The Real China Threat: Credit Chaos

Tyler Durden's picture

As Michael Pettis, Jim Chanos, Zero Hedge (numerous times), and now George Soros have explained. Simply put -

"There is an unresolved self-contradiction in China’s current policies: restarting the furnaces also reignites exponential debt growth, which cannot be sustained for much longer than a couple of years."

The "eerie resemblances" - as Soros previously noted - to the US in 2008 have profound consequences for China and the world - nowhere is that more dangerously exposed (just as in the US) than in the Chinese shadow banking sector as explained below...

Submitted by Minxin Pei via The National Interest,

The spectacle of a game of financial chicken in the world’s second-largest economy is both entertaining and terrifying. Twice in 2013, the People’s Bank of China (PBOC), the country’s central bank, tried to demonstrate its resolve to rein in runaway credit growth. In June, it engineered a sudden credit squeeze that sent the interbank lending rates to more than 20 percent and caused a short-lived panic in the Chinese financial markets. Apparently, the financial turmoil was too much for the Chinese government, which quickly ordered the Chinese central bank to reverse course. As a result, the PBOC lost both face and credibility.

However, as credit growth continued unabated and activities in the most risky segment of China’s financial sector – the so-called shadow banking system – displayed alarming recklessness, the PBOC was left with no choice but try one more time to send a strong message that it could not be counted on to provide unlimited liquidity to the banking system.

It did so in December 2013 with a modified approach that provided liquidity only to the selected large banks but pressured smaller banks (which are the most active participants in the shadow banking system). Although interbank lending rates did not spike to nose-bleeding levels, as they did in June, they doubled quickly. Most Chinese banks held on to their cash and refused to lend to each other. Chinese equity markets fell nearly 10 percent, giving back nearly all the gains since mid-November, when the Chinese Communist Party’s (CCP) reform plan bolstered market sentiments.

Unfortunately for the PBOC, the renewed turbulences in the Chinese banking sector were again viewed as too dangerous by the top leadership of the CCP even though it seemed that the PBOC initially received its support. Consequently, the PBOC had to beat another hasty retreat and inject enough liquidity to force down interbank lending rates. Thus, in the first two rounds of a stand-off between the PBOC and China’s shadow banking system, the latter is widely seen as the winner. The PBOC blinked first each time.

For the moment, the conventional wisdom is that, as long as the PBOC maintains sufficient liquidity (translation: permitting credit growth at roughly the same pace as in previous years), China’s financial sector will remain more or less stable. This observation may be reassuring for the short-term, but overlooks the dangerous underlying dynamics in China’s banking system that prompted the PBOC to act in first place.

Of these dynamics, two deserve special attention.

The first one is the rapid rise in indebtedness (or financial leverage) in the Chinese economy since 2008. In five years, the country’s total debt-to-GDP ratio (including both public and private debt) rose from 130 percent to 210 percent, an unprecedented increase for a major economy. Historically, such expansion of credit hasrarely failed to inflate a credit bubble and cause a financial crisis. In the Chinese case, what makes the credit explosion even more risky is the low creditworthiness of the major borrowers. Only a quarter of the debt is owed by those with relatively high creditworthiness (consumers and the central government). The remaining 75 percent has gone to state-owned enterprises, private real-estate developers, and local governments, all of which are known to have weak loan repayment capacity (most state-owned enterprises generate low cash profits, private real-estate developers are overleveraged, and local governments have a narrow tax base). Staggering under an unsustainable debt burden of roughly 160 percent of GDP (equivalent to $14 trillion), these borrowers are expected to default on a significant portion of their bank debt in the coming years.

The second dynamic, closely related to the first one, is the growth of the shadow-banking sector. Two drivers shape activities in this sector, which operates outside the banking system. To minimize their exposure to risky borrowers, Chinese banks have curtailed their lending. But at the same time, these banks have embraced the shadow banking activities to increase their revenue. Specifically, Chinese banks peddle new “wealth management products” – short-term securities promising high interest rates – to their depositors. The issuers of such securities, which are not protected or insured by the government – are typically high-risk borrowers, such as local governments (and their financing vehicles) and real estate developers.

