Chairman Mao believed the economy needs to run on two legs, but when it comes to corporate financing, China is advancing in a series of giant hops. Its banks are flooding the market with credit, while equity markets actually supply less capital as a proportion of the whole.
Chinese banks lent out a whopping 7 trillion yuan ($1 trillion) during the first half of this year, tripling the amount during the same period last year. In comparison, new capital raised through the stock market was merely 10 million yuan ($1.46 million), down 50 percent from last year.
This is worrying. Excess bank liquidity has arguably severely overheated the equity market. Companies traded in China command a hefty 40 percent premium to the price of the same shares traded in Hong Kong as cheap loans have lowered the required cost of return and propped up stock prices.
Meanwhile, the uneconomic allocation of credit has squeezed out equity as a method of financing. This debt-dependent system advantages state-controlled firms over a vibrant private sector.