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Guest Post: China's Shadow Currency

Tyler Durden's picture


Submitted by Matthew Lowenstein va The Diplomat,

China’s economy is straining to keep up a semblance of its former growth rate. The surest sign is the way a shadow market in bank paper has evolved to substitute the commodity that China is increasingly running short of: cash.

Bankers are passing around their own ersatz currency, stimulating trade with what, in effect, are off-the-books loans. As in the wildcat currency era of the United States, the antebellum period before America had a national currency, this paper trades at a discount from province to province. It is increasingly used for speculative purposes, is potentially inflationary, and is hard to regulate. The People’s Bank of China (PBOC) has been unable or unwilling to crack down, lest it provoke a serious slowdown. But when the world’s second largest economy must resort to passing around IOUs, the financial community should take note.

Bankers acceptance notes (BANs) are nothing more than a post-dated check with a bank guarantee. For example, a buyer in Chongqing might have a hard time passing checks to vendors in Shanghai. But if the purchaser gets his paper signed by, say, Bank of China, his check now has the guarantee of a major financial institution: it is money good. BANs facilitate trade by obviating the need for vendors to assess the creditworthiness of purchasers. But in China, this prosaic instrument of commerce has become a kind of shadow currency that allows under-reserved banks to purchase deposits, fuels speculation, and undermines the central bank’s control over the money supply.

From the bank’s point of view, Banker’s Acceptance Notes are all about getting deposits,” explains a banker in Zhengzhou. In a typical transaction, a customer with cash in his pocket can put down 100 RMB as a security deposit and walk away with double that amount in BANs. The bank is pleased because it receives hard currency in return for its own funny money. The customer is delighted: he has turned 100 RMB in cash into 200 RMB in something almost as good. In effect, the bank has given the customer a 200 RMB loan without using a cent of cash.

The transaction harkens back to U.S. banking in the era before fiat currency, when banks used their own banknotes to purchase reserves of everything from gold bullion to national bank notes, British pounds, and bushels of wheat. Chinese banks print their own scrip to purchase “reserves” of cash, i.e., deposits. If the bank paper is accepted, it functions as currency and banks get to hold onto their reserves. But if people worry about the bank’s credit, or need cash (perhaps during a crisis) the bank will be forced to redeem its paper, possibly in a hurry.

In theory, all BANs are issued to support trade. When a customer is issued BANs, he must show proof of an underlying transaction. And to the extent the notes truly are backed by trade – by televisions shipments to Chongqing, say, or refrigerator exports to Seattle – there is very little risk. The notes get paid down as transactions are settled, and the bank need not worry about them. But to the extent BANs are not used for trade – to the extent they are merely rolled over and circulate as a secondary currency – they represent a constant, outstanding bank liability to high-risk industries.

The truth is, most BANs are not used to support real transactions,” says a grinning shadow banker in Shenzhen. His company is one of many Chinese conglomerates whose business tentacles seem to span every industry from mining to tourism. But nearly half of its transactions are unprofitable: they are formalities, conducted solely for the purpose of acquiring BANs. “BANs are supposed to be issued only to support trade. But the rules are very flexible, and there are ways around them,” he continues. For example, trading partners can coordinate so that transactions net out. Party A sells Party B 100 RMB of widgets and Party B sells Party A 100 RMB of widgets. They both walk away with the same widgets they started with, and an extra 100 RMB of BANs each. As if by magic, the transaction has generated 200 RMB of highly liquid, bank-guaranteed financial assets.

BANs without underlying trade are used to finance speculation. Shadow bankers sell the BANs at a discount of about 5 percent – a process known as “discounting” – in return for cash. The seller of the note needs walking-around cash and is willing to dump his paper at a loss. After all, the seller is likely a speculator. He only loses 5 percent on the sale of the BAN, but his cash is invested in trust products or lent into the grey market at yields well in excess of 10 percent. The buyer of the note is likely to be a grey market BAN broker. As far as he’s concerned, he’s earning a risk free 5 percent by purchasing bank-guaranteed paper at a discount. In other words, a piece of paper – an IOU – is being passed around on which first a speculator and then a bank gives a guarantee. In this way, credit flows from the banks through shadow bankers and into property and other high-yield, high-risk industries such as mining or infrastructure. What looks to a banker like a purchase of televisions or washing machines in Shanghai could easily end up financing condominiums in Jiangsu or rolling over coal debt in Inner Mongolia. Most worrisome is that banks account for BANs as guarantees; guarantees are obligations that, a la Fannie-Mae, do not appear on a balance sheet.

