Chinese Banks Default, is Economy Crumpling?

Cash is tight in China's financial markets and that may be bad news for an economy that's desperately trying to turn things around.

Hi I'm Karen Chang, and this is the RunList

The grim indication came last Friday, when China's Ministry of Finance missed its targeted sale of government bills by a third. Instead of getting people to buy the 15 billion yuan worth of bills it was offering, it only managed to sell around 9.5 billion.

That was the first failed auction for the Ministry of Finance in almost two years. Less than two weeks ago, on June 6th, state-run Agricultural Development Bank of China also had a failed auction, when it only managed to sell over half of the 20 billion yuan bills they were offering.

So why is this bad news?

Well, basically it means that there's not enough cash in the economy, or businesses, banks and other financial institutions aren't willing to give up the cash they're holding on to. This is happening because essentially, Chinese regulators want to reign in the money market. But, this is tricky when they also want the economy to grow.

You see, for the past several years, in trying to pump up the economy, China has been injecting all this cash into it. So local governments and businesses have been borrowing all this cash, but they haven't been able to pay it all back, so now we have a situation where debt has just skyrocketed to extremely high levels--almost 200% of GDP at the end of last year. [VE: SHOW 198% OF GDP].

But there are other underlying problems with the economy that cash can't solve, like falling demands from overseas and at home. So this means the money that's being borrowed to make things, isn't bringing back the expected returns - and this means the debt can't be repaid.

So what happens when loans default? Well, the banks that lent the money are going to start failing because you can't stay in business if you keep lending out cash and none of it comes back. Reuters has reported about rumors that several Chinese banks have recently failed to pay their debts from other banks, which could be pretty serious if the banks start failing as a result of this.

So, you have a growing debt problem on the one hand, and on the other hand, you have a slowing economy and a weaker demand on the other. This is quite a predicament and one that the has the Chinese government biting its nails. You see, the Communist Party needs the Chinese economy to keep growing to maintain its legitmacy, so if China's banks start defaulting there could be economic as well as political consequences.

So is the writing on the wall for China's economy or do you think China's new leaders will be able to turn things around?

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