Op-Ed: China Is Dealing With an Addiction
To understand why investors are panicking about China's financial sector, it might make sense to think of the country as an addict.
Since the global financial crisis in 2008, China has been hooked on debt. The government, worried about an economic slowdown, turned on the credit taps, making it easy for major companies and local governments to borrow plenty of cash.
These mostly state-owned enterprises and governments took on mountains of debt, allowing them to stay in business and to build high-rises and trains. That helped to drive growth in the world's second-largest economy and support global growth.
Now these players and the banks are finding themselves cut off from unfettered access to cheap money. And like any addict being weaned off of an easy fix, they are going through withdrawal.
That is what's happening in the credit markets in China. Banks, accustomed to the People's Bank of China stepping in when cash is short, have been unpleasantly surprised in recent days when the central bank refrained from its usual action of easing their cash flow problems with short-term funding.
Instead, the banks are in the throes of a credit crunch. Banks are lending to one another at elevated rates, and money market rates jumped to a record of more than 10 percent Thursday as bankers scrambled elsewhere to find their next boost.
(Read More: China Faces Off With Markets as Money Rates Soar)
Many speculate that China's central bank is conducting a stress test of the nation's financial system or hoping to discipline lenders who took unnecessary risks. Another possibility is that the central bank, supported by the country's new leadership, is attempting to change the nature of banks, rein in rising debt and reduce wastefulness. Is this an opening salvo of reforms?
Yet the question is if the government has the stomach for this financial duress. Policymakers are aware of the dangers of debt abuse. However, if they don't mitigate the strain at the banks, they could risk triggering unpredictable and equally dangerous outcomes of an economy over-dependent on debt.
— By CNBC's Eunice Yoon