Wednesday, February 3, 2016

Could the Scale of the Banking System in China Force a Rescue Effort?

Has the Chinese banking system grown too large?

CNBC interviewed a fund manager, Kyle Bass, who is betting that it has.

The premise of Bass' bet goes like this: China's banking system has grown to $34.5 trillion, equal to more than three times the country's GDP. The country is due for a loss cycle . . . central bankers will have to dip into China's $3.3 trillion of foreign exchange reserves to recapitalize the banks, causing a significant depreciation in the value of the yuan . . .

For comparison, the U.S. banking system is around 1 times annual GDP, making it considerable smaller than that of China. The United States pursued deeply inflationary policies for years (though the economy proved resistant to inflation) after 2007 to rescue its banking system. After just a few large-scale shocks such as failed real estate or energy projects or natural disasters, China’s banking system could be weakened enough that China may be forced to follow a similar path. If that were to occur, there is no guarantee that the Chinese economy would resist the subsequent inflation.

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