GMO Feeding the Dragon & Similarity to Other Crises

I have just been reading Edward Chancellor's (of GMO) very good write up on the issues with the Chinese financial system and why it poses a systemic risk to the overall economic health of the Middle Kingdom.

"China scares us because it looks like a bubble economy. Understanding these kinds of bubbles is important because they represent a situation in which standard valuation methodologies may fail. Just as financial stocks gave a false signal of cheapness before the GFC because the credit bubble pushed their earnings well above sustainable levels and masked the risks they were taking, so some valuation models may fail in the face of the credit, real estate, and general fixed asset investment boom in China, since it has gone on long enough to warp the models’ estimation of what “normal” is."

Many of the things he and his co-author Mike Monnelly flag can be seen in the financial crisis I have looked at over the past few weeks:

FEATURE (Identified by GMO in China)	ALSO SEEN IN…
Excessive credit growth (combined with an epic real estate boom)	Iceland, Turkey and Latvia (to be covered later) Also to a lesser extent in Korea but in the corporate sector
Moral hazard (i.e., the very widespread belief that Beijing has underwritten all bank risk)	Iceland; Korea and the chaebols; Turkish banks with regards to the currency peg
Related-party lending (to local government infrastructure projects)	Iceland and its holdcos, Korea and its inter-chaebol loan guarantees, Turkey's private banks
Widespread financial fraud and corruption  (from fake valuations on collateral to mis-selling of financial products)	Iceland and the main bank shareholders
Contagion risk (posed by credit guarantee networks)	Iceland (love letters/collateralized lending); Korean chaebols
Loan forbearance (aka “evergreening” of local government loans)	Turkish public banks & duty losses
De facto financial liberalization (which has accompanied the growth of the shadow banking system)	Iceland, Korea, Latvia and Turkey (this seems to be common in nearly all crises)
An increase in bank off-balance-sheet exposures (masking a rise in leverage)	Korean Merchant Banks (see financial liberalization)
Duration mismatches and roll-over risk (owing to short wealth management product maturities)	Iceland, Korea and Turkey (again a very common feature)
Ponzi finance (i.e., the need for rising asset prices to validate wealth management products and trust loans)	Turkish private banks with their treasury holdings, and most of the Icelandic FX corporate loan book

I would also add another potential source of problems for China could be in its closed capital account and use of a currency peg. This doesn't look like a problem right now, however, pegs have frequently caused headaches/acted as preludes/catalysts for crises given the reluctance of the powers that be to abandon them when under pressure due to vested interests etc.