In the meantime, these borrowers are facing rising pressures for loan repayments in an environment of overcapacity and unprofitable investments. Unable to generate cash to service their loans, they have to turn to the shadow-banking sector for credit and avoid default. The result is an explosive growth of the size of the shadow-banking sector (now conservatively estimated to account for 20-30 percent of GDP).

Understandably, the PBOC does not look upon the shadow banking sector favorably. Since shadow-banking sector gets its short-term liquidity mainly through interbanking loans, the PBOC thought that it could put a painful squeeze on this sector through reducing liquidity. Apparently, the PBOC underestimated the effects of its measure. Largely because Chinese borrowers tend to cross-guarantee each other’s debt, squeezing even a relatively small number of borrowers could produce a cascade of default. The reaction in the credit market was thus almost instant and frightening. Borrowers facing imminent default are willing to borrow at any rate while banks with money are unwilling to loan it out no matter how attractive the terms are.

Should this situation continue, China’s real economy would suffer a nasty shock. Chain default would produce a paralyzing effect on economic activities even though there is no run on the banks. Clearly, this is not a prospect the CCP’s top leadership relishes.

So the task for the PBOC in the coming year will remain as difficult as ever. It will have to navigate between gently disciplining the banks and avoiding a financial panic. Its ability to do so is anything but assured. It has already lost the first two rounds of this game of financial chicken. We can only hope that it can do better in the next round.

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logicalman's picture

Isn't it obvious to anyone with 2 brain cells standing next to each other that THE BANKING SYSTEM IS THE PROBLEM destroying humanity?


The Gooch's picture

I thought it was smog and child labor?

I can't keep up.

johngaltfla's picture

WHen this sucker goes "oh shit" your ATM card will not work within 72 hours.

Bank Holiday time gang, just sayin'....

Vampyroteuthis infernalis's picture

This begs the question of what the commies will do. Will the let defaults take hold and implode the system in a debt-deflation crash or inlfate away the debts by turning on the super printing presses? We shall see.

Oracle 911's picture

I think they will first inflate it away and in a same time they will reevaluate their currency on international market. The easiest way to do this, print money sink and the US dollar, i.e. big US dollar denominated asset sell off coming on our way. Either because the Chinese gov. can't buy any asset/gold or they are having problems.


New oxymoron: Chinese gov. parting from their gold.

123dobryden's picture

great reversal coming:


child labour will actualy save poor western kids and smog will finally push the urban folks back to farmland where they belong...


moreover, the unly successfull anarchy uprising in the last hundreds years actualy happened on the farmland, in ukraine, where black army led by the first peasant himself Nestor Machno, charizmatic leader was able to defend an area of texas against red army, white army, austro-hungarian forces, german detchments, bandits and ukrainian republican forces for two years, sticking this:

"This Army does not serve any political party, any power, any dictatorship. On the contrary, it seeks to free the region of all political power, of all dictatorship. It strives to protect the freedom of action, the free life of the workers against all exploitation and domination. The Makhno Army does not therefore represent any authority. It will not subject anyone to any obligation whatsoever. Its role is confined to defending the freedom of the workers. The freedom of the peasants and the workers belongs to themselves, and should not suffer any restriction."

 on every newly freed village doors....unfortunately Machno alied himself 2x with comunist against foreign occupants, megaunfortunately saved their ass, when he stopped white army march on Moscow, ended up betrayed by them in a paris factory as a worker where he died of tuberculosis...not to mention his third wife trying to kill him in his sleep over there...women

Leonardo Fibonacci2's picture

Sum ting wong with credit tu lo

Carpenter1's picture

As long as they can print their way out of it they will. This thing only ends one of two ways; a catastrophic collapse of the economy or hyperinflation, likely both with the collapse first, then psychotic printing leading to hyperinflation.

Until then it's just more mad flailing to avoid the inevitable fall.

DoChenRollingBearing's picture

Or they could sell US Treasuries.  That would give them a lot of hard assets if they buy smart.  Although, who knows (uh, not me!) if that selling might bring other problems (a high Renmimbi) as well...

yrbmegr's picture

What did we learn from 2008?  Apparently nothing.

