Credit squeeze could turn a slowdown into a hard landing, writes Philip Wen.
He said it as an omnipresent local member for Griffith, and he said it again the next day, immediately after wresting back the Labor leadership. "The China resources boom is over," Kevin Rudd warned, and he will probably continue to sound the warning as he campaigns to extend his stint as PM beyond a couple of months.
The point he underscores is that Australia's economy must make profound adjustments to cope with the reality that the resources boom is on the wane.
In posthumously characterising it as the "China" resources boom, Rudd helped make it abundantly clear why commodities prices and mining investments are sliding, along with the share prices of all companies within the resources orbit. Just maybe, China's legendary appetite for our resources is not what it once was.
The events of the past fortnight or so in China's money markets have raised the eyebrows of even the staunchest of China bulls, and armed the growing band of doubters with more ammunition.
On June 20, the money market seized up and interbank lending rates - an important measure of liquidity within banks - soared above 20 per cent.
"That's not a real number at which you can get money," Silvercrest Asset Management managing director Patrick Chovanec says. "The danger [was] that you get into a situation that nobody will lend to anybody."
The talk then was no longer about whether China will go above or below 8 per cent economic growth this year. It was whether Beijing was approaching its own Lehman Brothers moment - one big bank default that cascades through money markets and destroys financial system confidence.
The central bank, the People's Bank of China , was forced into action. It was the PBoC that had methodically starved the financial system of cash for the preceding fortnight, in a calculated message to banks that the days of easy credit were over, and that banks had to be measurably more responsible with their lending practices.
The central bank sets an explicit target for growth in credit and in money supply to prevent the economy from overheating. But banks have simply invented new ways of lending through the "shadow banking" sector, synonymous with off-balance sheet wealth management products, which they and mid-sized lenders use to lure investors with the promise of higher returns than regular bank deposits.
It has been a craving for high returns, cultivated by the prevalence of easy credit from post-financial crisis economic stimulus and the ensuing infrastructure construction boom. The PBoC had hoped the pressure placed on banks via choking the supply of cash could help cauterise the runaway problem.
"Via higher interbank rates, the PBoC is telling banks they need to source their own liquidity, reduce their reliance on such products, and not expect the PBoC to bail them out when they face a cash squeeze," Standard Chartered analyst Stephen Green says.
But the brinkmanship has had unintended consequences.
"While we recognise that the Chinese government may want to reduce financial leverage and restructure the economy, we don't believe they wanted interbank rates to shoot above 20 per cent and risk a disorderly credit crunch," UBS analyst Wang Tao says.
China Development Bank, a government-owned lender, had to scrap a debt sale on Monday when it realised it would not be able to sell its paper at a reasonable price.
Local press reports suggested banks temporarily halted lending because of liquidity shortages, including the world's biggest bank, Industrial and Commercial Bank of China, and Bank of China. Some of those stories were swiftly removed from the internet. But by Tuesday, the PBoC admitted it had provided direct help to some institutions, without naming names.
There were reports of ICBC and Bank of China customers having trouble withdrawing cash at ATMs and over the counter. The banks blamed the disruptions on system upgrades.
ICBC chairman Jiang Jianqing later told Reuters there was no clear direction from policymakers on their goals during the money-market turmoil. "Those few days, even for us, we were genuinely a bit tense," he said.
Ultimately, in what the Financial Times described as a "volte-face that bore more than a passing resemblance to Mario Draghi's 'unlimited' bond-buying pledge" last year at the European Central Bank, the PBoC pledged liquidity support to any financial institution strapped for cash.
Addressing a forum in Shanghai on Friday, central bank governor Zhou Xiaochuan reiterated it would "adjust" liquidity to ensure the overall stability of the market.
For all the short-term alarm, interbank rates have eased since the central bank acted, and the volatility on the Shanghai stock exchange has also evened out. But what the episode has done is put the structural issues in China's financial sector into focus - and the drastic steps the central government appears willing to try to fix them, in itself seen as a positive.
"The surprising thing about this process has been the government's determination to see it through," notes China sceptic and Tsinghua University finance professor Michael Pettis, in a piece he penned for Foreign Policy.
For years, Beijing has struggled to rein in the easy credit that has fuelled China's breakneck expansion. There have been signs of strain, including an ominous property bubble, famous ghost towns, highways to nowhere and extensive vanity government projects, high-speed rail and airports.
Pettis says the new Xi-Li administration is determined to stay the course. "The central bank and the leadership in Beijing seem determined to try to get their arms around credit expansion - even if that means, as it absolutely must, that growth will suffer and the banks will come under pressure."
Standard Chartered analyst Stephen Green frames the conundrum as Premier Li Keqiang's "surgery" on China's economy, noting that surgery is meant to cure, not kill, the patient.
"Comparisons with the Lehman-related freezing of interbank liquidity in the US in 2008 are unhelpful - this is not a run on liquidity caused by a credit event. Instead, we believe it is a deliberate policy meant to de-risk the interbank system," he says.
But the consensus is that tightening credit will exacerbate the slowdown in Chinese growth. Earlier this month, the World Bank revised China's growth forecast down from 8.4 to 7.7 per cent. About a third of 56 analysts surveyed by Bloomberg believe China will struggle to match its growth target of 7.5 per cent. It would be the first such miss in 15 years.
Bank of America Merrill Lynch economist Lu Ting says, "The current growth rate is quite close to the floor that new leaders have indicated they will tolerate."
The alarming fact remains that even as the world's second-largest economy continues to gear down from double-digit growth, debt keeps rising, with little benefit for productivity and economic growth.
The target of the liquidity crunch also seems to have gone unscathed. China's efforts to rein in shadow banking have not driven up costs for borrowers in the bellwether for "grey market" lending, the coastal city of Wenzhou.
Rates compiled from a local government-backed agency showed one-month loans from pawn shops, small lending companies and individuals remained stable at this month's average of 23 per cent.
"It was not a crisis resolved, but a crisis postponed, and arguably a crisis aggravated," Anne Stevenson-Yang, of J Capital Research, says. "The easy credit is something regulators had tried to stop, recognising that long-gestating imbalances had grown grotesque. And yet the only option to avert the immediate crisis was to feed those ... imbalances."
The main question is whether the market believes Beijing will remain in control as it tackles runaway credit growth. It wants to cut credit expansion, but so far this year it has grown at unprecedented rates. Debt is building.
The majority view is that China will ride the bumps and settle at a slower rate of growth as it adjusts to a consumption-led rather than investment-led economy.
The assured stewardship of its economy so far has provided little reason for doubt. But the liquidity squeeze has given a worrying glimpse that not everything is on the central government's string as it performs its manoeuvres, and the doubters are being heard in greater voice.
"Regardless of what happens next, the consensus expectations that China's economy will grow at roughly 7 per cent over the next few years can be safely ignored," Pettis says. "It's likely that the days of the super-powered Chinese economy are over. Instead, Beijing must content itself with grinding its way through the debt that has accumulated over the past decade."
Back home, the criticism is that Australia has collectively mismanaged the resources boom, and that the distraction of political infighting has meant we are even less prepared on the way down than we should have been.
On Friday, Rudd was unequivocal of the potential fallout of the end of the "China resources boom". "This will have a dramatic effect on our terms of trade, a dramatic effect on living standards in the country, a dramatic effect potentially on employment."
If things in China get worse than expected, Australia will be ill-prepared, and even Rudd won't be able to help.