Will China’s Shadow Banking System be its Ruin?

May 5, 2015

by Michael Edesess

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From being considered a “backward” country only 30 or 40 years ago with a very high level of poverty, China has become a world economic powerhouse. Many now speculate that China will surpass the United States as the global leader, yet others predict that China will trip and fall. A great deal of concern has focused on China’s shadow banking system, and whether that system is reliant on a real estate bubble that will ultimately collapse, bringing the economy down with it.

The recent global financial crisis, in which the U.S., the U.K. and other world leaders tripped and fell, makes this scenario seem very possible. The urge to consider it likely, however, may also result from envious competitors anticipating the delicious schadenfreude they would experience if it came to pass.

Let’s look at how China’s shadow banking system operates and whether the fears of collapse are justified.

We’ve seen it before

I had a ringside seat when Japan became a major exporter a few decades ago. Amid China’s more recent export surge, we may forget how big Japan’s was.

When I was 16 years old, I got a summer job as a “feeder” in a dingy, dirty warehouse in Boston where shoes were retagged by women sitting at rows of dusty tables. My uncle, a buyer for the shoe company, “pulled strings” to get me the job. I don’t know how hard he had to pull those strings because the job was one of the worst jobs in the world.

The shoes were brought on pallet movers in boxes stacked in high piles. When they arrived, they bore the manufacturers’ labels. The women’s job was to retag them with the retailer’s tag. The women were paid by the piece, so they wanted no delay in receiving the shoes at their tables. When they finished retagging a boxful of shoes they would yell, “work” until one of the two “feeders” brought them another box. To bring shoes to them, I would shake one of the piles of boxes (I am short and was shorter then) until the top box came off, catch it and open it with a one-two punch, breaking the tape across the top and ripping open the flaps. I then brought the box to the last woman who had shouted, turned it, propped it on her desk and opened the flaps so she could pull out each pair of shoes and retag it. I would close the box she had just finished and stack it on another pile.

When I started, I was paid $1.10 an hour. About a month into the job, the minimum wage was raised to $1.12-1/2 cents an hour, so I got a raise. But I didn’t receive all of it because it was a “closed shop”; a portion was automatically withheld for Teamsters Union dues. At least the job made me stronger.

When I started, each box weighed about 36 pounds, a lot of weight to catch. About a third of the way through the summer, heavier boxes began to arrive – as I recall, 60 pounds each – filled with cheap sneakers from Japan. After a while, all of them were sneakers from Japan.

The rise and fall of Japan

After World War II, Japan was in ruins. As it set about its recovery, it began to make goods for export. But they were low in quality. In the 1950s “Made in Japan” was a laughingstock, a synonym for “piece of junk.” According to legend, to avoid that label some companies even set up plants in the Japanese village of Usa, so they could say their products were “MADE IN USA”.

With the help of American efficiency experts like W. Edwards Deming, who couldn’t get companies in the U.S. interested in his methods but could in Japan, Japan gradually became a manufacturer of high-quality export goods. It was so successful that in the late 1980s the United States worried that it was no longer “competitive” and needed to pursue a government-led “industrial policy” like the one firmly scripted and guided by Japan’s Ministry of International Trade and Industry (MITI).

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