Monday, June 29, 2009

Lending Bubble In China

Ambrose Evans-Pritchard writes for Telegraph U.K.; he is known for his British version of "Doom and Gloom", which, amid global proliferation of "green shoots", has fallen out of favor somewhat. Now the stock markets around the world seem to be hitting the wall at the same time, and people have started to doubt if green shoots were just weeds.

In this article, Evans-Pritchard casts grave doubt about the global "growth engine" that the rest of the world seem to depend on to pull out of recession. Instead of the stimulus money going to the real productive economy as many analysts and investors have claimed, China seems to have created a huge credit bubble.

China's banks are an accident waiting to happen to every one of us (6/28/09 Telegraph) [emphasis is mine]

"China's banks are veering out of control. The half-reformed economy of the People's Republic cannot absorb the $1,000bn (£600bn) blitz of new lending issued since December.

"Money is leaking instead into Shanghai's stock casino, or being used to keep bankrupt builders on life support. It is doing very little to help lift the world economy out of slump."

"Fitch Ratings has been warning for some time that China's lenders are wading into dangerous waters, but its latest report is even grimmer than bears had suspected.

"Fitch's "macro-prudential risk" indicator for China threatens to jump from category 1 (safe) to category 3 (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China's public debt may be as high as 50pc-70pc of GDP when "correctly counted".

"The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a "massive lending spree".

"Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate.

"Fitch traces the 2009 bubble to the central bank's decision to cut interest on reserves to 0.72pc. Bankers responded to this "margin squeeze" by ramping up the volume of lending instead. Over half the new debt is short-term. Roll-over risk is rocketing. China's monetary stimulus since November is arguably more extreme than the post-Lehman printing of the US Federal Reserve, though less obvious to the untrained eye."

So the Chinese central bank did what the Fed has been unwilling to do so far: cut interest on reserves, or even charge a fee on reserves. This is a sure-fire way to squeeze banks so that they increase lendings. And since the U.S. government's, and this administration's, expressed concern is that the money/credit is not going to the real world, I expect this to happen in the U.S. in non-too-distant future.

"... New loans doubled in May from a year earlier, almost entirely to companies.

"China's Banking Regulatory Commission fired a warning shot last week. "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy," it said."

Well, the Chinese government unleashed the "hot money" by cutting interest on reserves. What did they expect banks to do? Hold on to the money while they carefully evaluate the credit-worthiness of the borrowers? Then the banks will risk being accused of "hoarding" money and probably penalized in some way (like being charged fees for reserves).

Given all that, I don't quite understand Evans-Pritchard's deflationary stance. Probably he means price deflation, but even there, it's simply hard to picture 10% or even 5% price contraction in the face of massive monetary inflation around the globe. But this topic will be another post entirely.

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