The banks find the off-balance sheet accounting treatment of BANs particularly useful. Onerous statutory requirements force Chinese banks to keep a loan to deposit ratio (LDR) of 75 percent or less. BAN issuance simultaneously decreases loan balances while increasing deposits; it relieves LDR pressure on both sides of the vinculum. Of course, the change in LDR is a purely cosmetic change: the risk – and leverage – in the bank is just as high as if it had extended a plain vanilla loan, but the leverage is moved off balance sheet. Hence, to the extent BANs are used for speculation, they represent bank exposure to high-risk activities that is invisible to regulators, investors and even bankers themselves.

Not surprisingly, China’s local governments, themselves heavily involved in project and commercial finance, have become a huge market for BANs. Since 2008, local governments across China have been diligently at work on grand infrastructure and “urbanization” projects, of which ensuring an adequate supply of ghost cities seems to rank highest in priority. In the process, local government financing vehicles (LGFVs), the corporate subsidiaries that local governments use to fund infrastructure projects, have racked up an estimated 19 trillion RMB in debt according to the National Audit Office. Because LGFV investment has been so unremunerative – ghost inhabitants don’t pay taxes – the fiscal burden on local governments is crushing. For cities and counties that are short of cash, there is scarcely a more appealing solution to printing their own.

“There is a risk of banks and LGFVs colluding to fake security deposits and print BANs with no underlying trade,” warns a Ministry of Finance discussion document. Local governments up to their eyeballs in debt have the advantage of control – often of ownership – of banks within their territories, and can order up BANS at will. LGFVs turn to sister banks as a makeshift printing press, printing pseudo-currency virtually on demand. LGFVs use BANs to pay suppliers and obscure the truth about their overburdened balance sheets. A jaded banker in Tianjin complains, “When a borrower uses a BAN, they are supposed to record it on their balance sheet as a liability. But it’s kind of an unspoken rule that they don’t. To be honest, a lot of people see this is a major advantage of using BANs; they can pretend they have lower debt than they really do.” And the LGFVs never have to worry about principal repayments because banks are happy to roll over BANs as they come due. In short, LGFVs have nearly unrestricted access to notes that allow them to make payments, do not get recorded as debt, and never have to be paid down – i.e., their very own money.

Local governments printing their own money has led to a partial fracturing of the monetary system. A BAN issued by a local bank is likely to be accepted within its province, but its credit might not be honored – or honored only at a punitive discount – across provincial borders. An employee at an LGFV in Jiangsu engaged in contract work for infrastructure projects said his company routinely accepts BANs from Jiangsu banks. However, it refuses scrip from neighboring Anhui; out-of-province banks must pay in cash.

“A lot of smaller, local banks print more BANs than their balance sheet can support; in fact the reason they print BANs in the first place is because they don’t have the cash to make loans,” explains a banker at the Zhuhai branch of a major commercial bank, “Their BANs won’t be accepted outside of that province. It’s kind of like in international currency markets. The U.S. dollar is accepted in every country as the reserve currency.  Similarly, RMB are accepted anywhere in China. But provincial BANs can only be used within their native province.” It’s almost as if the non-consumer part of the Chinese economy had reverted to the 1930s, when each province issued its own legal tender.

It is impossible to estimate how much of China’s outstanding BANs were issued to LGFVs, but it is meaningful enough for the Guangdong Audit Bureau to list BANs as a new financing channel available to local governments. If China is to maintain a coherent fiscal and monetary regime, sooner or later its LGFV debt will have to be digested, either by paying it or writing it down. When regulators attempt to do so, they will find the National Audit Office’s estimate of 19 trillion RMB in LGFV debt understated, in part owing to BANs issued to LGFVs.

