China’s Banks, Our Oil Industry Threaten Colossal Financial Meltdown

“Sure, let’s take all these oil companies to the brink of default, then raise their borrowing costs. What could go wrong?” 

In times like these it’s good to remember history and the old saying about those destined to repeat it. Most people think they remember the Great Recession of 2008 like it was yesterday, only it wasn’t yesterday and the details tend to get lost over time. Ask most people what they think tanked the economy and most would guess that it was the housing market. If they were really informed, they might remember something about banks selling mortgage-backed securities that turned out to be bogus investments. Those are all good guesses but they’re only partially right.

The real economic killer in 2008-2009 that brought the global economy to the brink was a banking liquidity crisis. Banks stopped lending money and, in an economy where debt is money, that’s a big problem. Nowhere was that more apparent than at General Electric, where GE Capital, the company’s financial services arm, needed a sudden infusion of billions in cash. What brought the world to the brink in 2008 wasn’t housing crisis, it was a liquidity drought.

This Time It’s Not Us

Once again a nation’s banking system is facing a liquidity crisis only now it’s happening somewhere else. In the U.S. we’re used to economic calamity being triggered by events here but, this time, the real disaster is happening on the other side of the globe.

Kyle Bass, one of the people who successfully and profitably predicted the liquidity crisis of 2008 is once again sounding the alarm, this time about China. The math is pretty simple and frankly scary. China’s banking system has grown to $34.5 trillion dollars while China’s entire GDP is closer to a third of that number. The question Bass poses is how much of that $34.5 trillion Chinese banks stand to lose as their nation’s economy continues to slow and more and more of those loans go bad?

Doomed to Repeat History

China’s banking system got in trouble the same way ours did; by slinging money around like there was no tomorrow. Now their government may have to do what ours did in 2009 – start recapitalizing the banks. That will put a drain on China’s foreign capital reserves which will devalue the yuan, potentially by orders of magnitude. Coincidentally, that’s exactly the thing China said it wouldn’t do if the IMF made the yuan one of the world’s reserve currencies.

What will the IMF do about it? I’m sure they’ll issue a disapproving statement, perhaps even followed up by a strongly worded pronouncement—but actually doing anything? Ha ha ha, nope.  When it comes down to it, the IMF couldn’t break up a fight for the last cupcake at a middle school bake sale; they’re certainly not going to take on China.

Wait, It is Us!

Meanwhile, back in the U.S., we have our own brand new, homegrown liquidity crisis brewing. We went on a binge financing oil and gas drilling and projects to extract oil from shale and tar sands. Unfortunately, when we started those projects oil was seventy dollars a barrel, now it’s thirty. The companies that borrowed all that money aren’t making enough out of the oil they’re extracting to make their loan payments. As a result, the U.S. oil and gas industry is looking at a wave of hard defaults in the months ahead that could easily dwarf what we saw in the housing crisis of 2008.

To top it all off, the Federal Reserve, staring at this imminent debt crisis, is still talking about raising interest rates! Sure, let’s take all these oil companies to the brink of default, then raise their borrowing costs. What could go wrong?

We’re not looking at just one banking liquidity crisis; we’re looking at a simultaneous meltdown of two of the three largest banking systems in the world. Instead of putting itself on alert, ready to intervene in a liquidity crisis, Federal Reserve Chairman Janet Yellen is calling the stock market meltdown a “healthy readjustment.” It makes you wonder if we’re all reading the same headlines.