The Dreaded Debt Deflation Is Happening Now In Wenzhou, China


Photo: livepine on flickr

In a debt deflation, debt liquidation leads to falling asset prices. As the process continues, the repayments of debt (and default) would outpace extension of new credits, meaning that the banking system is destroying money through credit contraction.  That means deposits would fall, and so does money supply. Then it will lead to sharper falls in asset prices, more repayment and default, contracting money supply, deflation, and repeat.

This appears, as I speculated, to be what might be happening right now based on the monetary statistics, as loan demands appear very weak and both deposits and money supply falling. Now, here’s the anecdote that suggests that the it could well be happening.

And it is in Wenzhou again, the place where the shadow banking went bust last year.

Last year, we reported the shadow banking mess in Wenzhou that led to companies chiefs fleeing and/or killing themselves to avoid being killed by their creditors.  And the government came in, and you think the crisis is over.  Now, First Financial Daily is reporting an interesting scene happening in banks in Wenzhou.  Even at a normally non-peak hours in the afternoon, it says, banks are full of people queuing, not for borrowing money, but repaying debts.

This is a curious scene in a Wenzhou bank that suggests the debt deflation process has perhaps, if not started nation-wide, started for quite a while for Wenzhou since the bust of shadow banking last year. According to the report, informal lending in Wenzhou has fallen by 30% compared to last August, and Wenzhou banking sector profits has fallen 53.5% in the first quarter compared to a year ago.  In fact, some banks are losing money, which is, according to the report, rare in Wenzhou.  The report also mentions that non-performing loans, perhaps not surprisingly, have been on the rise.

The reasons for weak loan demand are just as expected: falling real estate prices and weak economic growth, which is along the similar theme as the weak credit demand the country.  Do note that, then, under such circumstances, monetary easing in forms of reserve requirement ratio cuts are not going to be useful at all in stimulating credit growth.

This article originally appeared here: China’s debt deflation: Wenzhou edition
Also sprach Analyst – World & China Economy, Global Finance, Real Estate

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