problems, just like the other Asian countries had just before the Asian financial crisis of 1997. This incident two decades ago has been analyzed in detail. It was triggered by debt fraud from two companies: Somprasong Land (a major Thai real estate developer) and Finance One (one of Thailand's largest finance companies). Currency traders began to shorten the Thai currency, and eventually broke the US dollar, resulting in a 40% fall in value. This steep decline made it impossible to repay loans in dollars. Currency weakness spread to South Korea, Indonesia, Malaysia and the Philippines. All of their currencies fell dramatically ̵
While the trigger was a debt failure as economic conditions shifted, the underlying factors had long been in place – these were export-driven economies that had close government operations with preferred producers, subsidies, favorable economic agreements, massive debt-financed growth and a currency bound to the US dollar. Sounds familiar?
Almost all economic crises have the same underlying problem – too much debt. China has a huge debt burden. Domestic credit to private sector banks is 161% of GDP. The 1997 crisis started in Thailand when the level was 166% of GDP. China's total debt, which includes corporate, household and government debt, has doubled since 2008 and is now 303% of GDP or over $ 40 trillion.
Another worrying change in the Chinese financial system is the current account balance. The balance has fallen dramatically over the last ten years and is on the verge of going negative. If there is a deficit, China will have to borrow foreign funds for future growth. As of 2007, it had a $ 420 billion operating account surplus, an amount equivalent to 10% of GDP.
The South China Morning Post reported in November 2018 that Chinese property developers are facing "increasing refinancing requirements", such as $ 51 billion. matures in 2019. China now has $ 3 trillion in US debt. The market has begun to buy credit insurance against Chinese debt, as default risk rose to its highest level in six years over the past week.
People's Bank of China seized the failed Baoshang Bank early this year. This was the first bank seizure in 20 years. In July, the Bank of Jinzhou had to be rescued by three state-owned entities. And if bank failures did not cause enough pressure, a federal court in Washington, D.C., Shanghai Pudong Development Bank and two other Chinese banks held contempt. Banks refuse to comply with a US bank register lawsuit for a Hong Kong company linked to North Korea sanctions violations. The contempt order allows the US Treasury to close the banks' US correspondent accounts, effectively knocking them down on the world economy.
All this is happening as China's economy slows to the lowest growth rate in almost 30 years and the United States imposes tariffs on exports. There is turmoil in Hong Kong as protesters march in the streets and the wealthy move assets quietly and flee to the West.
China is obviously waiting for President Trump to hope he loses the 2020 election. But the Chinese economy may be in a much more vulnerable position than markets realize, and it could massively destabilize the world economy.