"I want to pass through some of disturbing new developments in China to the FM community. It seems these have not been picked up by the western media.

"A Financial earth quake just hit Wenzhou, Zhegjinag province. The city is the vanguard of the reforms since 1978. It is now one of the most dynamic and richest cities in China with a large base of export oriented small to midsized private manufacturing enterprises. On 9/24, the owner of the largest spectacle manufacturer disappeared. It turned out he is on the hook for a bank loan and high interests private loans totaling about two billion RMB which he cannot possibly repay. On 9/25, another three factory owners disappeared. On 9/27 the owner of one mid sized shoe manufacturer committed suicide by jumping off a high building. The city is in a panic mode.

"All these happen as the chain of credit collapsed. The victims are either borrower of high interest private loans that cannot repay or lenders that cannot get their money back. The high interest private loans are very popular in certain areas in China. The interest is normally around 30%-40% annualized and some can go as high as 100%. Companies that have difficulty getting loans from banks go to these private pools to get working capital. It's kind of like a shadow bank. There is no collateral for these loans. Usually you need a group of people (companies) to guarantee the loans, so if you don't pay everyone that is guaranteeing your loan is on the hook. In good times the companies can pay these loans as they have decent margin and the turnover is extremely high. Now the margins of these export company's drops below 5% and there is no way they can repay these loans. As the banking saving rate is very low more people are willing to put money into these pools. Even companies with money are putting their money into this game as it is much profitable than their normal business. These is report saying about 20% of the public companies are conducting these private lending.

"At this point it's difficult to know how big the problem is and where the bank run will stop. But given the weak charts of Shanghai Composite and HSI, we really need to be cautious. The issues in Europe are known unknowns. The trouble in China could really trigger another round of panic."

Eoin Treacy's view Thank you for this illuminating email. This article from XinhuaNet.com carries some additional details. Here is a brief sample:

Credit Suisse estimated this week that in China the informal lending market could be worth 4 trillion yuan and is growing by 50 percent annually. Credit Suisse also said the surge in private lending over the past 12 months threatens financial stability.

The area around Hangzhou south of Shanghai is famous for its factories. Wenzhou in particular is renowned for clothing and footwear manufacture. The fall off in European and US demand for consumer goods, higher Chinese minimum wage requirements and higher commodity prices have resulted in a narrowing of margins for export oriented companies in this region. Some have moved further inland and others have moved to lower cost countries.

An inevitable result of central bank tightening is that highly leveraged business models fail. The informal lending market is a potential trouble spot, particularly if listed companies have been diverting cashflows into these operations. The question however, is to what extent this is already in the market.

The Shanghai A-Share Index has fallen to retest the 2010 low near 2400 and while overstretched in the short-term a sustained move above 2600 will be required to begin to suggest demand is returning to dominance.

Mrs. Treacy is travelling to this region next week to source inventory for her business. I will be joining her for a week and look forward to assessing the situation first hand.

Another educative email from the same author was posted in Comment of the Day on July 22nd.