Stock markets have been catching up to reality over the last few sessions. Up until recently there had been an argument that even if the U.S. economy performed poorly, there would be a decoupling and other countries would be alright. This assumption is now being questioned, leading to a global market meltdown.
Recent developments in the Chinese banking industry provide a great illustration of how this new paradigm is unfolding. With U.S. banks buckling under the subprime mess during 2007, analysts predicted that China would remain insulated (i.e. "decouple") from the credit troubles overseas. On the evidence of acquisitions from Bear Stearns to South Africa's Standard Bank alone, it looked like Chinese banks were set to take over the world. Then came the realization that China wasn't going to escape the monsters in the credit markets. Bank of China appears increasingly likely to report a large write-down on its investments in U.S. mortgage securities, and China's stock market has been free-falling ever since.
Underlining the concerns, Jiang Dingzhi, vice chairman of the China Banking Regulatory Commission, warned yesterday that China's banks will "see rising credit risks, with nonperforming loans more likely to rebound" as they face a host of economic uncertainties. Nonperforming loans have been a massive problem for the Chinese in the 90s, mainly the result of decades of lending to poorly run state-owned companies. Bank of China, as an example, in 1999 recorded nonperforming loans of US$71 billion, about 39% of its total loans at the time.
"What makes yesterday's warning so bleak – and has already been cited by analysts to justify a slew of earnings downgrades – is that the looming NPL (nonperforming loans) problem is more nuanced this time around," says Leo Lewis at The Times. He continues:
This time companies in highly polluting sectors will be added to the danger list of NPL candidates, as clean-up efforts and tighter regulation shatter their business models. Sectors previously seen as defensive in times of economic tightening could weaken suddenly as capital is diverted into more efficient machinery, cleaner use of energy and greater responsibility for environmental damage.
Although China's green investing may have a marginal impact, it's a stretch to suggest that it is going to lead to a dramatic increase in China's nonperforming loans. But Mr. Lewis' comments remind us that environmentalism and capitalism don't always go well together. Much has been said about a new form of Western guilt, "Environmental Fundamentalism," that is making the lives of the poor in Mexico even worse. Critics blame the government-induced increase in demand for ethanol in the U.S. for triggering a massive rise in the price of corn, the chief component of the tortilla. Going by Mr. Lewis' thinking, the same kind of "Environmental Fundamentalism" that has caused so much pain for the Mexican poor may now also increase the pressure on China's banking system.
Lehman released a report in September that focused on the cost of dealing with climate change. John Llewellyn authored the report and he demonstrated that every $1 of solar energy benefits cost $130 in taxpayer subsidy. The Lehman report criticized the wasteful ways of the green movement, showing that switching light bulbs is a more efficient way to cut carbon emissions than solar power. In a similar way, the latest developments in China's banking system is another reminder that it is expensive to tackle climate change.
If green investing is going to have any place in capitalism, Environmental Fundamentalism will have to make way for Environmental Realism.
Disclaimer: I have no exposure to Chinese banks.
Photo:seaworthy, Creative Commons, Flickr