China’s central bank tightened credit earlier this month in an effort to curb some of the excesses in the “shadow banking” system. A variety of pawnbrokers, trusts, leasing companies, and banks through their off-balance sheet operations have sold various wealth management products. Many of these have invested in opaque structures linked to real estate projects, which are often illiquid and of questionable value. These investments have in turned inflated prices in the property market.
China’s efforts to deflate some of these excesses drove interest rates up sharply and caused a liquidity squeeze in the banking system. Coming at the same time that the U.S. Federal Reserve had signaled a “tapering” of asset purchases (quantitative easing), stocks and bonds around the world suffered large losses.
To avoid a credit crisis, the Chinese central bank backed off early this week and pledged to provide funding support for any financial institution that needed cash. This reversal was in partial response to the fact that the central bank’s tightening actions had backfired. In an attempt to boost liquidity, many banks had accelerated their offerings of wealthy investment products to bring in more deposits.
China does not want to underwrite a financial crisis and push the economy into recession. It wants to slow growth from the 10% pace of the past decade to around 7.5% but not much lower. If the Chinese central bank can achieve moderate economic growth while avoiding a boom-bust in financial markets and real estate both the U.S. and San Diego would benefit.