Wednesday, March 12, 2014

Market Nervousness Over China

     China's crackdown on the its "shadow banking" is still producing ripples through the financial markets. The Sidney Morning Herald reports:
Copper's role as collateral for loans in China has sparked a sharp selloff as the government cracks down on the country's shadow finance sector. 
Financial deals being unwound due to sliding copper prices are in turn driving copper prices and the value of collateral even lower. 
The copper price plunged 2.6 per cent overnight on Tuesday, adding to a rough few days for the metal, and was trading at $US2.93 a pound in late trade. Copper has slumped 8.6 per cent since Friday.

... In recent years, copper has been one of the main commodities used by companies that fail to qualify for a traditional bank loan in China's tightly controlled financial sector. These companies, usually smaller, private firms, would import copper and use it as collateral to obtain a letter of credit. They would then sell the copper to pay back the loan.
When prices were rising and demand for copper was strong, banks were happy to oblige. However, as the spot copper price on the London Metal Exchange has fallen by almost 10 per cent since the beginning of the year, these type of deals have lost their allure. ''It's very hard to get a transparent picture of the bonded warehouse [copper] that sits in China, who owns it or where it's going,'' UBS commodity analyst Jo Battershill said.
Reuters reports that copper prices have stabilized, but that Asian shares are still declining.
Asian shares were on the defensive on Thursday as nervous investors tried to limit their exposure to risk, ahead of a batch of key Chinese economic data that may offer clues about the extent of any slowdown.

Markets have been seesawing all week amid uncertainty about a standoff in Ukraine and weakness in the Chinese economy, although copper rebounded from earlier losses on Wednesday and Wall Street ended little changed as investors stuck to the sidelines.

MSCI's broadest index of Asia-Pacific shares outside Japan added 0.3 percent but was still near its lowest levels in two weeks, a day after both European shares and emerging market shares fell to one-month lows.
One of the primary concerns for a slowdown is that China's exports fell over 18% in February, compared to the prior year--the largest slump since 2009 in the depths of the financial crises. I see this as a sign of a decline in global demand. On a positive note, however, the expectations of slowing growth in China has forced oil prices down slightly--to $98 per barrel according to the Washington Post.

     What is amazing to me, however, is that China is considering opening the "money spigots" in its banking sector should growth fall below 7.5%--something typical of more dire economic emergencies in most countries--by reducing the reserve rates for its banks, which is currently 20% (although I doubt that the real reserve rates are that high).
The central bank is considering cutting RRRs again, according to the Chinese paper Economic Information Daily, to “ensure steady growth and prevent potential risks,” a sign that policy makers are concerned about the health of the economy amid analyst concerns about it slowing and the risks of a “hard landing.”

Trimming the RRR could potentially help to shrink the shadow banking system, especially the high-yielding, high-risk investment products that have created a dangerous bubble of undisclosed debt in the Chinese banking sector. That’s because banks rely on shadow banking, using off-the-books securities called wealth management products, in order to skirt the reserve requirements. If allowed to lend more on the books, banks will, presumably, do so.

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