HOW CHINA´S FINANCIAL CRACKS COULD SPREAD / THE WALL STREET JOURNAL

How China’s Financial Cracks Could Spread

If China’s growth falters, the fallout will be felt around the world

By Aaron Back


Can financial turmoil in China play havoc with the rest of the world? It has already happened.

On the first trading day of 2016, China’s central bank sent shockwaves around the world by sharply lowering the value of the yuan. The decline in the currency itself, which came after the bursting of a stock market bubble, was not the biggest concern. Rather it was a sudden loss of confidence in China’s growth story that reverberated around the world.

No matter how closed China’s financial system is, the country’s heft as the world’s second largest economy, as the biggest buyer of nearly all commodities and as the biggest exporter means what happens in China won’t stay there.

How the ripples of China’s actions played out over the next several weeks shows what could happen if the country’s dependence on borrowing to fuel growth hits a wall. China’s stock market plummeted, pulling the S&P 500 down 11% from the start of the year to Feb. 11, when it bottomed.

Oil and other commodities fell harder, with West Texas crude falling to $26 per barrel the same day.
 

Currencies of commodity-producing nations like Australia and Brazil were hit. Saudi Arabia’s currency peg to the U.S. dollar came under speculative attack. Commodity trading houses like Switzerland’s Glencore and Hong Kong’s Noble Group faced investor fears over their solvency.

This turmoil had knock-on effects on financial companies. Banks that made loans to oil drillers and miners looked exposed to defaults. The prospect of lower growth in China and commodity-producing emerging markets sent global interest rates lower, impairing banks’ profit margins. In the U.S. banks were among the hardest hit sectors, with the KBW Nasdaq Bank index falling 23% by February 11.

No two crises are exactly the same, and China is unlikely to allow its domestic stock market to become so stretched again. But if the Federal Reserve keeps raising interest rates, it could put renewed downward pressure on the yuan. The country’s new capital controls haven’t been tested by a big shock either. China’s shadow banking system has grown dramatically, so any attempt to rein it in, or any breakdown in the byzantine chain of wealth management products, could threaten Chinese growth and send cash flowing out of the country.

A Chinese financial crisis likely wouldn’t play out like the U.S. housing bust, which caused the worst global recession in decades. But China’s stumble in early 2016 didn’t require the collapse of a complex financial product or the failure of a major bank to hit markets around the world.

The combination of plain old commodities and leverage were enough to spread the damage.

Anyone searching for ground zero of the next crisis should look closely at how a crack in China’s growth story could be transmitted globally.