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China's Banking Crisis

January 16, 2004

Bloomberg reports on a bailout of the banking system in China.  According to the article, they used 1/10th of their foreign exchange reserves to "boost the capital adequacy" of their two largest banks.  "Boosting capital adequacy" is a euphemism for bailing the bankers out for bad loans under the fraudulent system of fractional reserve banking.   The Chinese central bank has accumulated vast foreign exchange reserves ($450 billion according to the article, mostly in US$) because of their policy of pegging the exchange rate between their currency and the US$.  This is part of the grand dollar game, a system that allows Americans to live beyond their means when the rest of the world loans us money to purchase their goods.

In order to keep the price fixed, they must be willing to buy the US$ in any quantity that is offered at the fixed exchange rate.  What do they buy it with?  More of their own currency, that they can print at will through their banking system.  The buyers would typically be Chinese firms who have exported goods to the US but have to pay their costs in the Chinese currency.  They need to exchange their dollar revenues for their renminbi costs.  The renminbi that the Chinese central bank prints to buy dollars thus flow back into the Chinese commercial banking system.

The Austrian school has argued that this type of credit expansion funded by money creation tends to be invested in projects for which there will not be enough savings in the economy to complete.   Eventually these projects will go bust, and to the extent that they are funded by bank credit creation, the banks will be in trouble as well, which usually leads to a government bailout of the banking system.   According to Pesek, "China is sitting on a bad loan problem than is worse than Japan's."


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