At the end of last week markets were understandably troubled by the implications of a “tapering” of Quantitative Easing by the US Federal Reserve. Indeed one of the consequences of this which is rising bond yields has continued this morning as prices have fallen further and the yield on the benchmark ten-year Treasury Note has reached 2.6%. Whilst is still historically low it has risen by 1% since the beginning of May. However this was not the only factor in market uncertainty as increasingly disturbing developments have been coming out of China and in particular in her monetary system where liquidity has been drying up leading to fears of a credit crunch there.
What has happened?
The Shanghai Interbank Offered Rate or SHIBOR has been rising in June and on Thursday the overnight rate rose to 13.44% and the one week rate rose to 11%. This led to fears of a liquidity squeeze in the Chinese economy in response to this although the official view from the Xinhua new agency was this.
Liquidity shortage creates opportunities
For whom? Apparently depositors were likely to get better returns. As it happens they would have had to be quick as the one week SHIBOR dropped back to 8.49% on Friday and 7.32% this morning.
If we look back we see that this time last year the one week rate was more like 2.5% and that up to now whilst rates had been going higher there had only been one brief episode above 5%. So in a world now sensitised to the problems caused by liquidity squeezes there were obvious worries.
What was the People’s Bank of China (PBOC) doing?
At a time like this all eyes should be on the central bank as controlling money market interest-rates is its most fundamental job. This becomes even more important if the spike is accompanied by a decline in transactions as it has been in China. However the PBOC waited until Friday to respond.
In fact a squeeze was official policy
The PBOC had stood to one side because policy in China is currently attempting to trim a monetary boom. Rather unfortunately for its criticisms of “weak imperialist capitalists” its boom has had elements of profiteering,shadow banking systems and speculation just like a weak imperialist capitalist!
If we look at today’s monetary data we see this.
At end-May, broad money (M2) stood at 104.21 trillion yuan , increasing by 15.8 percent year-on-year down 0.3 percentage points from end-April but up 2.6 percentage points from the same period last year.
Narrow money (M1) registered 31.02 trillion yuan , rising by 11.3 percent year-on-year, down 0.6 percentage points from end-April but up 7.8 percentage points from the same period last year.
So we see that as of the end of May the boom was continuing particularly compared to a year ago and accordingly the PBOC was attempting to rein it in. It is via this route that we have seen it try to look the other way when monetary conditions tightened and only responded when the pot was clearly boiling over.
The PBOC has released a statement on its website this morning but intriguing dated it for the 17th. It tells us this via Google Translate.
financial institutions must continue to conscientiously implement the prudent monetary policy, and effectively improve risk awareness, and constantly improve liquidity management and scientific initiatives, continue to strengthen liquidity management, promote stable monetary environment.
Commercial banks should pay close attention to the market liquidity situation, to strengthen the liquidity factors analysis and forecasting,
It does not surprise me that this statement has not calmed matters much as the PBOC as even allowing for the coded nature of official pronouncements it seem to be telling the banks that this is essentially their problem! Whilst this is true it is again following a road trod by the central banks of the weak imperialist capitalists.
A fundamental issue here is exactly how one safely deflates a boom driven by a shadow banking system as using interest-rates to do so has so far not worked. Rather than letting air gently out of the ball such moves have invariably clattered us straight from boom to bust. So if the PBOC does succeed here it will have succeeded where others have failed. But the evidence of last week and indeed this morning are that there are to say the least genuine risks here for China’s economy and those who depend on it.
The Chinese Economy
In a very unfortunate coincidence of timing new evidence of a slow down in the Chinese economy was emerging. On Thursday we got the latest business survey from HSBC.
Flash China Manufacturing PMI™ at 48.3 (49.2 in May). Nine-month low.
Flash China Manufacturing Output Index at 48.8 (50.7 in May). Eight-month low.
So in a case of be careful what you wish for the Chinese leadership got some further evidence of an economic slow down just as fears of a credit crunch were rising to a peak. If we look into the detail of that report we saw the only only factors that did not decrease were inventories and delivery times. So a broad based decline was recorded with implications for subsequent months.
In the western nations and in the Euro area in particular 2013 had until the last few days shown a clear divergence between strong stock market peformance and weak underlying economies. China has until now been a doppelganger for this as she has had strong economic growth but a weak stock market. This has gone a step further today as the Shanghai Composite Index has fallen some 5.3% taking it below the 2000 level to close at 1953. It has been heading lower since the 2444 of February 18th of this year. Indeed even Anthony Bolton appears to have given up on it,at least for now.
Adding to the fears will be the fact that today’s falls were led by bank stocks particularly ones involved in off balance sheet and shadow banking system activities. Such banks have for example been offering long-term Wealth Management Products to their customers whilst obtaining at least some of the finance from short-dated interbank funds.What could go wrong?
So we see that the world’s main command economy looks in danger of following the same route into economic trouble as the weak imperialist capitalists. Although some care is needed here as it has a capitalist tinge these days and the capitalist central bankers are doing their best to mimic command economies. However China faces a challenge which the west failed which is to safely deflate a shadow banking boom.
There are things which can be learnt from the West’s failure back in 2007 and they are as follows. Central banks should learn against any surge in market interest-rates to try to ameliorate the consequences. This is conceptually awkward as there will be an element of stimulus here when it is invariably preaching that a slow down in needed. But intellectual flexibility is required when we note that any attempt by “Mr. Market” to sort this involves an economy shooting straight from boom to bust. At the same time the effectiveness of monetary policy has been slashed as velocity collapses. So my policy prescription for the PBOC is to step into these markets and provide liquidity in an attempt to pass the test which we failed.
This will not be easy as the PBOC has become used to dealing with the opposite problems of high credit growth and a booming economy. If it can gently deflate the Chinese boom it would have done well but if we look wider afield we are left with worries about what will happen to nations who depend on trade with China. This is illustrated by the price of copper which in falling nearly 3% this morning is hovvering just above the US $3 mark or a third below the peak of early 2011. So dependent nations such as Australia are in danger of feeling further chill winds.
Looking at prospects it seems that the world overall may see disinflationary winds from such trends. How far that will progress I do not know but I do know that US index-linked government bonds or TIPS seems to be reflecting this much more than UK ones. If this is based on Mark Carney’s entry onto the UK monetary scene we do not have to long to wait.
Central Bank Swaps
Over the weekend there was a development on this front.
Governor Zhou Xiaochuan and Governor Mervyn King have signed an agreement to establish a reciprocal 3‑year, sterling/renminbi (RMB) currency swap line. The maximum value of the swap is RMB 200bn. The swap line may be used to promote bilateral trade between the two countries and to support domestic financial stability should market conditions warrant.
As ever come caution is needed but if you ask yourself the question why might this be needed? You will find yourself answering that it would be useful in a renminbi credit crunch.
Courtesy Mindful Money for QFINANCE (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.