Exponere Mendaces's picture

China has a better chance surviving than the USA, that's for sure.

But hey, don't want to rain on the "FUCK YEAH 'MERICA" vibe. Maybe if some of you preppers actually did something besides stacking ammo, we wouldn't be talking about bankers and dirty politicians raping the public.


outofideas's picture

Lead by example. What are you doing? Or are you waiting for someone else to do it for you?

caShOnlY's picture

But hey, don't want to rain on the "FUCK YEAH 'MERICA" China has a better chance surviving than the USA

Oh really?  who needs prepping. Think they can be beat this?

Simplifiedfrisbee's picture

It is the blind consumption of resources and services that is the root problem. Banking is a problem that is overlooked.

garypaul's picture

*yawn*  wake me up when something actually happens.

Simplifiedfrisbee's picture

Go back to sleep Paul. The wonderland awaits you. Make sure to unload your weapon before you put it under your pillow. Wouldn't want to spoil your dream now would we? And that Gold you have sure is not the ticket to liberation.

RagnarDanneskjold's picture

The only reason there was no credit crunch in September was because the PBOC took action ahead of time. A cash crunch is now a regularity every three months. The only question is how soon and with how much money does the PBOC intervene.


China's Financial Crisis Began in June; PBOC Must Pump More or Deflation Will Return


Chinese Cash Crunch Could Return in September; Why Not Spend ?8 million to Avoid a ?10 million Fine?
chump666's picture

The collapse of capitalism inside a commie country.


You gotta laugh...

The Navigator's picture

The collapse of FIAT CURRENCY inside a commie country - happened in China in 1949.

Happened in Hungary in 1946.

Capitalism is NOT the cause of collapse.

Collapse of capitalism is the result of central bank printing of fiat currency.


infinity8's picture

Uhh. Didn't this happen somewhere else, already?

Binko's picture

When the newly urbanized masses of China realize that they all aren't going to have a future that includes a decent apartment, a motor scooter, a factory job with growing wages and a chicken in every wok they are going to explode in rage.

I'm looking forward to the moment when 1000s of large Western manufacturing companies suddenly go "oh shit, I guess we shouldn't have relocated all our production and the production of all of our suppliers to a massive, unstable quasi-communist nation that is engaged in the largest and riskiest experiment in social engineering in human history."

FilthyPhil37's picture

They'll just bring the blue collar manufacturing jobs home and call it progress.

Things that go bump's picture

Even if they wanted to do that they packed up all of the equipment and shipped it to China when they decided they could do it cheaper there. I'm not even sure we have the ability or know-how to tool back up. Instead of tool and die makers we've been turning out cogs for the FIRE industry. 

Billy Shears's picture

yes,  but those Chinese girls give awesome head!

Colonel Klink's picture

Rut Roh, Blace fol impact!

BudFox2012's picture

Well, at least I can take solace in the fact that once we collapse economically, the Chinese will be too broke to invade us.  See, there are silver lining to every cloud if you look for them.

new game's picture

i have been reading about these one off debt tigers for years- they never roar.

china is going to implode! -yea right. central contolled banking in a comunist nation. haha.

hello, it will be a non-event. so a city can't generate enough rev. so what. arrest and jail the city?

 a few will be sacrificed but moar of the same after stategic defaults.  maybe even goverment

forclosed/takeover of empty cities up for auction...

a reset strategically...


Musashi Miyamoto's picture

I ponder on the future actions of 100,000,000 Chinese men with no female counterpart. However will they spend there energy? Will it be to praise the legacy of Mao and the people's state? I have a sneaking suspicion... no not social uprising... why do you think...

DoChenRollingBearing's picture

Simple: war, issue each young fella an AK-74, and tell him to "Go North young man!" (Siberia).

jonjon831983's picture

Or... possibly send them to do infrastructure projects abroad like in Africa... just mingle a bit with the locals, who knows settle down.

