Financial “Collateral Damage” Highlights China’s and Fed’s Impossible Task

by Mish

The recent tightening of credit we have seen in China is primarily aimed at clamping down
on shadow financing. Wealth management products have rapidly grown in size, from only
8% of total banking deposits in 2012 to over 20% today.

The top chart shows China’s banks’ claims on non-banks, which is where a lot of shadow financing shows up. As we can see, growth in this category has fallen precipitously from 70% YoY to 20% today.
However, there is collateral damage from this tightening. For one, bank-lending rates are starting to rise as their cost of funding rises (bottom-left chart). Policymakers in China want to confine the rise in rates in to the interbank market, but this a next-to-impossible task. Too great a rise in lending rates would feed negatively into the real economy.
Moreover, as the bottom-right chart shows, tightening has led to broad credit growth falling to near to 0% on a 3-month basis. A negative second derivative in credit must be watched for any inhibitive effects it may have on economic growth – especially in a country so heavily credit-dependent such as China. A negative first derivative in credit, as we are on the cusp of today, leaves economic growth even more fragile.

Impossible Task

I don’t agree with VP analysis on everything, but I do agree on most things. I find this report spot-on.

China has an impossible task of slowing its shadow banking sector running rampant and maintaining growth.

China’s Dilemma

I do not know what China will ultimately choose, but something has to give one way or another.

China’s unpleasant choice is a bubble bust now or a bigger bubble and a bigger bust later.

By the way, the Fed faces a similar unpleasant choice, as do central banks in general. Asset bubbles are everywhere.

Mike “Mish” Shedlock