China's shadow banking squeeze could choke Australia

We have not fully realised it yet but China’s attack on its shadow banking system is an attack on the Australian economy. Australia is very intertwined with Chinese shadow banking in minerals, property and, of course, the Australian dollar and sharemarket.

The view in Australia has been that when the temperature in China gets too hot as a result of the shadow banking clamps, and unemployment starts to rise, China will pull back and all will be well in Australia. That’s probably right, but no one can be sure. Fasten your safety belts because I fear my previous alerts were correct (A nasty Chinese flu could hurt Australia, March 19).

Let me explain just how we have become part of the Chinese shadow banking system. Australia rides on the back of iron ore, coal and gas exports, and our residential property markets are being boosted by Chinese investment. The China Banking Regulatory Commission has warned Chinese banks to tighten controls over letters of credit for iron ore imports and that has caused a sharp fall in iron ore prices. Steel mills and traders had been using iron ore stockpiles to raise money as other sources of credit dried up. It was crazy financing, although it appears to have enabled the Chinese shadow banking system to access low-cost global loan money.

In physical terms, it looks like there is about $12 billion worth of iron ore on wharves or ships looking for a home, and a number of steel mills are facing bankruptcy. BHP and Rio Tinto are low-cost iron ore producers but if the China shadow banking squeeze is prolonged it will hit their profits.

Meanwhile, the squeeze will put even more pressure on higher-cost producers like Fortescue. It will also mean that Australian tax revenues will be hit hard. We will need a lot more than a levy. Not surprisingly, the coking coal price has also fallen, leading Peabody in Queensland to consider closing mines.

The Chinese shadow banking system used a similar method of crazy financing to enable property developers to build apartments in major cities. This time they used copper and gold, rather than iron ore, as the financing tools so there are large stocks of both metals -- particularly copper -- funding real estate. Many of the apartments are empty (The trouble with China's hot property, April 21). This is a Chinese version of the subprime loans in the US which caused the global financial crisis.

Again, it’s no surprise that apartment prices in Shanghai are falling and some reports even claim the discounts are up to 40 per cent. And if the shadow banking clamps continue, that property price fall in Shanghai will spread around the country -- certainly into the largest 10 or 20 cities, led by Beijing. That will, of course, slow development dramatically and affect demand for steel and other building products.

But a fall in Chinese property prices could have a more serious impact on Australia. Right now we are seeing a boom in Chinese buying and developing of apartments in Sydney and Melbourne and to a lesser extent Brisbane. We are looking at a Chinese-style glut of one and two bedroom apartments.

I do not know the connections between the Chinese shadow banking system and the level of Australian investment in either apartment development or other residential investment (Chinese money is driving a housing glut, February 18). But I know that many of the developers have big stakes in Chinese property and will be funded by shadow banking. If the Chinese keep the clamps on shadow banking, then Australia had better watch out.