Combatting Credit Crunch, China Opens Door to Private Bank Reforms

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The Chinese government indicated recently it would be substantially liberalizing its banking system.  What might this mean to American consumers?

Long micromanaged by Beijing cronies and managed in the interests of other government cronies and favored connected enterprises, the Chinese banking system has long been all about financing big government projects and has lent very little to the private sector.  Additionally, China’s centralized banking system has historically been a poster child for the problem of crony capitalism: the country ranks 80th out of 176 countries on Transparency International’s Corruption Perceptions Index. (The U.S. is #19, meaning it’s perceived to be much less corrupt, and Denmark is #1. Afghanistan, North Korea and Somalia all tied for #174. Hong Kong, incidentally, rates above the United States at #14).

But this week, the Chinese government dropped hints that it would soon be legal to create private lending institutions – that is, lenders not controlled from Beijing – to provide some liquidity to an entrepreneur class that is creaking under the strain of a widespread credit crunch that threatens to impede growth.

While the government has not committed to a specific plan or timetable as yet, this should come as welcome news both to the Chinese people and to the global capital markets. If China embraces this rather western-style approach to banking, it promises to unleash a lot of Chinese energy in productive and profitable ways. It also is likely to help the Chinese unemployment situation – which is always delicate because of the huge “floating population” of 221 million temporary urban residents who have come in from the countryside and frontier to live and work in the cities, but who have no permanent residence there.

Background

The Chinese economy – a swaggering giant during the 2000s and through the recession in the West, has been sending some mixed signals over the last couple of years – largely due to the deflation of some highly speculative urban real estate markets in places like Shanghai. But the spring has been looking good: Industrial production surged from 8.9 percent to 9.3 percent at the end of April, thanks to increased power production. Heavy industries also increased their industrial output by 9.6% percent in April. Chinese export growth continued to accelerate, as well. China’s retail sales also continued to sport double-digit growth through the spring.

On the other hand, Chinese authorities have been concerned about a growth rate decline: GDP growth fell to 7.7 percent in Q1 of 2013, compared to 7.9 percent the previous quarter.

Now, American readers should take these numbers with a grain or two of salt. The western reader should understand that while a 4 percent economic expansion in the U.S. would be a very powerful year indeed – and would indicate the kind of economic overheating that would lead Chairman Bernanke and the Federal Reserve Board of Governors to start hiking interest rates and restrict the money supply to head off economic growth.

In China, though, even a 6 percent growth figure would be disappointing. While China’s coastal regions present a modern face to the West, much of the Chinese economy is continuing to go through a radical transformation. The Chinese masses, in a nutshell, have discovered what a middle class existence feels like – and they like it. They love it. They want more of it. A generation of Chinese has left the farm, moved to the cities and escaped the poverty-stricken existence of their ancestors. They have increasingly embraced a lifestyle that includes cell phones, color television, the (still censored) Internet, and even air conditioning.

The move to liberalize is of a piece with the career of the director of the People’s Bank of China – the central bank for Mainland China – Zhou Xiaochuan, who has long been an advocate of reforms. 

China’s demographics are also blessing the country with a substantial tailwind: China currently has a huge swathe of people now entering their years of prime productivity, and will be in that happy situation for some time. The historic Chinese savings rate also gives Chinese planners some elbow room in crafting monetary policy. The Chinese authorities would like their people to save a bit less, and spend more, boosting local industries. Nevertheless, China is resisting calls for another round of monetary easing, preferring a soft landing to the prospect of a re-inflation of eventually painful bubbles such as the ones we have been seeing appear in urban Chinese real estate.

Anatomy of a Credit Crunch

Here’s what’s happening: Banks in almost all countries routinely borrow from one another to meet their own short-term liquidity demands. If a large customer at a small bank makes a big withdrawal, or needs a big loan, the smaller bank will shop the loan around, and a bank that has some surplus cash is usually happy to lend the money overnight, or for short periods of time, for a reasonable interest payment. Naturally, a lot of this goes on very quickly, and largely based on faith and confidence in the other banks in the system. The vast majority of the time, the bowery is able to pay off the interbank loan with no problem.

However, there have been some reports of Chinese banks that have been slow to pay back these interbank loans – which erodes confidence in the system as a whole, and makes it harder for all the other banks in the system to borrow. As the second-order effects take hold on smaller private entrepreneurs who cannot access the capital markets more directly, a credit crunch is born.

Outlook

The hinted at reforms are a positive development by any measure. They’re not official yet, though: The government’s holding off on announcing a detailed plan until after a Communist Party meeting this fall. But if they go through as planned, a burgeoning private lending industry in China can potentially go a long way towards expanding the Chinese middle class. It could also potentially facilitate the creation of some more intense competition for American manufacturers – balanced by a larger pool of middle-class Chinese consumers who themselves are a market for American exports.

Lastly, the Chinese government also told the nation’s banks to stop charging hidden fees – which goes to show that people are the same everywhere you go.

 

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