Friday's Top 10: Chinese credit oh so crunchy; Xi Jingping's crackdown on the 'four winds' of bureaucracy, formalism, hedonism and extravagance; How China's shadow banks might implode; Clarke and Dawe; Dilbert

Here's my Top 10 links from around the Internet at midday today.

As always, we welcome your additions in the comments below or via email to bernard.hickey@interest.co.nz.

See all previous Top 10s here.

My must read today is #5 on the connection between Xi Jingping's crackdown on hedonism and extravagance and the Chinese credit crunch.

1. The Chinese credit crunch - As David pointed out in today's 90 at 9, China's authorities appeared to back down somewhat on their hard line drive to slow down Chinese bank lending.

Bloomberg reports the People's Bank of China injected liquidity overnight, but the spike in borrowing costs yesterday to a decade high of over 12% freaked a whole lot of people, not to mention the Australian stock market. 

But it's clear now that the new leadership in Beijing are determined to take some of the heat out of China's shadow banking sector and some of the usual infrastucture-driven stimulus.

Beijing wants to make growth more sustainable, which means slower.

We'll see what that does to China's banking system and their shadows, which have expanded credit in China by more in the last 5 years than was built up by the US economy in decades of operation.

The pressure is on. The chart below shows the parallels between short term interest rate spikes ahead of the Lehman crisis and China's interbank rates in recent days.

Here's the Washington Post with its assessment of the Chinese Credit Crunch:

Thursday was a very bad day for China’s economy, the world’s second-largest and a crucial pillar of the global economy, with credit markets freezing up in an unnerving parallel to the first days of the U.S. financial collapse. The question of how bad depends on whom you talk to, how much faith you have in Chinese leaders and, unfortunately, several factors that are largely unknowable. But we do know two things. First, Chinese leaders appear to be causing this problem deliberately, likely to try to avert a much worse problem. And, second, if this continues and even it works, it could see China’s economy finally cool after years of breakneck growth, with serious repercussions for the rest of us.

Things got so bad that the Bank of China has been fighting rumors all day that it defaulted on its loans; if true, this would risk bank runs and more defaults, not unlike the first days of the U.S. financial collapse. There’s no indication that the rumors are true, and no one is running on China’s banks. But the fact that the trouble has even gotten to this point is a sign of how potentially serious this could be.

2. Has the PBOC really relented? - It seems the Bloomberg report that the PBOC had eased the pressure may not be true, the Washington Post reported.

Here’s where things get a little confusing. Bloomberg News reported Thursday evening Beijing time that, as panic moved through the Chinese financial system, the country’s central bank stepped in and offered $8.2 billion in “relief” to the Industrial and Commercial Bank of China, which just happens to be both state-owned and the largest bank in the world. What does this mean? Maybe that Chinese leaders got cold feet and are trying to walk back the self-imposed crunch, maybe that China’s largest bank managed to negotiate some preferential treatment, maybe that leaders are worried their most important bank might actually be less healthy than they thought and want to protect it from default. Or maybe this is just part of the process of easing down the markets. But then the Chinese Web portal Sina announced that the reports were false(thanks to Bill Bishop for this link), adding some unnecessary confusion and uncertainty to an already volatile situation.

So what happens next? There are four categories of outcome. The first is that Chinese leaders back off on the credit crunch and nothing happens, in which case they’ll probably just try the strategy again later. The second is that they press on and it works miraculously, cleaning out the financial system without causing too much pain. The third is that this spirals out of control, maybe because Beijing underestimated the risk or acted too late, potentially sending the global economy lurching once more. The fourth, and probably most likely, is that this works but is painful, averting catastrophe but slowing the Chinese economy after 20 years of miraculous growth.

3. Here's what the Chinese leadership are actually saying via the Chinese Securities Journal - As cited by Nomura via FTAlphaville.

“We cannot use as fast money supply growth as in the past, or even faster, to promote economic growth… This means that authorities must control the pace of money supply growth.”

And a speech from Premier Li on credit growth. From a different Nomura note: The State Council held a meeting on 19 June to discuss credit policies. Premier Li indicated that the government should provide more credit to high-end manufacturing industries and strategically important new industries and restrict further lending to industries that face severe overcapacity problems. He did not mention the liquidity problem at the meeting, but reiterated the importance of containing financial risks.

