What do the economies of Argentina, Venezuela, Greece, Ukraine, and China have in common? It’s not recession. Nor is it inflation. It’s not even currency instability. So what is it?
The Long Shadow of Shadow Banking
What China, Argentina, Greece, Venezuela, and Ukraine all share in common is an ongoing struggle with global shadow bankers, who continue to destabilize their financial systems and drive their real economies, at different rates, toward recession and worse.
Since 2010 shadow banks have speculated intensely in Greek government bonds, driving up bond interest rates, forcing the government in turn to impose ever more draconian forms of austerity in order to pay their loan debt to the IMF, the EU, and shadow bankers like global Hedge Funds. Shadow banks have played a major role in forcing more severe austerity on the Greek people, and the hardship that has produced in lost jobs, falling wages, reduced pensions, cutbacks in essential social services, and privatization of public goods. Wages and working class standards of living are reduced, in order to ensure ever-rising interest payments to shadow banks and their investors.
In Argentina, U.S. shadow bankers were behind much of that economy’s prior debt crisis and defaults early in the last decade. Today, the same shadow bankers are at the center of a fight to extract even more payments from Argentina than previously agreed upon years ago in a resolution of that prior debt crisis. As U.S. central bank policy and collapsing world oil prices together force a decline in Argentina’s currency that threatens to push its economy into recession, U.S. shadow bankers continue to maneuver to cut off further global credit access to Argentina as a way to force it to pay them more than before for prior loans—a strategy that may accelerate Argentina’s slide into recession. Argentina’s economy thus reels under a triple assault by global finance capital – led by the U.S. central bank, exacerbated by global oil finance and oil futures securities traders, and simultaneously squeezed by U.S. hedge funds leading a charge to reduce Argentina’s credit availability still further.
In Venezuela, much of that economy’s current troubles are also traceable to shadow bankers, working in consort with global commercial bankers and the USA government. Shadow bankers are serving as a key conduit for funneling capital out of the Venezuelan economy. That has resulted in collapsing Venezuela currency, and in turn accelerating import drive inflation, and declining credit availability for the economy in general. Even more so than Argentina, Venezuela is being hammered by global oil commodity futures traders, as well as the rapid rise in the USA dollar. Whereas hedge funds and other shadow bankers are working behind the scenes to deny global credit to Argentina as a tactic to force it to pay U.S. funds even more, in Venezuela the vulture fund tactic is to exacerbate currency decline and capital flight from Venezuela’s economy.
The Ukraine is yet another classical case of shadow bankers preying upon an economy in distress. In the wake of the Ukraine’s descent into economic depression in 2014, the IMF and western commercial bank and government (European Commission) policies have put heads of western shadow banks in direct and daily management control of Ukraine’s economy. This past December, the CEO of the USA private equity firm, Horizon Capital, Natalia Jaresko, was appointed by Ukraine’s Poroshenko government as its official Finance Minister, while a western European, Aivaras Abramavicius, with close ties to Swedish and German shadow banks, was appointed as Economics Minister for the Ukraine. Shadow banks in the case of Ukraine will now be able to dismantle and destabilize the Ukraine economy ‘from the inside’, instead of dictating its policies from the outside as has been traditionally the case of other economies.
Relatively smaller economies like Ukraine, Greece, and even Argentina-Venezuela are more vulnerable to the financial intrigues and maneuvers of global shadow bankers—the overwhelming majority of which originated and are still based in the USA and the UK. Shadow banks are definitely a phenomenon of Anglo-American global finance that re-emerged on a global scale several decades ago, expanded in the 1980s, became truly global in the 1990s, played a central precipitating role in the global financial crash of 2007-09, and have come to represent in the 21st century one of the defining characteristics of global capitalism today.
A Brief Overview of ‘Shadow Banking’
Shadow banks are that exploding growth segment of global finance capital that share the following characteristics: they are largely unregulated, they invest primarily in financial asset securities of various kinds (i.e. stocks, government and corporate junk bonds, foreign exchange, derivatives, etc.) instead of real asset investment (plant, equipment, software, etc.), they target high risk-high return opportunities based on asset price appreciation and volatility to realize financial capital gains, their investments are highly leveraged and debt driven, their investment targets are highly liquid financial markets worldwide that enable a quick entry, price appreciation, and subsequent just as quick short term profit extraction.
Their client base is predominantly composed of the global finance capital elite – i.e. the roughly 200,000 worldwide ultra and very high net worth individuals with net annual additional income from investment flows of $20 million or more—for whom they invest individually as well as for themselves as shadow bank institutions.
