Did The PBOC Blink? Um, Yes

Includes: FXI, PGJ
by: Craig Pirrong

The WSJ’s ChinaRealTime blog asked that question. The answer is fairly obvious.

Recall about a week ago that China was experiencing an acute liquidity shortage, resulting in the spiking of repo rates to 25 percent intraday. The PBOC remained aloof. Then it intervened, providing liquidity and making soothing noises. Interbank rates (SHIBOR) and repo came back down, though they still remained at elevated levels.

The narrative is that the PBOC was trying to teach banks and shadow banks (trust companies, marketers of wealth management products and the like) a lesson: cut down on the extension of dodgy credit, or else.

But as I noted in my post last week, the PBOC was in a bind. It could refuse to supply liquidity, and watch the system blow up. Or it could supply liquidity, and undermine the credibility of its “or else” threat. Not surprisingly, PBOC chose the latter course.

The ultimate result is likely to be quite different than the PBOC had hoped for. Banks and shadow banks will likely conclude that the PBOC will always come to the rescue. The “or else!” threat is incredible. Meaning that Chinese credit will continue to grow, and the ultimate reckoning - which must occur - has been merely delayed.

I have read some reports questioning where money invested in Wealth Management Products will go at the end of the quarter, when they mature. Well that’s the problem, isn’t it? If the WMPs can’t roll over, if the money invested in them goes somewhere else, the rather dicey assets they hold can’t be funded, with the following consequences: (a) some WMPs will default, (b) others will call on the (implicit) liquidity puts extended by banks, thereby communicating the contagion to the banks, and/or (c) WMPs will dump assets on the market, depressing prices, with deleterious consequences for others holding similar assets.

The PBOC is riding the tiger. Its relenting at the last minute makes it clear that it is loath to dismount. Market participants will note this, and respond accordingly. Meaning that the supposed teaching moment will not provide the lesson that the PBOC intended. It will instead convince market participants that they will be rescued if it looks like the system is about to crack.

Again: the reckoning with China’s extreme financial imbalances and malinvestment has merely been deferred.

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