Shadow banking creating China's worst credit bubble

Deflation is a possibility.

Fitch Ratings said the cause is China’s extremely opaque shadow banking system of trusts, wealth management funds or WMPs and offshore vehicles that allow companies to avoid regulations and hide huge amounts of debt.

Fitch noted that the credit-driven growth model is clearly falling apart and could feed into a massive overcapacity problem, and potentially into a Japanese-style deflation.

It also said there is no transparency in the shadow banking system, and systemic risk is rising. Fitch said it has no idea who the borrowers are, who the lenders are and what the quality of assets is, and this undermines signaling.

China's credit has gone from US$9 trillion at the peak the financial crisis to US$23 billion, and its ratio of credit to gross domestic product has spiked to 200%.

Fitch said this is beyond anything it has ever seen before in a large economy. It doesn't know how this will play out and noted that the next six months will be crucial.

Ominously, Fitch said there is no way China can grow out of its asset problems as it did in the past. It thinks this will be very different from the banking crisis in the late 1990s.