Sunday, March 1, 2015

2015-01 Interest Rate Trends

In January 2015, state-sector and private sector interest rates continued their convergent trend. The overnight Shanghai Interbank Offer Rate (Shibor) ended January at 2.81%. That was a significant decrease from December’s close of 3.53%. However, it was still higher than the trailing average for January and February closes, which were 2.61% and 2.34% respectively. Both January and February are considered to negate the effects of the Lunar New Year.

The Wenzhou Comprehensive Index ended January 2015 at 19.75%. That was slightly higher than December’s close of 19.68%, although it was in between the trailing average for January and February closes, which were 19.91% and 19.62% respectively.

Although these two rates should be significantly different because of time horizons and risk profiles, there are more factors than just these two influencing the spread. As Ludwig von Mises reminded us, “[O]ne must never lose sight of the fundamental difference between the market phenomena of prices, wages, and interest rates on the one hand, and the legal phenomena of maximum or minimum prices, wages, and interest rates, designed to nullify these market phenomena, on the other hand.” (Human Action, 1998, p. 394, fn 25) The Shanghai Interbank Offer Rate is primarily determined by the liquidity of the Big Four state-owned banks, institutions that receive artificially created credit first. The Wenzhou Comprehensive Index is determined by the liquidity of private lenders and borrowers, who in most cases are cut off from state-owned bank funding, so are the last to receive artificially created credit.

Interestingly, the growth in M1 is now lower than the yield on a 12 month certificate of deposit. That usually means trouble for banks in a fractional reserve fiat currency system.

If interest rate liberalization continues, these two rates will converge further. That most likely means higher interest rates for the state-sector, which is highly leveraged and experiencing deteriorating cashflows on rapidly devaluing assets. Fortunately for the private sector, not being direct beneficiaries of the largest artificial credit expansion in history means that if it can survive the last few years of high interest rates and still maintain positive earnings, the future contraction phase of the business cycle will be much more bearable.