THE CHINESE BLACK BOX & A WARNING SIGNAL?
Shibor is blowing out again in China (h/t ZeroHedge). Shibor is the Shanghai Interbank Offered Rate. This is the rate at which banks lend in the interbank market. It’s generally viewed as a sign of stress levels in the banking sector. Latest readings show the rate approaching levels seen only a few times in the last few years:
What’s so interesting about all of this is that it appears to be due to the reckless stimulus and central planning approach implemented by the Chinese government. The Wall Street Journal reports:
“The first wave of problem loans originating from the 2009 economic stimulus is about to hit the banking system. If the reports citing anonymous officials are true, Beijing is considering assuming responsibility for some 2-3 trillion yuan ($300-450 billion) of these loans that were made to local government borrowing vehicles.
The scale of such a rescue is staggering–at about 7% of GDP it is bigger than the U.S. TARP program. It also comes out of the blue; the banks’ audited accounts still show that their nonperforming loans have fallen dramatically. Yet the bailout would nearly equal the total amount of bad loans spun off from the four major state banks during their restructuring in the early 2000s.”
I don’t even know what to make of the actions of these Chinese central planners. Their economy essentially looks like one huge black box built on quicksand. I don’t think anyone truly understands the extent to which this economy is being propped up by government intervention. And no one knows if it is sustainable. For now, the one thing we know is that history has shown that this sort of debt based growth has a tendency to result in inflation and economic imbalances. These situations always resolve themselves in the same way – with economic decline. The extent of the inevitable decline is contingent upon how much this government is propping up the economy. Unfortunately, the black box nature of their economy makes that nearly impossible to quantify. But the risks are apparent.
“For now, the one thing we know is that history has shown that this sort of debt based growth has a tendency to result in inflation and economic imbalances. ” – why do not you think it will be in the USA as well? Debt is enormous, no way out.
We got the inflation in the form of a massive housing bubble. Welcome to the implosion.
Wonder how much of this also has to do with the end of QE2.
China has to have pretty serious exposure to Europe and the dead-zone following QE2 with its lack of support for eurodollar banks could make things very ugly for Europe. (I’m assuming the ECB continues to be controlled by Germany and continues to be useless).
Anyway, always a good idea to stay away from black boxes. Actually, shorting them seems to pay off pretty well, assuming your pockets are deep enough to handle being underwater for years on end during the hype.
Very interesting! But labels on the x-axis of the chart would make it more informative
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OK, I think this is a false alarm. It’s just a consequence of the PBoC raising reserve requirements:
http://www.dailymarkets.com/stock/2011/06/14/peoples-bank-of-china-raises-reserve-requirement-50bps-to-21-5/
Theyve been raising rates for a year now. Why would this change anything?
This doesn’t have anything to do with rates. You’re misreading “reserve requirement” as rates.
Interbank rates demonstrate the supply/demand environment for reserves. A higher interbank rate means a higher demand for reserves relative to supply. The PBoC increased the reserve requirement by +0.5% (effective 20-June), thereby altering the supply/demand situation and some deficient banks waited until the last day before hitting the interbank market.
That’s all that happened and it will resolve shortly. Nothing to see here.
Still doesn’t answer Dan’s question – this should be more of a linear function based on that logic…
Why should it be linear? You’ll have to explain that logic…
A fixed increase in reserve requirements will translate into a highly variable increase in interbank rates due to the complex risk landscape of existing loans and the variable level of existing surplus reserves. That’s not linear.
As the article you linked to below explains: “The cash squeeze worsened today because it’s the reserve ratio payment day”. Exactly right.
So unless there are serious short-term risk issues in the Chinese lending landscape, SHIBOR will ease pretty quickly. Banks will meet this extra reserve requirement over the longer term the way they always have, by restricting new loans and/or boosting repayment requirements on existing loans. If either leads to cascading defaults of existing loans then there is a big problem, if not, interbank rates will ease naturally.
Additionally, if there are already plenty of surplus reserves in the system, a short-term spike in interbank rates can occur as a result of those reserves being highly concentrated in a few banks. Over time, as reserves disperse through the system, interbank rates will ease. The opposite occurs if concentration builds or there is a shortage of reserves (until the interbank rate hits the upper bound set by the discount rate). Reserve concentration is a non-linear factor.
In the worst case, we hit the discount rate which, as demonstrated in the middle of the chart above, can be forced down by the central bank (which statically sets the discount rate unlike the funds rate). Rumors of a Chinese liquidity crisis are greatly exaggerated.
China’s problem is that is has been far too slow to allow the Yuan to appreciate, it kept the discount rate too low for too long, it has been too slow to raise reserve requirements, and it has not been aggressive enough in setting a higher target rate. Consequently it has excess inflation. Any, or all of these four factors can be targeted to address Chinese inflation, at the expense of recession. Unfortunately, recession is a very negative political topic and won’t be widely accepted as “a recession we have to have”.
http://www.bloomberg.com/news/2011-06-20/china-1-day-shibor-rises-most-in-5-months-as-redemptions-drop.html
As reported elsewhere, chindia yield curves are inverted.
As well, 6mo eurodollar vs. tbill is now ~0.6 (even though 3mo libor-ois is only 0.15) …
Is this another warning signal?
http://historysquared.com/2011/06/20/a-look-at-global-yield-curves/
Check the title of the graph: “”Buckle your seat belt”
Just saw a Bloomberg report the other day where a Chinese developer constructed a building the size of the Chrysler building in a city that has a population of 200,000. Wow!! So when someone tries to sell the China story ask them if they understand that China is still has a Communist, Authoritarian Government with a centrally planed economy.