How bad are things in China?
That is up to debate. However, as we discussed a lot over the past year, things are not rosy for the second largest economy. There are a number of headwinds that can really spread to the rest of the global economy.
When the world's manufacturing center is having issues, it is bound to affect everyone else.
Now we are starting to see massive structural issues that could pose a major problem.
Evergrande Was The First Shot
Remember the coverage that Evergrande got? This was something that reminded many of the subprime crisis in the United States. While it wasn't enough to take out the global economy, it was a warning shot.
Evergrande "suddenly" started to enter risk on defaults. The company was running about $300 billion in debt. Unfortunately, the problem was not limited to just this one entity. It was the entire real estate development sector.
It got so bad people were looking to get their money back on units that were not being completed. Of course, the company could not accommodate that. In the end, the decisions appears for the developers to finish as much as they can while paying debt denominated in YUAN back. Those that were issued in USD are basically facing default.
When something this big starts to unravel, it is going to have an impact.
Good Ole Fashioned Bank Run
China could experience something that was common in the US during the Great Depression. Many banks experienced runs as people did not have faith in the banking system. When confidence is lost, financial institutions have a tough time remaining solvent.
What we are seeing now is mirroring that. While it is not widespread, this is something that has the attention of the PBOC.
So far, 6 rural banks have frozen deposits meaning people cannot get their money out.
They are:
- Yuzhou Xinminsheng Village Bank (located in Xuchang City, Henan Province)
- Zhecheng Huanghuai Bank (City of Shangqui, Henan Province)
- Shangcai Huimin Rural Bank (Zhumadian City, Henan Province)
- New Oriental Village Bank (City of Kaifeng, Henan Province)
- Huaihe River Village Bank (Bengbu City, Anhui Province)
- Yixian County Village Bank (Huangshan City, Anhui Province)
This naturally spurred some protests.
So far, the situation in terms of publicity is being contained. One of the top priorities is to not have this spread. If there is a run on banks across the country, the entire banking system could freeze up.
Then the government might need to implement a bank holiday like happened in the US 90 years ago.
Should The World Be Concerned?
This is a tough question.
If there is a bank run in China, the major issue becomes who has exposure. This is a situation whereby the entire global banking system could see activity freeze up. In 2019, we saw a freeze in overnight lending as banks were unwilling to lend to each other due to the fact nobody knew who has exposure to Deutsche Bank. This send short term lending rates skyrocketing.
It took the Fed entering the market with about $700 Billion daily to provide the liquidity to keep the lending going and interest rates down. If the latter got out of control, money market companies would have blown up.
The interdependence of the domestic banking systems with the global one is undeniable. This means that we could be looking at another instance where a banking crisis results. While it is far too early to call for that, it is worth paying attention to.
If we get something like that, look for a 50% drop in the S&P. Cryptocurrency will also be affected.
Bank runs are never a good thing. They can escalate out of control very quickly.
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