China's Financial Crisis Began in June; PBOC Must Pump More or Deflation Will Return

Earlier I posted: SHIBOR Drops After Chinese "QE"; Downward Pressure on the Economy

I referred to the PBOC's liquidity injection as "QE" because of its massive size (and according to reports, it has already failed with rates moving higher once more). Relative to their economy, the PBOC's three-day effort exceeds the Fed's monthly asset purchases. More importantly, these interventions are now becoming a normal part of PBOC policy.

The first cash crunch came in June. In September, there wasn't a serious cash crunch, but there were fears, which I covered in Chinese Cash Crunch Could Return in September; Why Not Spend ￥8 million to Avoid a ￥10 million Fine?

Now the cash crunch is back in December.

In the past three end of quarter periods, Chinese banks either experienced a cash crunch or have feared one.

June: China bond market ends up following PBOC’s net capital injection

Since June, the central bank had injected 305 billion yuan in total via open market operations.

September: PBOC makes record liquidity injection

China's central bank pumped a record 290 billion yuan (45.74 billion U.S. dollars) into the money markets via reverse repurchase agreements (repos) Tuesday in an effort to ease a cash crunch.

December: China Shares End Up; Banks Lead Following PBOC Cash Injection

Borrowing costs in China's money market soared again Monday afternoon following a brief fall earlier in the session, despite the PBOC's cash injection. The People's Bank of China said late Friday that it had injected over 300 billion yuan ($49.3 billion) into the financial system over a three-day period.

June: Inject ￥300 billion in one month; success.
September: Inject ￥290 billion in one day; success.
December: Inject ￥300 billion over three days; failure.

This is the same pattern seen with QE in the West. Central bank interventions must increase over time because the market tolerance to interventions increases.

There will be a bigger PBOC intervention before the end of the quarter, or the problems of June will reemerge and we will see global assets tumble.

June marked the beginning of China's financial crisis. It wasn't clear then, but it is clear now: the Chinese financial system will have recurring cash crunches every three months because it has a solvency crisis. These crises will expand in time, coming earlier each quarter, or expand in size (or both), requiring ever larger liquidity injections by the PBOC. Eventually, the PBOC will formalize its interventions into a policy and strenuously avoid calling it QE.