Shadow bank ‘forms’ include private equity firms, hedge funds, asset and wealth management companies, mutual funds, money market funds, investment banks, insurance companies, boutique banks, trust companies, real estate investment trusts – to note just a short list – as well as dozens of other forms and newly emerging initiatives like peer to peer lending networks, online investment funds, and the like.
Shadow banks have been estimated to have investable assets (i.e. relatively short term and liquid) of about $75 trillion globally as of year end 2014, a total that does not include revenue from ‘portfolio’ shadow-shadow banking. That is projected to exceed $100 trillion well before 2020.
Shadow banks and their finance capital elite clients make money when financial asset prices are volatile, i.e. when such prices rapidly rise or fall or both. It is thus in their direct interest to cause asset price volatility and instability—whether in provoking a rapid rise in government bonds rates(Greece), in contributing to the collapse in currencies (Venezuela, Argentina), or in IMF-enforced ‘firesales’ of companies (Ukraine). Their strategy is to exacerbate, or even create, financial price inflation in the targeted market and financial instruments, be they stocks, junk bonds, real estate, foreign exchange, derivatives, etc. That same financial price instability, however, is what causes havoc with the real economies of countries—like those in southern Europe in recent years, in Asia in the late 1990s, Japan in early 1990s, and which led to the global financial crash of 2008-09 itself.
In the Shadows of China
In the case of China, a much larger economy than the others noted above, the impact of shadow banking has been relatively recent.
A study by JP Morgan Bank in 2012 estimated that the shadow banking sector in China grew from only several hundred billions of dollars in total assets under management in 2008, to more than $6 trillion by the end of 2012. In percentage terms, shadow banks assets accelerated 125 percent in just the second half of 2009, followed by another 75 percent growth in 2010. Shadow bank assets grew additional 35 percent and 33 percent in each of the two years, 2012-13. By 2013 the total had risen to more than $8 trillion, according to the research arm of Japan’s Nomura Securities company. Shadow bank total assets rose another14 percent and $1 trillion in 2014—to more than $9 trillion.
At the center of shadow bank instability has been the so-called ‘Investment Trusts’. According to McKinsey Research, Investment Trusts today account for between $1.6-$2.0 trillion (of the roughly $9 trillion) of all shadow bank assets in China. Trusts’ assets grew five-fold between 2010 and 2013. Approximately 26 percent of the Trusts provided credit (and therefore generate debt) to local governments for infrastructure spending, another 29 percent to industrial and commercial enterprises, another 20 percent to real estate and financial institutions, and other 11 percent to investors in stock and bond markets. Local government debt in particular has risen by more than 70 percent in China since 2010. In other words, shadow bank credit has gone mostly to those sectors of China’s economy where debt has accelerated fastest and produced financial bubbles.
This explosion of shadow banking and speculative investing originated in the wake of the 2008-09 global economic crash. In 2009 China adopted an aggressive fiscal and monetary policy that resulted in China quickly recovering from the 2009-10 global crash – very much unlike the USA, Europe or Japan, all of which relied primarily on monetary policy injections by their central banks and adopted only token fiscal stimulus (USA), actual fiscal austerity (Europe), or else undertook no fiscal stimulus(Japan). In 2009 China introduced a fiscal stimulus package of nearly 15 percent of its GDP, while the USA, in contrast, provided only a 5 percent of GDP stimulus in 2009, Europe contracted fiscal spending as part of its austerity program policies, while Japan did nothing much fiscally.
It is important to note that accompanying China’s 15 percent fiscal stimulus was an equally massive monetary injection as well. Part of the money injection came from China’s central bank and its state owned banks, which loaned significant sums to state owned enterprises and other businesses starting 2009-2010. But part also came from opening China in late 2009 to shadow banking, which freed up liquidity both from within China and resulted in massive capital inflows from foreign investors.
Total credit extended by shadow banks in China from 2010-2014 is mirrored in the corresponding explosion of total private debt in China that has paralleled the rise in shadow bank lending. As shadow bank credit and debt accelerated to more than $9 trillion today, corresponding total debt in China rose from 130 percent of GDP to more than 240 percent of GDP. That growth in China’s total debt has, moreover, been almost exclusively ‘private sector debt’, with much of that provided by the shadow banking sector.
