China’s “financial frailty”

Here’s a story you don’t hear every day.

In 2009 China encouraged local government to borrow heavily to finance local infrastructure projects.

The low interest rates they set to fund this spending spree (and keep the renminbi down) have led investors to place their savings with “shadow banking system”. That has now grown larger than the official/formal banks. The government has control over less than half the financial system.

This reduces the government’s ability to use monetary policy to control the economy.

Local governments are less able to borrow since the value of their land (used as collateral) has fallen. They have also begun to sell “prized assets” at an “unprecedented rate”. This limits government spending as a stimulus to the economy.

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