What does it take to shake the Chinese market? If stock turmoil in Shanghai and talk of bank default don't strike fear in the heart of the nation, images of a metropolis falling into a chasm will perhaps do the trick.
An image from the film “2012,” in which the city of Los Angeles is swallowed by a massive crevice in the earth, circulated in Chinese social media this week, accompanied with a headline reading “Talk of a Chinese economic collapse goes viral.”
The notion of a collapse of China's banking system came into full focus in mid-June, starting with a rapid rise in the rate at which banks lend to each other. Much to the chagrin of commercial lenders, the central bank had refrained from pumping liquidity into the market for several days. That atypical action challenged the notion that Beijing will always guarantee a free flow of cash as it has for more than a decade.
The government has since come to the rescue, promising liquidity to banks with healthy balance sheets.
The relief was a little late, however. Markets in Shanghai fell last week, with a particularly sharp dip on Tuesday followed by a same-day recovery. Standard and Poor's and other rating agencies issued warnings on banks' abilities to pay investors and continue making new loans, which could raise the risk of default for some companies.
Bank of China and Industrial & Commercial Bank of China reportedly stopped lending to businesses and individuals outright.
In reality, the banking system itself is far from the edge of insolvency. The tightening was a short-term exercise by People's Bank of China that intended to punish bad lending practices and starve the shadow banking sector. The main risk associated with the squeeze was the possibility of the government mismanaging the situation, according to Bank of America Merrill Lynch China Economist Lu Ting. But control over liquidity was still tightly in the hands of the government.
How much control Beijing has had over the masses in the face of a banking crisis is another question for study.
“China’s interbank credit crunch has been getting worse with media speculation about a moratorium on transfers and cash withdrawals even at some of the largest banks,” Lu said in a note issued Tuesday.
A quick search on China's most popular search engine Baidu revealed a high volume of news reports and chatter containing the phrase “China economic collapse.” On China's twitter-like service Sina Weibo, the hashtag “All I know is to wait for the economy to collapse” was posted and re-sent numerous times. “Banks have no money” was another popular phrase among the micro-messages.
The country was clearly rattled in its cyberspace environs, and confusion seemed to rule in Shanghai last week. In bars in the country's financial hub, the meaning of interbank liquidity was a hot topic of debate among Chinese, as was its effect on individual banking accounts. The call to pull cash out of accounts, along with other panicked inquiries over the safety of Chinese stocks, could be heard over the clanking of beer glasses.
So far, the central bank may have been successful in grabbing lenders' attention. There is still indeed plenty of liquidity in the market, according to a Thursday note from Goldman Sachs. Investors and business owners can expect lower interbank rates in early July.
However, Beijing may have not intended to bring about such a whirlwind of worry among the masses. The risk of runs on banks, as well as greatly undermining already poor investor confidence, looms in banking exercises such as this.
China's new government seems stuck in a difficult position when it comes to tightening up excess lending. The cash crunch in the second half of June shows that the process of reform isn't only frightening for officials reluctant to cede power. The Chinese people will also need to brace themselves for the disruptions necessary for putting the economy in order.
