2012-03-24

Yen trouble is bad news for China

Andy Xie is looking at Japan's mess and considers the impact for China.

The Yen's Looming Day of Reckoning
Japan's nominal GDP contracted 8 percent in the four years to the third quarter of 2011, and six percentage points of that was due to deflation. Without increased government expenditure, the contraction will be one percentage point more. Japan has not seen this kind of sustained deflation since the 1930s.
...A yen collapse will impact China and South Korea most, just like in 1998. It will trigger substantial weakness in their industries. If a banking system succumbs, the shock can bring down an entire economy, as South Korea's experience in 1998 demonstrates.
Both China and South Korea have weak banking systems. South Korea's banking system is one of the most leveraged in the world due to high level of household loans. In 1998, a similar shock sank its banking system that was overleveraged with industrial loans. Now it is overleveraged with household loans. A shock could sink it again.

Overinvestment and a property bubble make China's banking system very vulnerable to such a shock. Unless China substantially increases the capital in its banking system, a big yen devaluation could cause China's banking system to sink. China suffers from overinvestment and a property bubble, as Southeast Asia and South Korea did in 1997. In terms of the magnitude of leverage, China's situation is much worse. Hence, a yen devaluation could wreak havoc to China's economy.

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