Beijing has managed to keep credit and cash growing despite falling property prices, weak corporate profits and slowing GDP growth. Such successful financial management may help it avoid the kind of liquidity trap that made the U.S. recession so painful. But it could encourage the kind of behaviour that has kept Japan in a slump for so long.
China's current slowdown was triggered by a correction in an overinflated, credit-fueled property market. When such bubbles burst, lenders typically reel in credit fast. That happened in the United States, starting a negative feedback loop of loan defaults, bank losses, lower economic output and receding credit.
On paper, China has averted such a crunch. Though annual mortgage loan growth has dropped to 12.5 per cent from 53 per cent in early 2010, overall loan growth has recovered to nearly 40 per cent and the money supply is expanding at 13.6 per cent.
But China's banks lend how they're told. That explains how government stimulus in late 2008 resulted in a 1,500-per-cent jump in new bank loans, despite the slowest GDP growth in a decade. Pouring loans into an economy can slow a credit bubble's collapse, but it delays a healthy recovery by propping up sick enterprises and crowding out more profitable ones. Japan's asset price bubble collapsed in 1991, but banks kept refinancing struggling borrowers. It wasn't until 1994 that lending fell.
China could be entering a similar quagmire. As domestic GDP growth slows, companies are keeping earnings off-shore, slowing growth in domestic deposits. That's pushing lenders close to loan-to-deposit limits. Most already favour state-backed companies. Smaller, private companies are forced to seek costlier funding elsewhere.
As a result, loans are growing, but they're increasingly short-term, with loans of more than one year maturity actually falling 25 per cent so far this year. That means refinancing could crowd out new lending.
China's population is younger and the economy is growing faster than Japan in 1991. But the credit non-crunch may make it be tougher for China's incoming leaders to reduce the dominance of exports and of state-owned companies in the economy. Creative destruction is painful but vital.