According to the People’s Bank of China, almost nine trillion RMB of BANs are circulating in an economy with a monetary base of 107 trillion RMB.  This huge economic underground is a measure of the extent to which highly speculative investment is outpacing the ability of Chinese banks to finance through deposits. If LGFVs and property developers had sufficient cash flows they would not need to resort to BAN funding. If returns on invested capital were sufficient, banks would see their deposits grow organically and not be reduced to purchasing RMB with this strange breed of banknote. These notes may behave like money, but their use is constricted; they cannot be used to purchase groceries or pay wages and will never be acceptable internationally. The BAN economy is thus separate, unable to be integrated with the rest of China’s economy. How long can it be sustained?



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Sat, 12/14/2013 - 19:36 | Link to Comment DoChenRollingBearing
DoChenRollingBearing's picture

Just by chance, the Central Bank of DoChenRollingBearing bought some "junk silver" in dimes and quarters today -- first time ever.  Hey!  Better than bogus (Chinese derivative fiat)!

Sat, 12/14/2013 - 19:41 | Link to Comment LetThemEatRand
LetThemEatRand's picture

I got a bunch of junk a while back.  It's insurance. 

Sat, 12/14/2013 - 20:11 | Link to Comment ajax
ajax's picture



What an interesting article and fucking creepy as well.

Sat, 12/14/2013 - 20:59 | Link to Comment Pseudonymous
Pseudonymous's picture

It sounds like a currency war between Chinese provinces.

Sat, 12/14/2013 - 22:27 | Link to Comment disabledvet
disabledvet's picture

that's a good way of putting it actually. Warren Buffet bought a Indiana I believe...and it had millions of dollars of "Bank Notes" created by the bank itself...this was back in the 80's! There was a time during the 2008 collapse when California was issuing IOU's to it public employees as payment...but when BofA stopped accepting that as money they were forced to return to the market. Obviously the economy has since not only recovered in California but gone beyond even the bubble years now. the USA...has a long and troubled history with paper currency...although China's is more recent. The temptation to make something "too good to be true" actually so is always quite high. Bernie Madoff is a textbook example of "suspension of disbelief" gone bad. Classic sign of a DEFLATION as "good money drives out the bad" once the worm turns.

Sun, 12/15/2013 - 11:09 | Link to Comment Doña K
Doña K's picture

Similarly, several decades ago, it was a crime punishable by long prison sentence in the peripheral countries of Europe to bounce a check.

Vendors would post-date checks by a month or more and get merchantize. That vendor would take the check cosign in the back and give to his supplier and so on until sometimes the check would be cosigned by several vendors. At the end of the check's date, whoever had the check signed as well and walked into the branch were the check was drawn and collected the funds. And that was the only way to do business as cash was scarce and profit margins were thin.

Sometimes, the original issuer would wait in the bank as soon as it opens and intercept the last holder and offer to pay him interest for everyday he did not post the check. But if the holder insisted, he would have to honor the check as he would be facing stiff sentence. If there was no money, it became a criminal act and the chain of cosigners will be unraveled backwards. The issuer will go to prison and the first cosigner will have to honor and so on. If you multiply that accross a country there was a 60 day lag of a big chunk of paper promises.

Sun, 12/15/2013 - 17:26 | Link to Comment BigJim
BigJim's picture

 But when the world’s second largest economy must resort to passing around IOUs, the financial community should take note.

Lulz, isn't 'IOU' the very definition of all our overlords' currencies now?

Sun, 12/15/2013 - 21:50 | Link to Comment Buck Johnson
Buck Johnson's picture

And the Chinese IOU's will turn, trust me.  This type of IOU is to easy to inflate and to extrapolate to even more.  And for them to resort to this instead of using their own RMB for everything tells me that they are doing everything they can to stop inflation but without enough money they risk stagnation and so the local economies have been given the wink and the nod to issue their own notes.  What is happening they are fighting Hyperstagflation and it's not possible to fight this without taking the fiscal medicine they need.

Sat, 12/14/2013 - 20:14 | Link to Comment NoDebt
NoDebt's picture

There have been ZH articles over the past couple of weeks about China doing more "QE" than the US and Japan COMBINED.

Serious question:  Is this PART OF how that's happening, or is this ON TOP OF that "official" Chinese QE?

