Chinese guarantees and the illusion of safety

A “guarantee” is only as good as the guarantor. If you buy a car with a ten year parts and labor guarantee, you make the assumption that the company will be around for that long and able to make good on its promise.

That’s becoming a potential problem in China. The Wall Street Journal shows how a lot of Chinese loans are ‘guaranteed” by guarantors who may not be able to make good in case of trouble.

Since 2007, the central government has instructed banks to lend more to small firms run by entrepreneurs, the most efficient part of the economy but one that banks have traditionally eschewed. Banks prefer to lend to large and state-owned firms that have sufficient collateral – typically land – to cover their loans.
The banks’ solution has been to insist that in the absence of collateral, someone else guarantee the loan – absolving banks of the need to look too closely at borrowers’ ability to pay, while giving loans the veneer of being safe. In some cases, the guarantee will come from another small firm – maybe a neighboring factory, and a company run by a close friend.

This would not be a problem for the industrialized world if China had not become the world’s largest economy. Major firms throughout the world are making big bets on the Chinese economy. The Chinese are known for their “creative” accounting.   The next big “Black Swan” event could come at us out of the Orient.

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