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China Syndrome: The next financial crisis will be criminally complicated

AP Photo/Andy Wong

At the New York Times, Paul Krugman turns his attention to China. Simply put, the Middle Kingdom could be the next domino to fall — after the U.S. financial crisis an the ongoing eurozone crisis — in what now looks like a pitched global battle between regulated finance and finance that, if not purely criminal, isn't exactly above-board.

Krugman zeroes in on the big difference between limited consumer spending in China, surging investment spending, and our old friend, real estate:

Do we actually know that [Chinese] real estate was a bubble? It exhibited all the signs: not just rising prices, but also the kind of speculative fever all too familiar from our own experiences just a few years back — think coastal Florida.

And there was another parallel with U.S. experience: as credit boomed, much of it came not from banks but from an unsupervised, unprotected shadow banking system. There were huge differences in detail: shadow banking American style tended to involve prestigious Wall Street firms and complex financial instruments, while the Chinese version tends to run through underground banks and even pawnshops. Yet the consequences were similar: in China as in America a few years ago, the financial system may be much more vulnerable than data on conventional banking reveal.

If that's sounds scary, it's because it absolutely is. In the U.S., the shadow banking system — Krugman usefully defines it as "neither subject to government supervision nor backed by government guarantees" — was poorly understood, even by those who were allegedly supervising it, both on Wall Street and in Washington.

The economy nearly collapsed due to a run on this system — and go ahead and ask the average person if they know now, three years after the fact, what that means.

If Krugman is right, then shadow banking has come back, opportunistically, in another context — China, and its post-Western model of authoritarian capitalism. But this time, the system is actually much closer to the criminal aspects of society than it was in the U.S. Which means that if sorting out what happened in the U.S. was very, very challenging after the meltdown, then figuring what happened in China — if it all does fall apart — is going to be virtually impossible.

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