Things are getting tough for small, private businesses in China. As the WSJ reported yesterday,
Many smaller private companies, unable to obtain bank loans because of the government’s tightening of credit to fight inflation, have turned to so-called shadow lenders for funding. Such lenders often charge exorbitant interest rates, and many smaller enterprises, struggling to repay the debt, have gone under…Since April, nearly 100 factory owners in Wenzhou alone have fled the city after failing to repay high-interest debt, according to state media reports. Such distress, economists warn, could spell bigger problems for China’s vast banking sector and the economy at large, potentially leading to defaults even on bank loans at normal rates. That could cause banks to cut credit lines to sound businesses and their suppliers.
These small companies face a growing profitability problem: high-interest debt, increasingly expensive labor, widespread power outages, and a more competitive global market are forcing small-time manufacturing companies, of which there are many, to the wall. Efforts by the central government to control inflation by tightening access to credit have hit small companies hardest. Shadow-lending has typically eased access to credit for these small companies and banks, but the price of this credit is ruinously high and the opportunities are coming under increasing scrutiny from the central government: “Analysts say there is now a risk that this source of credit could dry up, bringing down even thriving companies, with ripple effects on the formal banking system”.Best case, this is just another phase of the business cycle, and China moves on. Worst case? This could be the Big Squeeze at work: the nightmare scenario in which the profitability of Chinese manufacturing falls, creating credit, unemployment and social problems on a large scale.I’ve argued before that the Mother of All Bubbles may be excess manufacturing capacity in Asia. Decades of above average returns on investment, compounded by a range of state policies aimed at encouraging the development of this kind of enterprise, have led to a massive overcapacity: the world can’t consume as many widgets as manufacturers need to sell.What would set that off would be a contraction in demand from the developing world, much as we’ve seen in the recession and slow growth that has dogged Europe and the US since 2008. Watch China, and especially watch its small manufacturing sector. If tight profit margins persist for this sector, bad things could be in store.Very bad things.