But should it be? Now, there’s no doubt that if Greece defaults, we are looking at a major financial clusterflock. Liquidity will disappear overnight, credit will become a lot more expensive and European banks (particularly French banks) will be forced to write down billions. Given the interconnected world of finance nowadays, the effects will reach far and wide.
However, the DLR is not yet convinced that this will happen. The EU is rather good at creating those fudges that allow cans to be kicked, situations to be ignored and the whole merry-go-round to keep spinning. Given what’s at stake, the most likely outcome still seems to be a tenuous Greek government (reaffirmed through last night’s confidence vote) holding on to pass the mid-term austerity plans and the EU/IMF throwing cash at the problem until it goes away. It is feasible that the unpopularity of the austerity measures will eventually lead to the programme being halted, or that the austerity measures themselves will fail as they prevent any economic growth, but both Paris and Berlin seem determined to save Greece and, with it, the euro.
But this mega-diversion has sapped attention away from another little mini-credit crunch/debt problem that is going on and isn’t really being talked about. This one’s in China. So, not much to worry about then, given that it’s only the second largest economy in the world.
It all started in the US. Following the sub-prime debacle, Lehman Brothers/AIG collapse and credit crunch, China feared for its economic life. In a bid to prevent a disastrous slowdown and amid rising discontent as its manufacturing industries started tanking, it forced the state-run banks to lend money like jiggery. Chinese banks lent triple the amount in 2009 as they did in 2008. Some of this went into soaring real estate prices, some of it went into infrastructure projects and a fair chunk went to local governments.
But the local government borrowing was poorly regulated, opaque and often going into projects that were not viable. Essentially, local party officials saw an opportunity to grab some cheap cash from the central government and went batshit crazy with it. Now, Beijing has meekly admitted that the balance sheets of the local governments may not be that healthy. In fact, it quietly announced a massive bail-out a few weeks ago — up to USD460 billion worth of bailing out. (By contrast, the US’s Troubled Asset Relief Programme totalled USD300 billion.)
All this occurred amid the European debt problems. Given that the EU is China’s largest trading partner, the country has repeatedly assured Brussels that it will continue to buy European bonds, and it appears to have followed through with this. But this could prove even riskier for the banks if the debt turns bad.
Now some strange things have started happening in Chinese inter-bank financing. The Shanghai Interbank Offered Rate has spiked to near-record highs. Shibor is essentially the rate at which banks lend to each other in China. The higher it is, the greater the cost of borrowing. A higher Shibor would normally indicate greater uncertainty about the safety of the unsecured funds being lent.
This could all be a storm in a teacup. Shibor was always going to increase, because the reserve requirement ratio (that is, the amount of money banks have to hold) was raised by the government. Beijing has increased the RRR six times this year in a bid to cool runaway lending and slowly defate a possible bubble. Shibor also spiked in January around the time of the Chinese New Year, and around previous RRR hikes. What’s more, China is sitting on the world’s largest foreign exchange reserves, so cash shouldn’t be a problem.
But the issue is that the size of the debt, and in particular the bad debt, in China is far larger than Beijing is letting on. If liquidity becomes tighter, these loans could come back to haunt the Chinese financial sector. Credit crunch 2.0? Not yet, but just chalk it up as yet another threat to the global economy along with Europe and the US debt ceiling. Hurrah.