EVERYONE IS FOCUSED ON “FED DAY” – which is the day of the month (today) on which the Fed announces its latest increase in the Fed Funds Rate (expected to be 0.75%, and the market has “priced it in” already).
BUT – there is an economic issue brewing overseas that is 100x more momentous and serious than anything the Fed might say or do.
That issue is the pending Chinese Banking Crisis.
We largely take our banking system in America for granted.
But most Americans don’t realize how important it is and that without a robust and fully functional banking system, no modern economy can survive.
Our banking system did come close to collapsing though in 2008 when the housing market collapsed, and that is why our government officials were in a state of panic.
If our banking system had collapsed in 2008, we would have seen a depression that would have made the crisis we actually faced seem like a walk through the park.
CHINA IS FACING A SIMILAR BANKING CRISIS NOW, but the magnitude is much worse and it seems unlikely they will be able to resolve the problems.
What’s Going On In China?
There are two things taking place in China: (1) bank runs or depositors withdrawing funds en masse; and (2) borrowers refusing to make payments on their loans en masse.
Either issue alone could easily collapse a banking system, but seeing both at the same time is terrifying authorities.
CHINA’S PROPERTY SECTOR (at $55 Trillion) IS THE LARGEST ASSET CLASS IN THE WORLD, dwarfing America’s entire stock market even.
The problem is that the entire sector is artificially propped up by enormous borrowing and speculation – much like America’s was prior to 2008.
Making the problem worse is the fact that Chinese borrowers are forced to take out loans and make payments against properties before the properties are even constructed.
Worst of all, the value of those properties is plummeting for a variety of reasons, putting the entire system in extreme peril.
Chinese depositors and borrowers are starting to see how precarious the entire arrangement is and they are getting very worried.
A. Chinese borrowers don’t want to make payments against properties when they believe the values are dropping or will drop significantly (just like we saw in America in 2008), and they especially don’t want to make payments against properties that may never be built at all because the developers are facing bankruptcy.
B. Chinese depositors don’t want their life savings in a bank with too much exposure to all of these bad real estate loans.
Here is a short article discussing the bank runs and what the Chinese authorities are doing to stop them (bringing in tanks).
And – here is an excellent 10-minute video explaining what is going on in China with much more detail than I set forth in this blog.
What Will Happen?
Many pundits don’t think China will be able to fend off the onslaught of declining property values and non-performing loans, much like the U.S. was not able to stop its real estate collapse in 2008.
The U.S. was, however, able to keep the banking system afloat with massive bailouts and other measures.
But – the U.S. economy was much larger relative to its real estate and banking sector and America had the advantage of having the world’s reserve currency – which enabled it to borrow and effectively print the money it needed for bailouts in a way that the Chinese likely can’t.
Rates Will Fall
A collapse of China’s banking system would be horrible news for the world economy, no matter what anyone’s concerns about China may be, as China is the 2nd largest economy in the world.
This would likely cause severe economic hardship for not just the Chinese but for everyone who relies heavily on them for trade and commerce – and economic growth will likely slow throughout the world for years.
This horrible news alone is the type that will bring rates down significantly in the U.S., as negative economic news always does and this is about as negative as it can get.
But what will bring rates down even more will be all the capital that moves to the U.S. in order to escape the risks posed by a potentially collapsing Chinese economy.
So, while falling rates may be a good thing for the mortgage world, the collapse of the Chinese banking system would be a horrible thing for the broader world.
Hopefully the Chinese can fend off such a collapse, but it seems unlikely.
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