What If China Has a "Lehman Brothers" Crisis?

Image: wikipedia.com

For some time, the People's Republic of China has been Uncle Sam's foremost creditor. This precarious relationship has its foundation in the notion that both countries have reasonably reliable sovereign debt. Few worry that Beijing or Washington will simply walk out on their government bonds. However, we've learned the hard way that misuse of other fiscal tools can destabilize an entire nation's economy and, for that matter, its society. The United States got a close look at this scenario during the financial calamity called for convenience the "Lehman Brothers bankruptcy".

A situation with similar disastrous overtones may be taking place in China now. A senior auditor in The Middle Kingdom recently claimed that local government (i.e., provincial and municipal) debt is nearing the point of no return, in its literal and figurative senses. According to a story in today's Financial Times, Zhang Ke, vice-chairman of China's accounting association, said the debt "'is already out of control. A crisis is possible. But since the debt is long-term, the timing of its explosion is uncertain."

A PRC financial calamity would be felt globally. Beijing might be compelled to cash its US Treasury holdings, potentially diluting their value and raising Washington's borrowing costs. China would purchase fewer imported goods, thus slowing down an already sluggish world economy. (That's especially bad news for Euroland.) Its population may become restive, a situation that is far and away the Chinese leadership's worst nightmare. For better or worse, the world, including the USA, is tethered to events in the country Napoleon called the "sleeping giant". The titan's financial collapse would be felt by all. That's why we should care about Mr. Zhang's warning.