China promises bank rescue in next crisis as market prophets warn on rising US rates

Fang Xinghai, vice chairman of China Securities Regulatory Commission
Fang Xinghai said China would contain the risk from a banking collapse

China’s financial regulator has vowed to rescue the Chinese banking system immediately to avert a banking crisis when the bubble bursts, issuing a blanket guarantee that no major institution will be allowed to fail.

Beijing says it has studied the errors that led to the Lehman crisis in the 2008 and will not allow a chain reaction to occur, even if this means paying a price in terms of lost economic growth and dynamism.

“We have too much debt in our system. If something bad happens, we have learned from the US financial crisis, and we will move very swiftly to contain the risk so that panic caused by a small institution does not spread,” said Fang Xinghai, the deputy chief of the China Regulatory Securities Commission and a key architect of policy.

“The Chinese regulators will come in immediately so that interbank lending does not seize up and so that the system can function. Those who are ‘shorting’ China and betting on a financial collapse, thinking they can make money, will be wrong again,” he said, speaking at the World Economic Forum in Davos.

Mr Fang, a rising star in China, said the real risk is the United States, theatrically waiving a piece of paper with a chart showing that the Shiller cyclically-adjusted earnings ratio of the S&P 500 index of equities is now higher than in September 1929 on the eve of the Great Crash. “There is risk there,” he said.

He accused President Donald Trump of polluting the climate by proudly tweeting each new record on Wall Street, raising concerns that he will lash out at regulators or the US Federal Reserve if they take any steps to rein in the boom. “It unavoidably has an impact,” he said.

The bizarre exchange came as a chorus of voices in Davos warned that an inflation surprise and US monetary tightening threaten to detonate a nasty denouement for overheated assets in 2018. Professor Ken Rogoff from Harvard University said as much as three quarters of the entire stock market boom is a simple function of the super-low interest rates.

“Inflation could come on us suddenly. If they start tightening faster and real interest rates go half way back up to normal levels, we will see a collapse in the markets,” he said.

“What worries me is that if we do have a recession, there is no ‘Plan A’. I don’t think either fiscal stimulus or QE would be as effective as last time.” 

Jes Staley
Jes Staley, chief executive officer of Barclays, speaks during the panel

Barclays chief Jes Staley said the world looks rosy with growth hitting 4pc this year but nobody really knows how much leverage is being stretched to double-down on the boom. “When this thing turns, hold onto your hats,” he said.

The worries were echoed by Anne Richards from M&G Investments who warned of a “severe correction” if anything disturbs animal spirits and pops the current mood of exuberance. “If interest rates go up meaningfully over the next 12 months, a bunch of people will not be able to pay the money back. Markets are not pricing this in,” she said.

Mrs Richards said regulators habitually fight the last war and cluster together, stress testing the same concerns. But the time-honoured pattern is that the next upset will come from nowhere, and probably this time from a technology shock. “All of our businesses would stop if for any reason we were not able to access the cloud. How would the world react if all our cell phones went down simultaneously?” she said.  

Anne Richards, chief executive officer of M&G Investments
Anne Richards, chief executive officer of M&G Investments, at Davos

For now, China’s pledge to prop up the financial system come what may - rather than allow market discipline to punish the reckless - gives global investors an extra security blanket and may encourage even bolder speculation. It is an invitation to moral hazard, with possible repercussions in a country where citizens are acutely sensitive to any signal from the Communist Party.

Whether the Chinese authorities really can conjure away the risk of the financial crisis after such torrid excess is an open question. State ownership of the banking system through the ‘Big Four’ lenders certainly gives them extraordinary control at a time when the Dodd-Frank reforms in the US arguably make it even more difficult for the Fed to nip a liquidity crisis in the bud.

Yet critics doubt whether Beijing has a full handle on the vast nexus of shadow banking, which has pushed total private credit to $30 trillion. “When I hear China saying that it is different, I have to wonder,” said Prof Rogoff, author of a celebrated study of financial busts through history - ‘This Time is Different’.

Zhou Xiaochuan, the ex-head of China’s central bank (PBOC), admitted recently that if the country is not careful it could indeed face ‘Minsky Moment’,  the tipping point when credit cycles break and euphoric booms collapse under their own weight.

Mr Fang said Beijing is fully alert to the danger. It has even coined the term “Grey Rhino” - China’s answer to the Black Swan - to curb the mania. “Every kind of crisis seems to be associated with a bubble, whether it is in equities, debt, or something else. Our problem is really about debt. It has been rising to 250pc (of GDP) but the good news is that it plateaued in the last quarter of last year,” he said.

Crucially, debt is at last expanding more slowly than nominal GDP. Yet this has its own sting in the tail since it implies that China’s economic growth rate in 2018 will slow hard, a possible new reality that has yet to percolate into the consciousness of markets.

If combined with rising rates in the US, this would risk a fresh phase of capital outflows and a repeat of the ‘China scare’ seen in early 2016. Beijing could find itself at the mercy of global forces after all.

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