Sun, 12/15/2013 - 01:17 | Link to Comment thestarl
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I just wonder ND how long this whole game is sustainable?I mean sooner or later the musics gotz to stop man.

Sun, 12/15/2013 - 01:27 | Link to Comment thestarl
thestarl's picture

Aaaaaahhh who knows?

Sun, 12/15/2013 - 11:17 | Link to Comment Doña K
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One of the reasons Chinese are into Bitcoin is that with capital controls, Bitcoin is the perfect vehicle to export and at the same time convert your chinese cash into any other currency. Volatility can work for you or against you but that's part of the risk which is better than get intercepted at the boarder and lose both your funds and your life.  


Sat, 12/14/2013 - 19:36 | Link to Comment quasimodo
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Good to see they don't have something called a derivative with BANS. Looks pretty much to be on solid footing to me.


Sat, 12/14/2013 - 21:58 | Link to Comment daedon
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But BANs are derivatives, they are derived from the paper they are written on.

Sun, 12/15/2013 - 11:22 | Link to Comment Doña K
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They can scan or xerox copy the Bans and rehypothecate them as well several times over.

Sat, 12/14/2013 - 19:43 | Link to Comment Winston of Oceania
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So the US isn't the only paper tiger? /sarc

Sat, 12/14/2013 - 19:59 | Link to Comment Zero Point
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But... but... China is the new superpower....

They're goin to da moon...?

Could someone possibly be trying to lie to me?

Whyever would we need a bogeyman?

Sat, 12/14/2013 - 20:03 | Link to Comment Jannn
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Shanghai Gold Exchange Physical Delivery Equals Chinese Demand, Part 2

Sat, 12/14/2013 - 20:05 | Link to Comment km4
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Dead Colorado school shooter was hardcore leftist, ‘Keynesian’ via @dailycaller

I wonder what assclown Paul Kruggles Krugman would have to say about this

Sat, 12/14/2013 - 20:35 | Link to Comment falak pema
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hardcore leftist keynesian....

Is that a new porn actors guild like the screen writers guild of McCarthyism fame?

The deadly TEN! Have them Obamacare  Aids tested! 

Sat, 12/14/2013 - 20:51 | Link to Comment joego1
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I wonder if it's possible that Keynesians are also Lemming like? We can only hope.

Sun, 12/15/2013 - 12:58 | Link to Comment bigfire
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MSM have been waiting for a genuine Tea Party terrorist for a while.  They're still waiting.

Sun, 12/15/2013 - 15:54 | Link to Comment headhunt
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He would blame his christian up-bring.

Sat, 12/14/2013 - 22:04 | Link to Comment KickIce
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"But when the world’s second largest economy must resort to passing around IOUs, the financial community should take note."


We've been doing that for years; separate books for wars, bailouts, social security trust fund...

Sat, 12/14/2013 - 20:14 | Link to Comment NOZZLE
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Can I use this Chinese Junk to pay the premiums on my ObangaCare policy? 


Sat, 12/14/2013 - 20:34 | Link to Comment q99x2
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You don't have to pay premiums. You go to any hospital you want and then they fine you.

Sat, 12/14/2013 - 20:26 | Link to Comment falak pema
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An awesome masterplan of intriguing magnitude, imagined through eyes so bemused by their cunning that they are reduced to slits like the openings of a D day bunker overlooking Omaha beach.

You wonder as you peer into those unscrutable eyes what cooks under that round mandarin hat, land of the half moon sun, wall of the half baked monkey.

Only the truculence of those round, well fed cheeks, as the benign smile that fleetingly appears like a phantom on those thin straight lips, gives us an inkling of the taciturn nature, whose sinister dimensions of untold foggy bottomness could have concocted this unending secret web of a thousand interstices, like the giant billion headed spider that it be.

The shadow currency that never was but that by its stunning virtual presence incurred panic in the hearts of the most brave to the point of enslaving their freedom in mesmerised subjugation.

The age of the Dragon has arrived carried into the night by silent footed elephants crossing the Alps.

Snowden unknowingy has unleashed the Wuntan whoflungdung Kraken on Xmas eve.

Happy new chinese year as you drown in your sweet n sour soup of doomsday machinations.  

Sat, 12/14/2013 - 20:55 | Link to Comment DoChenRollingBearing
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That was, um, masterful!  Still trying to digest it...

