Here are two figures for you. The Standard & Poor’s 500 was down by more than 1.5 percent (as was the Dow Jones Industrial Average) in early Monday trading, and U.S. 10-year Treasury notes were up by over 2.6 percent.
Here are two more figures for you. The Shanghai Composite Index was down 5.3 percent at the same time, and the Hang Seng lost 2.2 percent.
Separated by half a world, these two trends are intimately connected in ways that explain a steadily rising concern on the part of American investors for what’s going on in China right now. The reason for concern? American banks encountered roughly the same sequence of events a short while back.
You know it better as the 2008 financial crisis.
Yesterday, as the Wall Street Journal notes, the People’s Bank of China—China’s central bank—issued a stark warning to national banks, urging tighter control over liquidity risks and increased efficiencies in liquidity management. Last week, China’s overnight lending rate shot up to an intra-day high of 30 percent as the nation reels from an ongoing liquidity crisis.
While the PBOC declared that, overall, liquidity continues to remain within reasonable limits, some action needs to be taken rapidly to ensure liquidity remains safe. There is seemingly no pressing shortage of credit, though there have been reports of poor lending practices.
Interbank rates did subside following the report, with overnight funds dropping to 6.60 percent and seven-day funds falling to 7.59 percent.
Nonetheless, the central bank’s move was taken to be a clear indicator of the end of cheap official funding, meaning bank stocks declined sharply. Financial stocks lost 7 percent overall.
The big scare is the idea of what could happen if the money markets simply freeze up. In short, it would replay what happened in the U.S. financial crisis. Some lenders would go into default, which in turn would adversely affect the Chinese national economy, which would then reverberate around the world. That’s what the PBOC statement sought to clarify.
“As financial institutions, especially big commercial banks, strengthen their own liquidity management, they should at the same time play to their strengths and complement the central bank in stabilizing the market.”
However, a simple statement meant no real monetary or fiscal action, meaning the costs of funding continue to remain at high levels. That’s what sent some banking stocks sliding down. The CSI300 Index (SHA: 000300) lost 6.3 percent, and the .SSEFN saw 7.4 percent wiped out.
Over here in the U.S., Goldman Sachs (NYSE: GS) responded by reducing Chinese growth forecasts for 2013 from 7.8 percent to 7.4 percent and for 2014 from 8.4 percent to 7.7 percent.
Parallels and Differences
What the PBOC has done, in short, is clarify to risky lenders that they would be left out in the cold in the event of a major liquidity crisis.
As Yahoo! Finance points out, it was precisely the case of banks not lending to each other due to fears of vulnerability to bad debt that led to the U.S. market freeze-up back in 2008, which subsequently led to the collapse of Lehman, Bear Stearns, and so on.
In the case of China, fears over slowing domestic growth and an impending financial crisis has hit commodities especially hard; copper is at levels near two-year lows, while oil is losing value rapidly. Gold, needless to say, continues to do poorly. All of this has made the U.S. dollar stronger than at any time in very recent memory. In fact, it’s at two-week highs right now.
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Not everyone is convinced China is in as much danger as others are claiming, however. Take Mark Mobius of Franklin Templeton, for example. Yahoo! Finance reports that Mobius believes the debt situation over there may reasonably be compared to the U.S. subprime and market crises. However, he does not believe it will cause a similar meltdown on a national level.
The key difference between the scenario in the U.S. and the scenario over in China is that Chinese banks are owned by the government. That puts a powerful buffer in place, which will likely see any potential fallout greatly minimized.
Yahoo! Finance quotes Mobius:
“We have to ask what the consequence is, what will happen as a result, and the scenario will be very, very different in China, simply because the banks are controlled by the government, so they will not be allowed to go bankrupt.”
We can only hope he knows what he’s talking about; the man oversees $53 billion in emerging market funds, and he is heavily invested in China.
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