Tightness in the money market?

The stock market raced up today, with the SSE Composite closing at 2778, 3.49% higher than yesterday’s close. Since investors are still digesting yesterday’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 websiteextlink_3.gif. According to him, this is the breakdown of the food and non-food components of CPI:

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 storyextlink_3.gif, 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 today (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.

Originally published at China Financial Markets and reproduced here with the author’s permission.