Atomizer's picture

How many US hedge funds are tided into China spider ETF holdings? The bullshit will be exposed during the new stock market correction. SEC, Homeland Security, NSA will all be jacking off without lube. It will be blamed on another terrorist cell. This cell will be exposed within Wall Street and the White house. 

Coming to a theater near you.

satoshi101's picture

Are they going down?

I don't think so, if there were any truth in this story, the ETF/ETN's that worthless paper that represents CHINA, would be falling,

Given there not, ... ergo there is no basis to this story.

I'll say just this, want to know the status of country, ... go to the USA and count the number of PAWN-SHOP, that is how you know about DEBT.

MFLTucson's picture

Hahahahaa!!!  The US has a 17 Trillion dollar deficit with consumers up to their eyeballs in debt and homes upside down if not for money printing and these guys are talking about China!!  

Toolshed's picture

Yes, and they talk about the USA in other articles, about the EU in still others, and about Russia, Argentina, and pretty much the rest of the world in even more. Are you really that stupid?

The Final Straw's picture

$17 trillion deficit? Wow, that's 17 times worse than I thought.

Herdee's picture

So,who's going bankrupt first in the world game of chicken?Is there any particular order in the Keynesian lineup?Hint:Skin Colour and religion don't matter)

China,USA,EU,United Kingdom,even Egypt and scores of others.Something's going to give and when the world monetary system gets "re-adjusted",a lot of governments and people will end up in literal shock.Kind of like walking out of a very bad car accident.Jim Rickards thinks it'll be the next few years.All the big boys will be forced into a big pow-wow.

RSDallas's picture

They have been saying this year, next year for 5 years now???  I don't know about you, but I can't stay in this hole much longer. 

new game's picture

thanks for that perspective.  hmmm. is anyone feed up yet? not enough pain. maybe as many here are believing-this will be the year the choas begins. but, as i see daily nothing apears to be changing.

peoples out and about spending, working, buying new cars, buying other shit and it all seems just hunky dory. am i reading this zh shit to much and missing a recovery? some days i wonder if following this shit one big waste of time....

The Wisp's picture

So basically China is one big debt Pozi Scheme, and the only question is how big a state run Pozi can get before it blows up.. just like the carnival game where you race to  pop the water filled balloons, place your bets People.   Ring ... and there off. USA id of to a good start oh wait China and the Euro Are catching up. keep the guns centered folks we will have a winner shortly

CheapBastard's picture

He he he I bet most of that loaned money they can kiss goodbye since it was probably secreted out of the PRC into Kalifornia multimillion dollar houses.

The PRC CB will just have to print Billions more and hand out more RMB to keep the dumplings rolling.


It's all Boooyaaaah!


Atomizer's picture

Since I have my devil horns on . telling the truth. 

Just wait until some skull hat preacher tells the media to repeat the old threat about China must stop manipulating it's currency.

Rising Sun's picture



check that cancer rate in a few years

strangewalk's picture

But we don't need to worry about war, China's always been a peaceful nation.

Ten Deadliest Wars of Human History:

10) Russian Civil War, Russia, 1917-1921, lowest estimate: 6,000,000 dead

*9) Dungan Revolt, China, 1862-1877, lowest estimate: 8,000,000 dead

*8) An Lushan Rebellion, China, 755-763, lowest estimate: 13,000,000 dead

*7) Conquest of Timur (Tamerlane--Mongolian leader who sought to re-establish Yuan Dynasty in China), Asia-Russia, 1369-1405, lowest estimate: 15,000,000 dead

6) World War I, Worldwide but mostly Europe, 1914-1918, lowest estimate: 16,000,000 dead

*5) Chinese Civil War (Chinese Communist Revolution), China, 1927-1949, lowest estimate: 17,000,000 dead

*4) Taiping Rebellion, China, 1851-1864, lowest estimate: 20,000,000 dead

*3) Qing Conquest of Ming Dynasty, China, 1616-1662, lowest estimate: 25,000,000 dead

*2) Mongolian-Chinese Conquests, Asia and Europe, 1206-1368, lowest estimate: 30,000,000 dead

1) World War II, Worldwide but mostly Europe and Asia, 1939-1945, lowest estimate: 40,000,000 dead