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Blowing Bubbles in China

September 1, 2009

I came across this fascinating anecdote on ChinaStakes.com over the weekend.  It comes from a report in the 21st Century Business Herald and appears to validate fears that China’s lending boom is fueling a stock market bubble:

At the end of February, just after Spring Festival (the Chinese New Year), a loan officer from a large state-owned bank offered loans with a nice interest rate discount to Wu Hua, owner of a textile company in Hangzhou. Private enterprises, especially private enterprises in the textile industry, seldom enjoy such preferential treatment, but the loose monetary policy this year allows banks to relax lending standards, and banks have been busy looking for potential clients. Wu took the money.

In March, Wu received the first loan of 20 to 30 million yuan. (He has refused to disclose the total amount he has received.) How to spend the money was a problem. Because of shrinking export orders and an inadequate rate of operations, purchasing equipment would merely have resulted in greater losses. Wu took 30% of the loan to invest in stocks. “I dared not invest it all. If the loss reached 10%, I would withdraw immediately to ensure repayment to the bank.”

On July 29, the Shanghai market dropped 5%, surprising Wu. He saw sharp adjustment and increasing risk in the market. He also received a call from the bank officer, asking about the progress of the loan. On August 7, he withdrew all the money from the market. In less than five months, he had earned about 30% on his borrowed investment.

His loan period is one year at a rate of 4.779%, the floor limit required by the central bank. Suppose Wu borrowed 30 million yuan. The one-year interest is 1.4337 million yuan. Suppose he invested about nine million yuan in the stock market, and earned 2.7 million yuan. After repayment of interest, he would still have earned 1.26 million yuan.

I used to worry that loans would go to waste propping up failing companies.  But obviously the owners of those companies are way to smart for that.  Why incur operating costs when you can invest cost-free?  I suppose the good news is that Mr. Wu will be repaying his loan — unless his textile business goes bust in the meantime for lack of customers, which is also possible.  But the bad news is that somebody’s going to be left holding the bag when this is over.

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