Clothing factory in Dongguan, China

China is on the verge of unleashing a cataclysmic recession in mid to late 2011 and they know it.  Harsh economic policies have cut back private sector investments in the economy, ordering the largest banks in the country to keep record quantities of capital in reserve rather than lending it out to investors.  This will only aggravate the thirty-four month high inflation in China, currently at 5.5%, and will further stagnate the marketplace.  Industrial output has slowed, only rising by 13.3%, the smallest rate the Chinese economy has seen in twenty years.  The Chinese economy is slowing down and the Chinese government fears this will kick off a recession; by acting on these fears they might do just that.

Why Are Investments Declining in China?

The Chinese government has decreed that the reserve ratio held by all of the large banks, the counterparts to Bank of America and Citigroup, must be above 21.5 percent.  In comparison, America’s percentage is less than half of this rate. The reserve ratio is the percentage of all deposits in the bank that is held with absolute liquidity, meaning it can be spent at any time.  The rest is generally invested.  The more money that is invested the faster an economy grows.  A high reserve ratio means lower investments.  Lower investments correlates directly to decreasing economic growth; with less money being put into building homes and businesses the overall economy slows down.  This will trigger a recession if left unattended.

Are the Chinese Purposefully Causing A Recession?

No, they are shielding their economy from the worst of the projected recession. By raising the reserve ratio to record levels banks means that Chinese banks will be much more stable for this financial cataclysm.  It means they will have far fewer loans lent out, so when borrowers inevitably default less money will be lost overall.  In addition, the higher reserves will give the banks much more stable financial basis.  They will be able to pay off debts as they arise and will not be forced to look for bailout or fall into bankruptcy.  The peculiarly high reserve ratio protects the financial sector of China during the recession.  In the aftermath, private banks will be architects of financial reconstruction rather than panhandlers weighing down the economy.  If the United States had implemented this strategy before the 2008 recession there would have been few if any bank failures, they would have reserves on hand to prevent bankruptcy.

What is the Reserve Ratio?

The reserve ratio the percentage of money that each bank has to keep on hand at all times out of all of the deposits they have been trusted with.  The rest can be lent out, earning the banks a tidy profit while expanding the economy.   The American reserve ration rests around ten percent; this lower ratio allows much more money to be lent out.  While this does allow greater investments there has increased risk of too many people defaulting and driving the bank into bankruptcy.  Lehman Brothers and Bear Stearns failed during the 2008 recession because bad investments torpedoed the companies and the low reserve ratios were inadequate to patch the damage and meet payments.

How Will This Higher Reserve Rate Affect America?

In the short-term it will buoy up the Western economy, once the recession hits it will trigger the second dip in what will be known as the worst recession since the Great Depression.  International investors will flock to American and European banks as they are denied by Chinese limit their investments, especially risky ones.  This influx of mortgages and loans will translate into healthy profits for the banks of America.  Higher profits mean hiring more employees and expanding operations.  That is if the Chinese markets do not implode, like the Chinese are predicting.  Without high reserve ratios and with the risky investments taken from the Chinese markets western banks will be besieged by foreclosures and defaulted loans.  More banks will fail in the United States and the Western economy will plummet.  Only those who had the foresight to prepare for this disaster, the Chinese, will prosper.  In the aftermath of the 2011 recession, with the elimination of competition and rising demands for investments, the East will hold great and unprecedented financial power.