These messages reinforce our view that policy and liquidity will remain tight, at least before the Q2 data release on 15 July.

4. Greece and Cyprus on the boil again - Worries about Greece seemed so 2010. And we all thought Cyprus was fixed. Well, they're back. FT reports the IMF is about to suspend aid payments to Greece and Cyprus' bailout is already in trouble.

The latest gap emerged after national central banks, which were urged by eurozone leaders to roll over €3.7bn in Greek bond holdings, refused to do so when the first redemptions came due last month. That forced bailout lenders to speed up aid payments that were originally to go for other purposes later in the programme.

According to three senior eurozone officials, the problem was nearly compounded when some central banks balked at passing on the profits they made on their Greek bond holdings back to Athens, which is to contribute €2.1bn to Greece this year. But the holdouts, including France, have in recent days backed down, officials said.

Greece this month failed to sell off Depa, its state-owned natural gas company, and other government assets are running into similar challenges, officials said.

The troubles in the Greek programme come as eurozone finance ministers on Thursday night were forced to debate revising Cyprus’ €10bn bailout following a written request by the island’s president for major changes in how the programme restructured Cyprus’ two largest banks.

5. 'Echoes of Mao in China cash crunch' - The FT's Simon Rabinovitch also picks up on what looks like a deliberate attempt to slow down or stop the explosion in Chinese credit, particularly through the shadow banking system. Regular readers of the Top 10 over the last year will be aware of this shadow banking issue. 

Rabinovitch points out the link to Xi Jingping's crackdown on the 'four winds' of 'formalism, bureaucracy, hedonism and extravagance'. Explosive credit growth is certainly about the last two of those four winds.

Analysts have mostly viewed the squeeze in economic terms, as a warning to lenders that they must rein in dangerously fast credit growth. But in the midst of the extreme market stress, a statement issued late Wednesday by the central bank raised the possibility that politics are also playing an important role.

Bankers had been calling for the central bank to ease the pressure and a few investors had even predicted that it might cut interest rates. Instead, the People’s Bank of China ordered a thorough implementation of the new “mass line education” campaign launched this week by President Xi Jinping – a campaign that in its propaganda-style and potential scope carries echoes of the Mao era. The Communist party cadres that run the central bank were told to attack the “four winds” of “formalism, bureaucracy, hedonism and extravagance”, as demanded by Mr Xi.

“It is quite possible that the central bank’s policies have some connection to Xi’s campaign,” said Willy Lam, an expert on Chinese politics at the Chinese University of Hong Kong. “It seems to be much more serious than the short anti-corruption campaigns launched by Hu Jintao and Jiang Zemin [Mr Xi’s predecessors over the past two decades].”

The title of your book flags that changes in China’s financial system might be sowing the seeds of the next subprime crisis. How might that crisis play out, and is shadow banking a cause or a symptom?

I find shadow banking assets are very safe in general. We manage our own money very carefully. Given the tough regulation, we are not able to take too much risk even if we want to. But the rapid growth of shadow banking reflects on the failure of the much bigger formal banking system. For six decades, financial repression in China takes the form of regulated interest rates being significantly below inflation. That leads to rapid credit growth. Banks are forced to increase loans rapidly year after year. But sensible lending opportunities are not growing that fast. Therefore, banks are forced to lower lending standards, leading to growth of their own subprime lending. Of course, low interest rates send false signals about the viability of loans.

If China does face the risk of having its own subprime crisis, where do you think the weakest points in China’s financial system are?

I see the real estate bubble as the most likely starting point of the crisis, followed by local government fund-raising platforms.

You note that China’s money supply has expanded significantly more in recent years than that of the U.S. Is this something we need to worry about? Given that China’s monthly consumer price index numbers remain so low, why hasn’t it fed into inflation?

In itself, China’s money supply growth being much faster than those in other countries is not a worry. But at 16-17% year after year, monetary policy in China is very accommodative and inflationary. Credit growth and inflation reinforce each other, becoming a vicious circle. That is a pattern for three decades now. We have reached a point where the public has become very sick of it.

10. Totally Clarke and Dawe - Evan Essence talks about Australia's political system. Apparently Australia's government is elected using the Duckworth Lewis method.