What to fear if China crashes

“The example of how the global financial crisis began in one poorly-understood financial market and spread dramatically from there illustrates the capacity for misjudging contagion risk,” Adam Slater wrote in a July 14 Oxford Economics report.

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Lehman and AIG, remember, were just two financial firms out of dozens. Opaque dealings and off-balance-sheet investment vehicles made it virtually impossible even for the managers of those companies to understand their vulnerabilities — and those of the broader financial system. The term “shadow banking system” soon became shorthand for potential instability and contagion risk in world markets. Well, China is that and more.

China surpassed Japan in 2011 in gross domestic product and it’s gaining on the U.S. Some World Bank researchers even think China is already on the verge of becoming No. 1 (I’m skeptical). China’s world-trade weighting has doubled in the last decade. But the real explosion has been in the financial sector. Since 2008, Chinese stock valuations surged from $1.8 trillion to $3.8 trillion and bank-balance sheets and the money supply jumped accordingly. China’s broad measure of money has surged by an incredible $12.5 trillion since 2008 to roughly match the U.S.’s monetary stock.

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