China Is Backpedaling

The Chinese government now wants the country's banks to boost lending to help its slowing economy grow, according to Reuters. When people can borrow more cash, they invest it or spend it. That's just logic.

The problem is that this is exactly the kind of activity China has been trying to avoid as it rebalances its economy. Boosting lending means easy money; standards relax, putting more debt on bank balance sheets.

And those balance sheets are already weighed down with crushing amounts of debt. This summer the country's debt-to-GDP ratio hit 250%. Most of that comes from the corporate sector, which is already suffering. We can see that in inflation data released this week.

The key number to watch is Producer Price Index (PPI). It tells us how much money producers are getting for their goods.

In this case the producers are Chinese companies, and in November PPI fell 2.7% from the same time last year. It's the 33rd straight month in which PPI has fallen. This shows that demand in the country is slowing.

But Chinese companies have already taken on a lot of debt to survive - debt they may not be able to repay banks.

See the vicious cycle? That's why asking banks to lend more is just adding to a gigantic mess, not addressing the real issue.

"This measure is not able to address the primary causes of not-so-fast bank lending, which are rising NPLs [non-performing loans] and weak credit demand," Societe Generale analyst Wei Yao told Business Insider. "That is, commercial banks are unlikely to hit 10 trillion yuan. Or, if called to, they may ramp up bill-financing (very short-term credit) to fulfill the target, which offers little help to domestic investment demand."

In other words, banks will probably try to wiggle around this measure and save themselves a little pain by engaging in short-term lending - by issuing loans with a quick turnaround.

"For commercial banks, short-term lending carries less credit and liquidity risk and long-term lending," Wei continued. "Because they are more risk averse nowadays, they would prefer to lend short term if they have to lend. But that does not meet Beijing's wish of supporting investment demand."

The only thing that will really help Beijing, according to Yao, is a full-scale restructuring of the corporate sector. That, however, is painful. It takes time. And China's economy is slowing faster than expected.

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