China faced an acute cash crunch in June. That means Chinese banks had trouble borrowing money for their ordinary operational needs and it could signal more volatility for investors in other places.
Investors everywhere took notice when China's one-day repurchase rate, which measures the rate at which the central bank repurchases government securities from commercial banks, shot sky-high to nearly 14 percent on June 20 versus an average of 3.25 percent year-to-date. Instead of taking any decisive action, the central bank sat on its hands.
In fact, a week after the most acute phase of the crunch, Central Bank Governor Zhou Xiaochuan declared that the cash crunch was a reminder to lenders "to adjust their asset businesses." He also called for the market to "discover and correct" excessive lending. China has some specific ideas as to what "excessive" lending it would like to curtail, and what kind of lending it considers "supportive" of appropriate economic growth. In this case it appears that China used its largest state-controlled lenders to provide cheap funds to banks whose behavior the government deems helpful.
Before judging China for this tactic, keep in mind that the U.S. picks favorites too when it comes to institutions. We have been subsidizing credit for the housing industry for decades, most acutely today through the outright purchase of mortgage-backed securities.
China has spoken clearly: its government wants to orchestrate a "soft landing" for its economy as it tries to slow the rate of inflation. Policy makers are seeking to constrain the money supply to suppress what they perceive as possible price bubbles in areas like real estate. They would prefer to have Chinese growth settle into the target 7.5 percent range, down from the 9 to 10 percent growth rates seen from 2008-2011.
That's in line with the IMF's current forecast for China's growth at 7.8 percent this year and 7.7 percent in 2014. However, these actions to suppress price bubbles are cause for some concern. A Bloomberg survey estimates that China's money-market cash squeeze is likely to reduce credit growth by over $120 billion - an amount equal to the size of Vietnam's economy.
China-watchers are beginning to wonder if tight-money conditions of this magnitude could actually lead to a hard landing. These worries are reflected in the performance of the Chinese stock market. It has lost almost 10 percent so far this year, compared to a roughly 15 percent gain for the S&P 500,
Concerns in China over falling equities have pushed more money from individual investors into wealth-management products - the "shadow banking" system. That's a key point of frustration for China because one of the key objectives of the tight-money policy was to reduce the size of this shadow banking system. It's exactly this kind of manifestation of the law of unintended consequences that serves as a reminder that China isn't in precise control of its economic trajectory.
There's likely to be plenty of volatility along the transition to a slower-growth, more market-driven economy for which investors should buckle up.
Simeon Hyman is Chief Investment Officer of BloombergBlack, a new service available by invitation to affluent investors looking for a smart, easy way to take control of their personal wealth. To request an invite for a free 60-day trial, visit BloombergBlack.
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