Time to Cash in on China’s Credit Crunch?

Todays top stocks to buy“The world’s rising superstar just got a taste of life at the top as their exploding economy has finally led to a massive cash squeeze. Here’s what happened and the answer to the question, is it time to move in?” —

China’s day of reckoning may have finally come… and it may only be the beginning.

The People’s Bank of China (PBOC) recently orchestrated a spectacular credit crunch in order to curb the excessive lending being made by Chinese banks and to clamp down on China’s shadow banking system – which according to Fitch, may be hiding as much as $2 trillion worth of risky assets in off-balance sheet lending.

(Shadow banking refers to the lending and borrowing that occur outside the traditional deposit and loan model; that is, anything other than putting money in the bank and occasionally borrowing for things like buying a house.  These transactions are usually off-balance sheet.)

It reached a point a couples week back where the banks were actually running out of cash as short-term lending rates soared as high as 28%.  Chinese newspaper, the 21st Century Business Herald, even reported that the Bank of China defaulted on an interbank payment that afternoon, “deferring transactions for half an hour due to a fund shortage.”

However, just as the credit crunch was turning into a full-blown banking crisis, China’s central bank was forced to step in to calm the markets.

In a statement to the press, the PBOC said it had helped some banks and was ready to act again as the lender of last resort for those caught in a short-term squeeze.  However, it was also sticking to its stance of tightening market conditions as it seeks to rein in sharp growth in informal lending.

China’s stock market dropped nearly 2% – the lowest since the 2009 global financial crisis.

To no one’s surprise, the Chinese are downplaying the crunch, seeing it as more of a shock than anything.

“The liquidity squeeze gave them [China] a good lesson without triggering a real crisis,” said Zhao Huan, vice-president of China Construction Bank.

For the rest of us, the response might be a bit premature.

It may help to learn that the credit crunch has been brewing for some time in China already, according to investment firm GMO LLC.

Here’s a quick rundown:

  • In 2012, new non-financial credit in China grew by 15.5 trillion yuan (or US$2.5 trillion) – equating to 33% of 2011 GDP.
  • Between 2008 and 2012, total credit as a percentage of GDP jumped from 60% to 190%. To put it in perspective, this is faster than the US credit climb leading up to the 2008 recession, as well as Japan’s run-up before the asset price bubble burst in 1990.
  • China’s public debt, though it’s been officially stated at 30% of GDP, is actually closer to 90% when “off-the-books” government liabilities such as state-owned loans to local governments and governmental ministry debts (e.g. Ministry of Railways, etc.) are accounted for. This is on par with the US’ nearly 100% debt-to-GDP ratio.

It’s with the sharp credit growth in such a short period of time that GMO says historically leads to financial meltdowns.

What’s more, China’s economy has been losing momentum of late, further fanning the credit crunch flames:

  • The Purchasing Manager’s Index (PMI), a measure of the economic health of the manufacturing sector, fell to 48.2 in June after an initial contraction to 49.2 in May.
  • Imports for May fell to the lowest level in nine months as a result of a growing commodities glut. Major metals including copper and aluminum fell at double-digit rates.
  • Exports to the US and EU also fell lower in May compared to a year ago

It’s feared that should the credit crunch continue to linger, the greater the risk that China’s slowdown could weigh down on global markets.

Chances are, there would be a freeze in foreign investments in the region.

US companies will certainly feel the pinch as we ship hundreds of billions of dollars’ worth of goods and services to China each year.

Europe may be hit even harder as they send twice as much to the Chinese as we do.

For this reason, investors may want to hold off from any major financial decisions if markets slump – especially securities that have high exposure to the Chinese market.

But if you’re willing to look past easy short-term gains, there is one potential bright spot in the midst of China’s problems.

Longer term, this reining in of easy credit will be healthy for their financial system and economy as a whole – forcing banks and firms to scale back their participation in the shadow banking system and help to minimize questionable lending practices.

As the country continues its move away from being an export-driven economy to more of a self-sustaining economy, the government will promote investment into small and medium-sized businesses as well as projects that will target China’s rapidly growing consumer base.

So for now, be patient.

With signs of stability beginning to emerge, in the near future there will likely be some bargains that are ripe for the picking.

When I see those… I’ll tell you it’s time to strike.

Yours in profits,
Todays top stocks to buy
John Holt
for Top Stock Millionaire
Follow me on Google+, Facebook, and Twitter

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