Signs of a Financial Bubble Bursting in China?

Reading today’s Wall Street Journal over my morning coffee, I was struck by several stories with warning signs of a bursting credit bubble in China.

The Chinese government has been trying to tamp down speculation by restricting bank lending, but companies and investors have been highly creative at finding ways to keep the funds flowing.

Because copper is used so widely in manufacturing, economists see it as a proxy for economic activity in China, the world’s biggest copper consumer. Well, it turns out that “much of the copper stored in China…is used by companies and investors as collateral for loans from banks and other lenders,” the Journal says.

This is how it works: While it has gotten harder to fund speculative investments by borrowing money from Chinese banks, it is still relatively easy and inexpensive to borrow for financing trade. Companies have been arranging letters of credit from banks and using the funds to import copper. They then put the copper up as collateral for new low-cost bank loans, and turn around and invest the money in higher-yielding / higher-risk assets.

That sounds to me like a game of musical chairs, and in a game of musical chairs the music always stops one day.

In other news from this morning’s paper:

China reported a rare trade deficit in February. Exports were expected to grow 5%, but instead they fell 18% from the previous year.

China’s central bank on Monday weakened the yuan by the largest percentage in more than a year and a half. Recent yuan weakening has been seen mainly as the bank’s effort to deter speculation as it moves to liberalize trading in the currency, but of course a weaker yuan will also help flagging exports.

Last week saw the first default on a Chinese corporate bond. Shanghai Chaori Solar Energy said it won’t be able make a payment due on its 1 billion yuan ($164 million) bond. In the past, the Chinese government has always stepped in with bailouts to avoid impending defaults.

There has been trouble in another big shadow lending market called trust financing. Two Chinese trust companies so far this year have warned they would default on investment products linked to loans to coal mines.

Meanwhile, Chinese investors are pulling money out of banks and pouring tens of billions of dollars into high-yielding savings account run by internet companies. E-commerce giant Alibaba introduced a savings account in June that yields around 6%, compared to 0.35% on bank accounts, pulling in $65 billion in investments. Other big Internet companies have followed suit and set up their own funds.

Sooner or later, every fast-growing economy experiences a catastrophic bursting of a financial bubble. I have no idea when or if that’s coming in China. Just some worrying straws in the wind, all blowing in the same direction.