Cross-posted from Kate Mackenzie at FTAlphaville.
Should you panic?
It’s hard to know exactly what degree of control the PBoC has over the events unfolding in China’s interbank markets.
On the one hand, making the smaller banks and shadow finance entities sweat fits with the central bank’s new high-priority goal, introduced late last year, of containing ‘financial risks’, and also with a broader government theme of clamping down on excess.
On the other hand, Chinese liquidity is also being affected by external forces (shrinking capital inflows) and the shadow financing calendar (WMP end-of-quarter maturities). Michael Pettis says he suspects the PBoC was “caught flat-footed” by this combination of events, and it certainly isn’t hard to imagine. He also points out that this is a central bank which has almost no experience of any market conditions other than credit creation and expansion.
WMP redemptions could certainly be a problem this week. But WMPs have turned bad before, even affecting mid-sized banks in big cities, and their effect has been contained. That’s the (ahem) beauty of a command economy, in which banks and the media are under state control. Bank runs don’t spread so easily if people don’t hear about them.
Yet could this Chinese ability to conceal and contain financial panic be a double edged sword?
Pettis argues that for many years now, China has been able to use its opacity and control to boost its reputation for financial stability through low volatility. Those days may now be over (our emphasis):
Chinese financial markets often seem less volatile than one would expect for a poor, developing country, largely because of administrative measures that intentionally or unintentionally suppress normal volatility. These kinds of systems, however, are not less volatile. They seem less volatile because small shocks have minimal impact. Larger shocks, however, tend to cause a much greater than expected surge in volatility. Perhaps last week was a case in point.
Going forward we will probably see more of this in China. Volatility will be suppressed for periods of times only to erupt in greater than expected volatility from time to time. This is not only a China problem, of course. One can easily argue that the Fed’s actions under Alan Greenspan seemed to induce a “great moderation”, but only temporarily, and when the great moderation became less moderate, the economy was always likely to be more disorderly than expected. The euro, similarly, sharply reduced volatility in peripheral Europe for many years until it suddenly exacerbated it. Of course no student of Hyman Minsky would be surprised by any of this.
In fact, even suppressing bad news can backfire, he suggests. Pettis points to the panic in China over SARS early last decade as a possible case in point: although news of individual cases was often successfully damped down, rumours only grew and resulted in a panic that was arguably disproportionate to the outbreak. “(T)he attempt to suppress them can actually undermine credibility and so exacerbate the impact of the shock.” He writes that Argentina’s experience in 2001, when the government tried to deny it faced a payments crisis, is another situation where suppression of information may have made the resulting response even worse than if it had been admitted upfront.
Pettis, like StanChart’s Stephen Green, doesn’t think we are seeing a Lehman moment in China. But he does think there are three unanswered questions about this situation: if liquidity is adequate, as the PBoC says, where is it being hoarded?
Secondly, why hasn’t it received more attention from the mainland press (we think Pettis maybe answers his own question by wondering if it was an attempt to prevent depositor panic).
Thirdly, if there are large net redemptions from WMPs, where will that money show up? Writes Pettis:
I can only think of the following: more outflows from China, higher deposits in the banks, stock markets, real estate markets, cash hoarding.
None of which seem like particularly worthy destinations, if the PBoC is hoping its tactics will help improve the quality of credit allocation.
Again, the immediate facts prompt the question about how equipped the PBoC is to handle these situations, and whether the advantages it’s had in the past will continue to work at all, or even backfire.
Central banking is a confidence game. As Anne Stevenson-Yang of J Capital Research writes, the PBoC has to maintain the confidence of not just domestic financial participants; it also has to persuade speculative overseas capital that the country, and its currency, are still stable enough to invest in.
At the moment, the most likely end game of all of this is more realisation of misdirected investments that have resulted from the vast wave of credit growth over the past few years (which has in turn taken the place of export growth as China’s primary key of growth).
Recognising the misallocation — or being forced to recognise it — would in turn imply a steeper growth slowdown. Just look at how the sub-8 per cent growth has shaken global confidence. Nomura are now putting a 30 per cent chance of sub-7 per cent growth in H2.
Here’s another thought. Stevenson-Yang, who closely watches the amazingly rapid innovations in China’s shadow finance world, sees a risk that China’s feted huge foreign capital reserves could dry up.
That would be a shock.
