Updated 22 June 2013, 2:58 pm and 3:21 pm EST
Econintersect: An article from the Associated Press Friday (21 June 2013) expressed a sentiment that the People’s Bank of China (PBOC) appeared to ease its tight monetary policy when a “key interbank interest rate edged lower”. That is a comment that Econintersect heard repeated by talking heads at CNBC during the day. Many may have come to the conclusion that a temporary imbalance has come to an end. Upon closer examination that position is not supported.
Econintersect has looked at the SHIBOR (Shanghai Interbank Offered Rate) for the past week. There are eight terms tracked ranging from overnight (0 days) to one year (366 days). In the two graphs below there are several important observations:
- The four longest terms (three months up to one year) have changed very little during the week.
- The “yield curve has become increasingly negatively sloped during the week.
- While the overnight and one week rates declined on Friday, two weeks, one month and three months rates have continued to climb.
For comparison, the five days ending with 21 June 2012 had yield curves displayed below.
As a point of interest, 20 and 21 June were abnormal days for the SHIBOR yield curve a year ago. There was not one other day in June or July where the smooth positive slope was broken as for those two days.
Added 22 June 2013 2:58 pm EST: As reported yesterday by GEI News the most obvious targets of the monetary tightening are the increased credit expansion underway in the first five months of 2013 and the carry trade with low interest currencies (U.S. dollar, yen, euro). But the story has more details than were discussed in the earlier reports.
Jake Maxwell Watts (Quartz) has described the crisis as “engineered“. He says that it is eerily like the Lehman crisis that brought the world to its knees in September 2008. Watts says that in this case it might just work as China needs to drain liquidity from a massive shadow banking system created during China’s huge 2008-09 infrastructure stimulus.
Econintersect has seen many analysts say over the past several months that China’s debt situation is as unstable as was the U.S. in 2007-08.
However, as best we can determine, the large official banks and the PBOC are still in control of the financial system; and the shadow banks have not become too big to fail. By acting now the highly leveraged shadow banks with massive off-balance sheet assets at very high leverage can possibly be brought back from Ponzi status through either reform or forced insolvency.
But even Watts’ thorough discussion bought into the popular thought of the day that the PBOC had relented on a hard line. He wrote:
On Friday, PBoC relented and added 50 billion yuan ($8.2 billion) in liquidity to the financial system. Along with rumors that it ordered the country’s largest banks to free up money for the banking system, that brought sky-high interbank interest rates back to earth.
But Watts also quotes from a Nomura Securities research note:
“As their tenure will last for 10 years, they are willing to tolerate some short-term pain in order to achieve long-term policy objectives—preventing financial crisis and delivering sustainable growth,” the Japanese bank Nomura said in a research note. It predicted that defaults in Chinese manufacturing companies and non-bank financial institutions were imminent in the coming months.
It seems to Econintersect that China 2013 and the U.S. 2008 have at least two significant differences:
- China has apparently not allowed Ponzi finance to enter the largest banks and the country seems to have no TBTF (too big to fail) institutions involved.
- China seems prepared to follow (or at least to consider following) the Swedish model for resolving excessive debt rather than the Japanese model being followed by the U.S.
There is no transparency for Chinese monetary policy so there can be no certainty that intentions can be properly inferred. We will simply make the best guesses we can and then observe the action as it unfolds.
As we mentioned yesterday, there may also be a carry trade issue about which the PBOC has concern. The very low interest rates in Japan, Europe and the U.S. have created cash flows into China for the higher interest rates there. Part of the QE dollars from the U.S. are likely involved in this trade. The carry trade creates an additional source of liquidity in the shadow banking system in addition to the accumulated Chinese stimulus money spent on infrastructure. Some of the carry trade is being hidden in actual trade of goods and services, as discussed in Macro Business yesterday.
This carry trade money adds to the basis of high leverage Ponzi activity. At the same time many wealthy Chinese are removing money offshore, stretching the domestic exposure even further when the inevitable deleveraging occurs. China is making moves to reduce the chance that the PBOC and government will be left holding the bag because private assets extracted from the leveraging have been spirited away.
China may simply trying to stay ahead of the curve and force down the amount of carry trade activity in a controlled manner rather than wait to have it end unmanaged as QE tapers and interest rates elsewhere rise.
China can benefit from observing the U.S. and Japanese experiences resulting from not reclaiming excessive extractions by the elite as a financial crisis approaches.
The complex web of financial interections in China and extending globally is far from being unwound. And the details are still not defined. But one thing does seem clear: The pronouncements today about the ending of the Chinese financial system distress appear, at the very least, to have been premature.
Added 22 June 2013 3:21pm EST: Possible outcomes for the current policy were discussed yesterday:
Macro Business has offered a nice summary of possible outcomes for the current liquidity squeeze in China:
So what happens next? There are four categories of outcome. The first is that Chinese leaders back off on the credit crunch and nothing happens, in which case they’ll probably just try the strategy again later. The second is that they press on and it works miraculously, cleaning out the financial system without causing too much pain. The third is that this spirals out of control, maybe because Beijing underestimated the risk or acted too late, potentially sending the global economy lurching once more. The fourth, and probably most likely, is that this works but is painful, averting catastrophe but slowing the Chinese economy after 20 years of miraculous growth.
Below are two video interviews of experts on China discussing economic data and this week’s turmoil in the Chinese financial markets as the government (through the People’s Bank of China) applies liquidity withdrawal to an overheated financial system. The first video, from The Wall Street Journal, features former professor at Tsinghua University (Beijing) Patrick Chovanec. The second video is an interview by Bloomberg of Global Economic Intersection contributor, Peking University professor Michael Pettis. We have also included a debt bubble video by Max Kaiser, with Steve Keen appearing on the second half of the show.
Hat tip to Leith van Onselen at Macro Business for the first two videos.
- News Summary: China in Credit Crunch (Associated Press, 21 June, 2013)
- China Money Rates Retreat After PBOC Said to Inject Cash (Kyoungwha Kim, Bloomberg, 20 June 2013)
- China’s banking brinkmanship: an engineered financial crisis, explained (Jake Maxwell Watts, Quartz, 21 June 2013)
- The Swedish model for resolving the banking crisis of 1991-93 (Lars Jonung, Directorate-General for Economic and Financial Affairs, European Commission, 19 February 2009)
- Lessons from Swedish bank resolution policy (Edward Harrison, Credit Writedowns, 11 March 2009)
- Lessons from Japan’s Bank Crisis (Edward Harrison, Credit Writedowns, 12 August 2008)
- China: Financial Crisis or Controlled Steam Release? (GEI News, 20 June 2013)
- China Credit Crunch (GEI News, 19 June 2013)China moves to save its banks, or does it? (Houses and Holes, Macro Business, 21 June 2013)