China s GDP growth, which relies heavily on credit, will take a hit.

During this period, credit expanded rapidly as a share of GDP, reaching more than 300 at the peak.

But they remained underinsured against domestic credit risks the leading threat to emerging economies today.

Microcredit schemes and revolving credit funds could be used to develop community based water supplies and services.

Consequently, maintaining high GDP growth rates requires an ever increasing volume of credit and a continuously growing money supply.

As of this year, 1 of GDP growth is consistent with more than 3.5 of credit growth.

Credit Where Credit is Due

While domestic credit booms may be a threat in the future, emerging market banks have mostly remained immune from the fallout of the financial crisis.

Domestic demand is playing an ever more important role in underpinning growth as interest rates drop and the availability of credit cards and mortgages increases.

So far during the financial crisis and ensuing recession, the US has been incapable of kick starting credit growth, the major transmission mechanism by which monetary expansion feeds through to domestic economic activity.

Since 2008, banking sector credit growth in China has been among the fastest in the world, far outpacing GDP growth, and China s total debt has risen from 130 of GDP to 220 of GDP.

Each crisis hit economy had increased its financial leverage the ratio of domestic credit to GDP by 30 percentage points over five years shortly before their credit bubbles popped.

In the US, total private credit grew from around 70 of GDP in 1945 to well over 200 in 2008.

This would enable the PBC to manage domestic demand by allowing interest rates to rise in order to rein in credit growth and deter reckless investment.

This would mean that China s much publicized effort to boost domestic consumption might in fact call for appropriate credit market reforms.

Rural Credit

Credit

Banks and credit card companies have become much more cautious about extending credit.

Consumption is being spurred by record low unemployment rates, below 7 , and by credit growth, which has doubled, from 22 to 45 of GDP, between 2002 and 2010.

The supply of credit, in other words, resulted from the demand for credit.

Credit histories cannot be shared, because a credit bureau is just getting started.

In order to stave off job losses and sustain economic growth, China stimulated domestic demand by unleashing a wave of credit fueled construction. As commodity imports soared, the current account surplus fell below 2 of GDP.

The three small Baltic EU members provide an alternative model they had developed current account deficits of over 20 of GDP during the credit boom, and over the last three years have experienced double digit GDP contractions.

When the Argentine economy imploded in 2001, citizens lost their jobs and firms lost their access to credit, causing domestic demand to collapse. Output fell sharply.

Credit risk is best hedged through diversification across uncorrelated credits.

Credit stopped flowing.

Unfreezing Credit

(a) Credit and security structure

Limited access to credit

As a result, China s credit GDP ratio rose by 40 percentage points in 2008 2011, with most of the lending directed toward large scale investment by state owned enterprises (SOEs).

Germany s Secret Credit Addiction

Consider also the credit markets.

The third tool is credit policy.

Indeed, the Asian Development Bank estimates that European banks fund about 9 of total domestic credit in developing Asia three times the share of financing provided by banks based in the United States.

China s Credit Overdose

Credit and financing mechanisms (bilateral, regional, internal)

c. Provision of credit for small businesses

Ignorance of banking procedures and loan conditions

(Hayekians object to this, arguing that, because the crisis was caused by excessive credit, it cannot be overcome with more.)

Defective growth models in advanced countries, based on excess credit and domestic aggregate demand (and complicated by structural flaws and limited adjustment mechanisms in Europe), led to instability, a crisis, and a large negative shock to the real economy.

Clarifying ultimate responsibility for credit quality and risk would also reduce intermediation costs by eliminating the need to resort to informal channels, such as credit guarantee and trust companies.

Fueled by massive credit growth (equivalent to 30 of GDP from 2008 to 2012), the Chinese economy has taken on a level of financial leverage that is the highest among emerging markets.

Credit Default Swaps on Trial

China s credit binge is turning into a bust.

Banking failure caused a credit crunch.