There has been significant focus about what the Fed will or will not do in the next year, but the real issue or focus for investors should be on China financial markets. China has been in the previous role as the US, the marginal provider of global growth, so the news here is significant.
Let us not forget that China is a very controlled financial system. Rates just do not move because of the normal behavior of supply and demand. Well, generally this is the case. All financial systems are controlled, but if there is one place that government should be able to control credit markets, it is China. Now, it is harder than what we have seen in the past, but if there is a problem with financial system, the PBOC should be able to fix it. Unfortunately, keeping a lid on financial markets has a price. The government wanted to tighten credit to stop any financial bubble, but the effect was much greater than what was expected. There has not been a glide path. The problem is that bad loans have not be written down and poor credits have not be cut-off from funds.Now there is a day of reckoning and it is costly. This is one of the key problems with all financial crises, the eventual valuing of bad assets and the inability to pay for money borrowed.
Unfortunately, we are now finding out that there is a large credit crunch going on in the country and the shadow banking system has created a lot of leakage and the mechanism for potential damage. The off-balance sheet risks in the China market are like a huge iceberg for which there is not a good idea of size.Trying to cut credit for off-balance sheet financial products will not be easy.
The PBOC has extended more credit this week but interbank rates actually reached close to 30% last week. Rates are back down to 6.4% but were half this level in April. 90-day bill rates have increased from 4% to close to 6% also. This is supposed to be in a controlled economy. It can only happen if there a very large credit issues that the PBOC will not be able to easily solved without a major bail-out.
The Chinese stock market was in tatters on Monday so trying to tighten credit in this market may be a lot harder than what PBOC may have thought. So now we are in a special situation -there is no glide path but the world knows there is a problem.