China’s “Whack-A-Mole” Game Continues

By John Richardson

whac-a-moleTHE blog loves playing the the “whack-a-mole game” in our local arcade. How it works is that every time a plastic mole pops up, you have to try and whack it back down with a hammer in order to win points. Moles just keep popping up, no matter how frantically you deploy your hammer.

We think it unlikely that the Chinese government is enjoying playing its own version of the game.

“Shadow finance may be revving up for a comeback. China Beige Book numbers show a recovery in the sales of wealth management products, likely due to competition from online banking,”  writes John Maudlin in his latest weekly investment newsletter.

“This is cash leaving the traditional banking sector and, while non-bank lending did not pick up in the first quarter, the groundwork is being laid for it to do so.

“Online banking may be encouraging riskier behaviour. Online lenders are typically viewed as a force for liberalisation, as well as a potentially healthier alternative to unregulated shadow finance. Yet our data show their proliferation would impart significant costs as well.

“What appears to be happening is the higher returns available in online banking are forcing banks to move more transactions off-balance sheet, in order to avoid the interest rate cap.”

Using Jack Ma’s online banking revolution to create a more competitive environment for lending, and thus improve the efficiency of capital allocation, seems to involve some significant risks.

This once again illustrates that China is “crossing the river by feeling the stones” as it tries to innovate its way towards an entirely new economic growth model. There will be failures and successes, progress and setbacks, during a process that is bound to take several years.

The danger is that chemical companies interpret what are, in fact, failures with genuine, sustainable growth.

Here, in this case, is what we mean:

  • Imagine a situation, say in Q3, when, thanks to a rebound in shadow banking, small and medium-sized enterprises (SMEs) are flush with cash again.
  • They could regain their appetite for raw-materials inventory building, but this will not mean better “real” demand.
  • What it will instead mean is that the SMEs have regained their “risk on” appetite as they try to hurriedly complete property deals, and make some more money from “circular trades”, before the proverbial hammer once again comes down on the shadow-banking mole. The hammer must, and will, come down again because shadow banking is a systemic risk.

A sign that “risk on” has returned will be a change in the language of ICIS pricing reports, which, throughout this year,  have consistently reflected a much more challenging credit environment.

In last week’s Asian polyethylene (PE) report there was no sign of a change in that language, as we wrote that: “The China PE import market outlook was uncertain this week. Some market participants believe traders may face cash flow issues if discussions between their sellers and buyers remain in a stalemate in the coming weeks. Meanwhile, some traders are in the view that prices may soften in the short term due to limited interest from downstream clients.”

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