China’s Liquidity Squeeze Creates Enormous Global Risks

By Walter Kurtz, Sober Look

It is remarkable that China’s central bank has been unable or unwilling to contain the spike in short-term rates, as the interbank liquidity squeeze continues. This is roughly the equivalent of the Fed not being able to control the fed funds rate. You can certainly have fluctuations, but within a couple of days a major central bank should be able to inject enough liquidity into the system to bring down rates – unless of course the central bank wants the rates higher.

Something is amiss here. China is risking a recession unless the PBoC can bring this under control. Both the repo and the SHIBOR rates have risen to new highs in the past few days (see figure 1).

Some have suggested that the PBoC is in fact trying to tighten liquidity in the financial system in order to put the brakes on the rapidly growing shadow banking sector (see discussion). While an admirable goal, creating a liquidity squeeze in the banking system and sending short term rates to multi-year highs is NOT the way to achieve that. This is especially scary in the face of an already “moderating” economic growth.

Reuters: – China’s short-term funding costs surged on Wednesday, with the benchmark money market rate hitting a multi-year high, and authorities postponed the market’s close by 30 minutes to give banks extra time to complete their borrowing.

The money market squeeze that began early this month has worsened this week, forcing banks and other financial institutions to trim non-essential businesses, such as wealth management and arbitrage, traders said.

That response may be welcomed by the central bank, which has adopted a hawkish stance towards market liquidity since May, partly to clamp down on an increase in risky shadow banking activities, traders said.

The interbank market decided to extend the trading time to 5 pm as many banks failed to obtain enough short-term money needed for business at the normal closing time of 4:30 pm, traders said.

Such trading extensions have occurred several times recently amid the acute squeeze, traders said. “Everybody is disappointed at the central bank’s non-action,” said a dealer at an Asian bank in Shanghai.

It’s not clear if people fully appreciate the potential impact of this liquidity squeeze – including folks at the PBoC. This is not a game. These tight conditions and high rates over a longer period can easily derail lending activities across the country while potentially putting a number of financial institutions at risk and sending the economy into a tailspin. With the Eurozone still struggling in the aftermath of the crisis, let’s see what a recession in China (12% of world’s GDP) can do for global growth. Mr. Bernanke and company may need to go back to the drawing board very soon.

sl1

 

sl2

 

(1 week SHIBOR)

Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

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Comments

  1. Chinese authorities are doing the right thing: blocking the real estate bubble by reducing the shadow banking system as a first step to change their economical system. Totalitarian regimes hate bubbles, democracies love them. That’s also similar to what’s happening in Europe: the “euro” is a totalitarian monetary regime and is forcing deflation on the southern countries. So, if the other two bigger economic areas are following the same strategy how could Bernanke continue QE to infinity without crashing the US dollar ?

    • Problem is they cannot stop the property bubble.
      The bubble is what made the country “rich”, mainly the little provincial barons that are blowing it by building towers of condos nobody can afford anymore.

      The lesson might be that there is an ongoing power struggle going on in China : a central authority with an utopian plan vs local apparatchiks trying to cash-in as much as possible before the music stops.

      They would love that what they are doing look sound and economically rational but it is giving a disturbing impression that things are getting out of control…

      • I was in China many times; I spoke with many living there, read books, I’m a reader of the excellent blogs by prof. Pettis and prof. Ross: they are living there, they are insiders and they have very different opinions and both sounds convincing. So when the real experts do not agree how can you know what’s going on ? We can expand to the US and Europe. Do you believe there is really someone here that understands ? The level of complexity is too high for humans, we built a spaceship which is going somewhere and we don’t know much more than that.

        • Wouldn’t a property tax accomplish the same thing without such an enormous distortion to the economy? By playing with the Shibor rates, they are also hurting the guy who wants a loan to start the next Baidu, not just property developers and shadow bankers.

    • they do hate bubbles, in fact they will punish anyone found assisting the creation of a bubble. So the fear of being punished creates false reporting….until it is evident even to the blind man. I just want to know when they are going to start exporting the empty cities they’ve built.

      • Maybe the PBOC is more concerned about an inflationary threat to the regime than about the short term consequences of squeezing credit. Maybe they want a good shadow banking shakeout. They see what is happening in Brazil, and they want to nip it in the bud in China.

  2. Time to introduce game theory and behavioural economics.
    Maths & complex models arnt going to cut it.

  3. We are at record highs in margin debt……. that is a lot of selling just to unwind.

  4. It was only until last year when many investment advisers and consultants where chanting the benefits of investing in emerging markets because of their (reportedly) high economic growth. The real risks of investing are: superficiality, linear extrapolation, consensus around yesterday’s news …

    • EM is too generic. There are differences and some countries have long term fundamentals that better than in most fo the west. This is a sell off of leveraged positions and liquidations of good positions to cover for losses. Today the novegian krone is 4% down. Do you believe it ? Now in just one trading session is back to long term average respect the euro at about 8. Is Norway with a 13% positive account, the largest wealth fund x capita in the world going to fail ? Is it worst than PIIGS or is what I’m saying ? Now I’m buying 5 years norwegian bonds at 3% yeld both hands.

  5. What scares people is the fact that the financial players are WAY over leveraged. Greed drove them to cheer for more leverage now fear drives them. If the economies of this world were not over leveraged we wouldn’t care whether China squeezed it inter bank lending rate.