Cracks in China's poker face

Both the European and US sharemarkets are signalling that their problems still require a sustainable solution but for Australia the most important news over the weekend was the fear spreading around China that the underground lending market was in trouble.

When the Chinese authorities began clamping down on loans to property developers, the underground lending market ballooned to about $US625billion. And like all underground markets, it dabbled in all sorts of high risk situations.

But this avenue of finance is having trouble sustaining its lending, so is forcing the sale of apartments and reducing their prices. And that's hurting a large number of Chinese property entrepreneurs who often also own factories. The entrepreneurs are holding vast numbers of empty apartments in the expectation that they will rise in price.

It's a classic bubble but people are secretive about just what is happening. But the problem is very apparent in Macao, where shares in the big gambling houses have slumped. Australia has a big stake in the play via Crown.

Gaming revenue in Macao, at $US34billion, is 40 per cent higher than last year and five times larger than Las Vegas. Two thirds of the revenue comes from mainland Chinese, often as 'VIP gamblers'. According to the Financial Times, junket operators draw VIP gamblers to Macao casinos by extending them generous credit and being flexible about debt collection.

Many factory owners/property developers from the east coast of China have been making good returns from Macao by lending to the junket operators. However, some of the factory owners are in need of cash at home and have trouble borrowing so they have stopped funding the junket operators.

This crisis will not stop Chinese gambling and Macao is merely looking at a slowdown from enormous growth – but it is a symptom of what is happening in China.

A Credit Suisse strategy report warns that property market correction in China could trigger problems for banks, particularly those with higher exposure to informal lending activities. "We consider the informal lending market as the most likely short-term 'time bomb' facing the Chinese economy, which could possibly be more abrupt and damaging than the local government debt situation," Credit Suisse said.

This is one of the reasons why Hong Kong's Hang Seng index fell over 14 per cent in September. The Shanghai Composite Index is down 8.1 per cent in September and 16 per cent for the year.

This is Australia's front line.