A good deal of that private debt explosion has also taken the form of dangerous short term debt that requires frequent ‘roll over’ and refinancing. By 2014 a third of all new debt created in China was ‘roll over’ refinancing of prior debt. That means that should interest rates rise too far or too fast, many businesses heavily indebted to shadow banks will not be able to roll over that debt, and will have to default. In turn, defaults could result in panic sell offs of financial securities, followed by a general ‘credit crunch’ that will slow the real economy still faster than even at present.
The massive credit creation and debt assumption underlying the recent bubbles in housing, local infrastructure, sales of wealth management products on behalf of old enterprises, and Yuan currency speculation can result in a financial instability event in China should any of the following developments occur singly or together as China’s economy continues to slow: asset prices for housing or commercial real estate decline too sharply, revenues of older industrial enterprises like coal and steel collapse, or local governments can’t make interest payments on their massive previously incurred infrastructure debt. And all of the above have begun to happen in China since mid-2013.
In other words, shadow banks in China, in just four years since 2010, have created the economic preconditions for a very real potential major financial instability event in China, and a possible subsequent major general economic contraction in its economy—a contraction that will undoubtedly spill over to the rest of the global economy.
But the negative impact of shadow banks on China’s real economy is not just something potential, in the future. It began to occur around 2012, as China began to attempt to check the growth and negative effects of shadow banks on its economy.
During the past two years, 2013-2014, a struggle has been underway between China and its shadow banks. China’s effort to bring its shadow banks ‘to heel’, as they say, has resulted in some limited success in 2014 after a false start in 2013 – but only at the direct expense of a definite slowing of China’s real economic growth the past two years. Slowing growth in China the past two years has therefore been, at least in part, due to China’s attempts to tame shadow banking excesses.
In spring 2013, China tried to slow the asset price bubbles by making loans more expensive, by raising general economy-wide interest rates. That had unintended, counterproductive effects, however. It quickly resulted in a credit crunch that slowed the entire economy almost. Unable to get loans from China’s traditional banks, local governments attempting to continue the infrastructure boom borrowed even more from the shadow banks. Bubbles in housing and infrastructure grew further. China quickly responded in June 2013 by reversing its policy and cutting rates again. It also introduced a new fiscal ‘mini-stimulus’ spending program. But lower rates again provided more liquidity and stimulated shadow lending even more, while the fiscal mini-stimulus had little positive impact on real growth. China’s economy continued to slow in 2013.
In late 2013 China policy makers took another approach, introducing more direct measures to scale back shadow banks’ excessive lending. By 2014, rates were raised once more and another smaller mini-stimulus introduced, also with little effect. But the Yuan began to decline and the asset price bubble in residential housing also began to unwind. Now the concern was the currency may decline too much and housing prices fall too fast. Also on the negative side, reduced credit to industrial and commercial enterprises has already led to growing defaults and in turn more government bailouts; credit availability has been declining for property developers and local government infrastructure projects; and investors are moving their capital from shadow bank wealth management products into stocks and to Hong Kong. Local building, local infrastructure, and commercial enterprise spending are slowing, and with it the general economy.
In short, even China’s effort in 2013-2014 to tame the shadow bank sector is taking its toll on economic growth. China’s real economy has continued to slow. It is now estimated China’s 2014 GDP will barely attain a 7 percent growth rate. And independent sources consider this an overestimation, with the real GDP growth at 6.5 percent or less.
What China’s experience and struggle with Shadow Banks since 2010, and especially since 2012, shows is that shadow banks generate profits from excess lending and debt creation, from financial speculation, and from creating financial asset bubbles that primarily benefit their wealthy investors. The forms in which they ensure excess capital gains to their investors vary across economies. But they all share the common element of provoking financial asset inflation and consequent capital gains that accrue to their investors. Shadow banks add little to the real economy or real economic growth. And in the process of generating excess financial profits for themselves and their finance capital elite, they destabilize economies and can often lead to major financial asset collapses, general credit crunches and at times even credit crashes, that in turn lead to deep recessions and prolonged, difficult recoveries.
Even when confronted early and by otherwise strong economies, as in the case of China, that very confrontation itself can have negative consequences for economic growth. What all the country examples show, including China, is that shadow banks are the preferred institutions of the global finance capital elite. They always work to the benefit of that elite, often at the direct expense of the real economy, including non-financial businesses, and always at the expense of working classes who never share in the capital gains but pay the price in slower economic growth and repeated financial-economic crashes.
Jack Rasmus is the author of the forthcoming book, ‘Transitions to Global Depression’, Clarity Press, 2015; and Epic Recession: Prelude to Global Depression and Obama’s Economy, both by Pluto Press, 2010 and 2012. His blog is jackrasmus.com and website www.kyklosproductions.com.