"China's Shadow Currency"

The Diplomat has an article about the use (or, rather, misuse) of banker's acceptance notes in China allowing banks to, essentially, issue their own currency. From the article:

China’s economy is straining to keep up a semblance of its former growth rate. The surest sign is the way a shadow market in bank paper has evolved to substitute the commodity that China is increasingly running short of: cash.

Bankers are passing around their own ersatz currency, stimulating trade with what, in effect, are off-the-books loans. As in the wildcat currency era of the United States, the antebellum period before America had a national currency, this paper trades at a discount from province to province. It is increasingly used for speculative purposes, is potentially inflationary, and is hard to regulate. The People’s Bank of China (PBOC) has been unable or unwilling to crack down, lest it provoke a serious slowdown. But when the world’s second largest economy must resort to passing around IOUs, the financial community should take note.

Bankers acceptance notes (BANs) are nothing more than a post-dated check with a bank guarantee. For example, a buyer in Chongqing might have a hard time passing checks to vendors in Shanghai. But if the purchaser gets his paper signed by, say, Bank of China, his check now has the guarantee of a major financial institution: it is money good. BANs facilitate trade by obviating the need for vendors to assess the creditworthiness of purchasers. But in China, this prosaic instrument of commerce has become a kind of shadow currency that allows under-reserved banks to purchase deposits, fuels speculation, and undermines the central bank’s control over the money supply.

The author of the article compares the situation in China to that of the United States in the late 19th and early 20th Century before central banking and a single currency.

But printing your own currency has its downsides:

Not surprisingly, China’s local governments, themselves heavily involved in project and commercial finance, have become a huge market for BANs. Since 2008, local governments across China have been diligently at work on grand infrastructure and “urbanization” projects, of which ensuring an adequate supply of ghost cities seems to rank highest in priority. In the process, local government financing vehicles (LGFVs), the corporate subsidiaries that local governments use to fund infrastructure projects, have racked up an estimated 19 trillion RMB in debt according to the National Audit Office. Because LGFV investment has been so unremunerative – ghost inhabitants don’t pay taxes – the fiscal burden on local governments is crushing. For cities and counties that are short of cash, there is scarcely a more appealing solution to printing their own.

“There is a risk of banks and LGFVs colluding to fake security deposits and print BANs with no underlying trade,” warns a Ministry of Finance discussion document. Local governments up to their eyeballs in debt have the advantage of control – often of ownership – of banks within their territories, and can order up BANS at will. LGFVs turn to sister banks as a makeshift printing press, printing pseudo-currency virtually on demand. LGFVs use BANs to pay suppliers and obscure the truth about their overburdened balance sheets. A jaded banker in Tianjin complains, “When a borrower uses a BAN, they are supposed to record it on their balance sheet as a liability. But it’s kind of an unspoken rule that they don’t. To be honest, a lot of people see this is a major advantage of using BANs; they can pretend they have lower debt than they really do.” And the LGFVs never have to worry about principal repayments because banks are happy to roll over BANs as they come due. In short, LGFVs have nearly unrestricted access to notes that allow them to make payments, do not get recorded as debt, and never have to be paid down – i.e., their very own money.

Local governments printing their own money has led to a partial fracturing of the monetary system. A BAN issued by a local bank is likely to be accepted within its province, but its credit might not be honored – or honored only at a punitive discount – across provincial borders. ...

Read the whole thing.