Sat, 12/14/2013 - 22:30 | Link to Comment disabledvet
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I agree. two thumbs up on the wordsmith "richter scale" on this one.

Sat, 12/14/2013 - 20:30 | Link to Comment dick cheneys ghost
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rothschilds would be jealous


Sat, 12/14/2013 - 20:32 | Link to Comment whoknoz
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"Shadow bankers sell the BANs at a discount of about 5 percent – a process known as “discounting” –"


wow, I was expecting the process to be know as "banning"...

Sat, 12/14/2013 - 20:50 | Link to Comment joego1
joego1's picture

Anyone up for some Bitbans?


Sat, 12/14/2013 - 21:09 | Link to Comment Ban KKiller
Ban KKiller's picture

OK, the grand prize for financial fuckery goes to China. Be proud. 


Sun, 12/15/2013 - 15:51 | Link to Comment headhunt
headhunt's picture

Oh we have them beat by a mile.

Our 'financial fuckery' is spending several generations into the future.

We promise to pay - honest!

Sat, 12/14/2013 - 21:13 | Link to Comment yrbmegr
yrbmegr's picture

If the bearer has to pay for the BAN, it's what we call a money order.

Sat, 12/14/2013 - 21:18 | Link to Comment toros
toros's picture

This doesn't seem like a big deal to me. A bunch of banks making loans. So what? Sure some of the loans go bad and the bank loses. That's the way it's suppose to work in banking. What we got here in the US is the Fed backstopping every lose. Nothing is allowed to lose money. They just keep printing and printing and printing to cover all losses by the banks.

The Chinese used to recycle $USD that bought all their stuff for bonds. Now with the FED buying all the bonds where are all those $USD going?

Sat, 12/14/2013 - 21:28 | Link to Comment Cthonic
Cthonic's picture

Bans a make her dance

Sat, 12/14/2013 - 21:38 | Link to Comment Debeachesand Je...
Debeachesand Jerseyshores's picture

"I will gladly pay you Tuesday for a hamburger today".

Sat, 12/14/2013 - 21:44 | Link to Comment eddiebe
eddiebe's picture

Give you some bans for your gold!

Sun, 12/15/2013 - 00:40 | Link to Comment mantrid
mantrid's picture

keynesian clowns think economy crashes because of cash shortage. this is an example how free market solves the problem of cash liquidity - it creates another currency. sure this one seems highely risky but nevertheless it strikes keynesian (and monetarist) theories down.


now, will CCP ban the BANs>

Sun, 12/15/2013 - 00:41 | Link to Comment mantrid
mantrid's picture

one more thing: this is also counter-example to classical smith-eian take on history of money (barter into commodity money). money can start as IOY.

Sun, 12/15/2013 - 02:13 | Link to Comment kareninca
kareninca's picture

Really, really good article.

Sun, 12/15/2013 - 10:47 | Link to Comment andrewp111
andrewp111's picture

This is just another way modern day China resembles the 19th Century USA. Very high real growth from industrialization, a banking wild west, an economy based on caveat emptor, mass migration from the countryside to the cities, a rising but still subdominant military power, etc.. History rhymes but doesn't repeat exactly. Will the 21st Century see China become a world dominating military colossus? Will China be the first country to expand beyond earth?

Sun, 12/15/2013 - 15:45 | Link to Comment headhunt
headhunt's picture

Are these BANS's lack of cash money to fund or simply Chinas 'affordable housing act'?

Mon, 12/16/2013 - 01:04 | Link to Comment Cthonic
Cthonic's picture

Well that's the beauty of a banker's acceptance, near infinite amount of short term credit extendable with no changes to the enabling bank's balance sheet.  Works fine until the credibility/solvency of said institution is cast in doubt.

In other words, remember 2008 and the freeze up of the commercial paper market due to the run on money market accounts and death of ABS?  Corps had became complacent about access to cheap short term credit, then one day it simply wasn't available and they were left scrambling to raise longer duration financing at much higher rates.

Sun, 12/15/2013 - 17:26 | Link to Comment Quaderratic Probing
Quaderratic Probing's picture

California did the IOU thing and ...Oh never mind

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