Is There Tightness in China's Money Market?

The stock market raced up Friday, with the SSE Composite closing at 2778, 3.49% higher than Thursday’s close.  Since investors are still digesting Thursday’s mix of good news and bad news – GDP slowing, fixed asset investment soaring, CPI down, PPI up – I suspect the main cause of the decline may have been the decline in oil prices to $130 a barrel.

 

Cui Enze, one of my Peking University students currently completing a summer internship at Van Eck in New York, was nice enough to sleuth out the CPI numbers for me on the National Bureau of Statistics of China website.  According to him, this is the breakdown of the food and non-food components of CPI:

 

Month	Food, year on year	Non-food year on year	CPI year on year
January	18.2%	1.5%	7.1%
February	23.3%	1.6%	8.7%
March	21.4%	1.8%	8.3%
April	22.1%	1.8%	8.5%
May	19.9%	1.7%	7.7%
June	17.6%	1.9%	7.1%

 

Without the actual index numbers, it is hard to extract much information from this series except to note the obvious – that non-food inflation is low but rising.  If I make a simplifying assumption that non-food inflation last year ranged from zero to 1%, it implies that non-food inflation year to date is probably running at an annualized pace of 2-3/4% to 3-3/4%.  This is not particularly high in itself, but remember that these numbers are being held down by price controls and, more importantly, that if Chinese monetary policy were consistent with low inflation, the surge in food prices should have caused at least some deflation in non-food prices.

 

Enze also sent me a separate note in which he alerted me to an article in this week’s Caijing

 

Just read news on the Caijing website that the CEO of a big private company (GoldenSun) in Yi Wu of Zhejiang province disappeared the other day.  The reason is that this company has 1.4 billion RMB outstanding debt which was borrowed through informal banks. Of the 1.4 billion, 800 million is principal and 600 million is interest not paid. The asset of this company has been audited or sold to repay part of debt.

This company had been borrowing through informal banks at an interest rate of only 2%-3% in 2005, but ever since late 2007, the interest rate has climbed as high as 12%, which brings a huge cash flow pressure to the private companies in Zhejiang. This year, several other owners of private companies in Yi Wu have fled because they can't repay the high interest.  As most of the small companies in Zhejiang are export companies, the RMB appreciation and rising price of raw materials have significantly reduced their profit margin.

 

I checked the English version of Caijing and saw the story, although it didn’t have as much information as the Chinese version which Enze cites.  It did say the following:

 

A source told Caijing that Zhang raised money through a local version of China’s informal “gao li dai” credit system, which lets private individuals lend cash at high interest rates to persons or companies through go-betweens known as “hui tou.”  The system flourishes thanks to legal loopholes.  In Zhang’s case, the hui tou allegedly included local officials and lawyers. Many lenders mortgaged homes to raise the money that Zhang borrowed over the past two years, the source said.

 

The article closes by quoting a Yiwu-area banker as saying: “More bosses will flee later this year.”  I suspect that these sorts of stories are going to become more common.

 

For now I don’t know how common these sorts of defaults are likely to be, but at least this article does address one question that comes up a lot.  I have often heard people assert that the informal banking system is not a significant source of banking risk because loans are too small to matter, even in the case of serial default.  But this story involves loans from the informal sector of significantly more than $100 million to one client.  This sounds like regular banking to me.

 

Another student, who wants to remain anonymous for obvious reasons, also sent me an interesting note (it’s great to have such great students).  He is spending the summer as an intern at one of the larger and better city commercial banks in the southeast.  He tells me (with some editing on my part, largely to hide names):

 

We saw some weird stuff yesterday in the money market.  If you only looked at the money rate, it was a normal day, but in the real market, a Big Four bank unexpectedly ran out of liquidity, and they were asking for money eagerly from other banks.  Because this bank is a major money-provider in the market, small or city banks like us cannot lend them money at a very high rate (because of their power and "mianzi").  We worry that they may punish us later when we lack money ourselves, so most of us choose to say: "Sorry, but we also lack money."

It wasn’t until 3:30 in the afternoon, that the bank finally got the money it needed, but because of their lack of money, small banks also could not borrow.  Our bank was also caught in this trap and not able to borrow one cent before 3:30.

