Streetwise Professor

June 27, 2013

Did the PBOC Blink? Uhm, Yes.

Filed under: China,Economics,Financial Crisis II,Politics — The Professor @ 6:36 pm

The WSJ’s ChinaRealTime blog asks 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 WMPs 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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  1. I like this for some reason: “The People’s Bank of China (PBOC) is fondly known as yangma, or “central mommy,” by interbank bond traders because it usually takes care of its family of banks.” You can have the nanny state or the mommy state.

    Comment by David Hoopes — June 29, 2013 @ 5:57 pm

  2. @David. Momma don’t let your babies grow up to be shadow banks.

    The ProfessorComment by The Professor — June 29, 2013 @ 6:41 pm

  3. We are approaching the “water bed” moment. That is when pushing down one part of the structure, another will pop up. This is something we have become very familiar with thanks to “Wrongway”(Greenspan) & “TooTall”(Bernanke). The real issue is that the credit creation system was not restricted. As Schumpeter pointed out money can and is created outside of the formal banking system in many ways. In other words unless forbidden, it will be created until such time as having cash becomes indispensable. This is punishing to the newly rich – aka the Party and its proxies in the economy.

    It might be more accurate to say rather than merely blinking, the PBOC pretended to have an Emily Letella moment, once they were reminded of the cost to the politically connected.

    Comment by sotos — July 1, 2013 @ 2:35 pm

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