China's Banks

Jim Grant is one of my favorite reads. His newsletter, Grant's Interest Rate Observer, is a bit out of my price range but I'm fortunate to score an issue every now and then.

His May 20th newsletter discusses troubles under the hood w/ China's banking system. While China's markets and massive growth have been all the rage, people seem to forget that a socialist regime oversees the country. Central planners control capital allocation on a macro scale. When bureaucrats sitting in a room are deciding how to allocate capital, they are likely to make more mistakes of longer duration than individuals making decisions in unhampered markets.

Grant suggests that Chinese banks are holding gobs of non-performing loans--loans that banks were required to take on per govt officials. These loans are currently not marked anywhere close to market.

This situation, of course, is reminscent of the credit crunch faced by banks in the US. Grant suspects that, because the Chinese system is so opaque, the potential exists for big problems if things start to go bad.

His 'new working hypothesis is that the banks of the People's Republic...will execute the greatest belly flop in the history of paper money.'

Should this come to pass, there is no way that the problem would be contained to China.