 

My student goes on to tell me that his money market traders told him that these sorts of liquidity squeezes have become increasingly common during this quarter.  I haven’t been able fully to figure out what this means.  It may simply be the expected consequence of the several hikes in minimum reserve requirements.  If so, this puts a little hair on the statement I cited yesterday by a banking regulator who warned that further reserve hikes were hurting the system. 

 

I wonder if anyone else among my readers saw something similar and can explain what happened or how common it is.  One of the few things I learned from my banking classes at Columbia Business School (and amply confirmed in my many years as a bond trader) is that problems in the banking system usually first turn up in the plumbing – the otherwise very unglamorous  money markets.  I always tell my finance students to keep an eye on the money markets, and I am glad to see that at least one of them has taken me seriously.

Comments

[pldragon]

The story about the Yiwu boss is definitely not surprising at all.
I also believe there will be numerous defaults before the end of 2008.
Well, since they affect "private banking", the government can pretend that it is not its business...
But because usually, private banking involves thousands of lenders, the risk of social and polititcal instability is greatly increased.

The second story is truly astounding for me: I don't doubt for a second that it is true, but I have a question: All of the big 4 banks are quasi-national banks, I mean not private ones: In case of liquidity crunch like the one mentionned, the government would not step in ?

Sure, I do understand that interventionism would run counter to their desire to reduce the volume of money available for credit , and therefore to the fight against inflation and hot money...
But what about the confidence of the public in banks? or will chinese people soon start to buy gold frantically like in Vietnam ?

[mkhanarian]

This was a very interesting article, and really shed some light on the banking system in China. With that said, some of the observations made by your diligent students seem to indicate something more than a simple liquidity problem. While I am sure their credit issues, many of the lending and money market problems seem to indicate some possibly illicit behavior. Honestly, I do not know what to make of it, keep up the investigating!

[huangthomas]

The existence of Banks in China is a more recent event, no more than 100-year. How Chinese conduct their "banking (saving and borrowing)" for the last 5,000 year for short term cash needs or to fund private bussiness? The most commonly used method is "mutual assistance club". The "Head of Club", so-called huitou = hui (club) + tou (head). Let say you have a club of 30 members put together by the head of the club, this is how it works. He will select 30 members (including himself) from his close friends and relatives who have fair to good credit records and can afford to have monthly savings of $1,000. Each members are committed to saving 1,000 per month for the next 30 month (this is the number of the club memebers including the head of the club). The first month, each submit 1,000 with a total of $30,000. The head of the club take $30,000 ($1,000 is his own money) and every month thereafter, he returns $1,000 to the club. He get to use $30,00 interest free, which is the reward for his effort to organize and runs the club. On the 2nd month, there are $30,000 on the table, which is open for bid (monthly interest). The highest bidder, say 2 to 5%, will take $30,000 and pay back $1,000 + 2 to 5% interest rate he committed, for the next 29 month. Thus the highest bidder get the loan and payback each month $1,000 plus the interest he promised to pay. This type of club is the way the families solve their short term cash need in the old society or earning interest on their saving without banks or credit cards. The reasons this is still going on is relatively high interest rate for the "savers" and may be lower interest rate for the borrowers compared with credit cards or personal loan, without telling what the money will be used for, from banks. This is why they are also referred to as "mutual assistance club". Once in a while some member may obtain the loan and deposit in Qian Zhuang to earn extr-interest. Next on DangPu & KaoLiDai (Qian Zhuang)

[pldragon]

@ Thomas...waouww...real... great stuff...FirsttimeI finally got the complete and clear explanation .... In Taiwan, there are also some informals groups borrowing money between themselves, often among teachers for example..and time to time, one ugly story surfaced about how one of them made a run with the money...Tks for the detailed explanation

[M. Pettis]

Huangthomas, thanks. This is actually one of many types of informal banking sytems in China, some dating back to hundreds and even thousands of years. Pawn shops, for example, are very big in the south, with some companies having over 1000 branches -- and they lend against stock, real estate, as well as the normal items. There are alos the standard loan-sharking activities. Kellee Tsai has a very good book on the topic.