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China's Cash Crunch: This Isn't The Country's Lehman Moment, But It Signals A Change Of

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THE ECONOMIST JUN. 29, 2013, 12:14 PM 1,990 1 EMAIL MOREThe EconomistMANY
commentators, including this newspaper, like to compare Chinas economy with Americas, the
worlds biggest, which it is on course to rival in size if not in sophistication. Recently, however,
parallels between the two economies have started to look more ominous. China suddenly seems to
be exactly five years behind America. After several years of excessive credit, much of it in the
shadows of the banking system, Chinas financial institutions stopped lending to each other this
month; on June 20th interbank interest rates briefly soared to 25%. The crunch seemed horribly
reminiscent of Americas financial crisis in 2008, from which it has yet to recover in full.Two
questions emerge from this. Is Chinas economy in as much trouble as Americas was in 2008? And
have the authorities done the right thing? The answer to both is: not really. A lot depends on China
now pushing through reforms.The pros and cons of already owning your bad banksChinas economy
certainly has some worrying excesses. Credit has been rising much faster than GDP, and property
prices, especially in coastal cities, have been soaring. That is often a sign of trouble. Sharp rises in
lending, accompanied by property booms, set the stage for Americas crisis in 2008 and many others
like it. In those cases, when rash investments turned sour banks went bust, lending stalled and
confidence evaporated. Governments had to step in, recapitalising some banks and urging others to
resume lending.Yet Chinas situation is different in important ways. It has an extraordinarily high
savings rate. Unlike America in 2008, the country as a whole is living well within its means. Its banks
are subject to pretty stringent rules: their loans cannot exceed 75% of their deposits, and, unlike
many countries, China is already implementing the global prescriptions on bank capital known as
Basel 3. And the state already owns the biggest banks. That has its drawbacks (too many loans have
gone to state-favoured firms), but a bonus is that, when those loans turn bad, the state does not
need to nationalise anything: it can tell the banks to keep lending while it decides how to allocate
the losses and when. In effect, Chinas state can serve as a bankruptcy judge for the economy,
keeping creditors in check, spreading the pain in an orderly fashion and, above all, preserving the
value of the economy as a going concern.Chinas cash crunch also came about for a different reason.
In 2008 Americas interbank market froze because banks refused to lend to each other. Chinas froze
last week because the central bank itself refused to lend. Despite the need of some banks for cash as
the end of the quarter approached, the central bank sat on its hands, allowing rates to spike and
signalling its determination to restrain the reckless growth of credit.Letting interbank rates spike is a
brutally effective, if crude, way to punish overstretched lenders; it may also have sent a useful
message to profligate local governments. But it risks punishing everyone else, too (see article). As a
result of the central banks abstention, rumours swirled about bank defaults and ATMs running out
of cash. On June 24th Chinas stockmarkets suffered their worst day in years; the Shanghai
composite index fell by 5.3%. The central banks inaction threatened to endanger the confidence
that makes banking possible. Fortunately, the authorities eventually woke up to the danger, moving
to calm the markets on June 25th.The priorities now should be to start cleaning up the financial
system and rebalancing the economy. Letting banks raise interest rates on deposits would help them
attract funds that are now disappearing into the shadow banking system. Introducing deposit
insurance would also help distinguish protected deposits from unprotected, shadowy
alternatives.The government also needs to cool some overheated industries and liberate others. It
should suppress speculative demand for housing by imposing an annual property tax on the market
value of homes, broadening a pilot tax in Chongqing and Shanghai. And it should do more to
encourage private investment in industries, from railways to telecoms, that are now dominated by
state-owned enterprises. That would free Chinas banks to lend to other sources.Such reforms will
take time to work and will slow the economy in the short term. Growth may run at only 6% next
year, according to Dragonomics, a research firma sharp reduction from the double-digit rate that
China has become accustomed to, and significantly below the governments target for this year of
7.5%. That may cause a flurry of anxiety in Beijing. Yet the alternative is more wasteful lending and
unproductive spending. China is a resilient economy that has grown its way out of problems in the
past. But if it lets bubbles expand, then comparisons with America may become more
apposite. Share Alerts Newsletter URL

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