It doesn't seem like the mechanism is what people are worrying about. It depends on whether the illiquidity is just a temporary thing or if it represents debt that will never be paid. If 2% of the GDP is fake/unresolvable debt, that's a huge, huge problem.

If it's a constant stock, sure there could be a sudden loss in confidence. But if the stock is constantly turning over due to existing certificates reaching term, others changing hands at increasing discounts, and new ones being issued, then perhaps no party risks a sudden, large loss.

Well, that's the question, isn't it. If it's truly steady state, then it works. But in practice, firms that miss one payment tend to miss the next too. This kind of debt arbitrage (and other related tricks like payday loans and collections agencies) tends to only work when it's a one-off kind of thing, or if the entities are so small that the overall risk to the system is low.

The contention here is that a whole economy is filled with this, to the tune of 2% of GDP! I mean, I don't know whether or not this is solvent but if it were my economy I'd be awfully worried.

Basically because:

1. Things are very different in China. If you can get away with not paying, it's not really wrong in the same way as in America. They have a different business culture based more around mutually assured destruction.

2. China has a massively leveraged internal economy, propped up by massive stimulus with the RMB. Only because of the two-currency BS they pull can they continue making this work. But because external nations don't actually use RMB, they could end up having a worse recession because of it. Or maybe better, because of the two currencies. Honestly, it's hard to know.

3. It's much harder to enforce these in China (unless you have the right connections, in which case you probably don't need to go through normal courts any way).

I'm not saying it's a bad idea, and I'm all for it in principle. I guess these are really more general issues with China and her economy which incidentally apply to this than issues with the concept.

>3. It's much harder to enforce these in China (unless you have the right connections, in which case you probably don't need to go through normal courts any way).

This is a bit of an interesting question actually. Because in reality these IOU's aren't much different from a loan. And failure to pay a loan is punished pretty severely by china's Social credit system: https://en.wikipedia.org/wiki/Social_Credit_System . So in theory it perhaps shouldn't be too hard to punish people for this, but then again I don't really know too much about the chinese financial system.

"Only because of the two-currency BS they pull"

Is this really a big issue? The current spread between CNY and CNH is less than a third of a percentage point.

Capital controls in general might be keeping CNY (and CNH) stronger than it would be otherwise.

Sounds small, but it's hit as much as a 2% spread [0]. More importantly, they take this off of every transaciton. It makes FDI much cheaper for them when they go into other countries. It allows them to debase their currency internally and reap the benefits while charging others with a stronger external currency. When you factor in shadow banking etc., the exchange rate is not the same as the actual value inside China, because she is such a heavily gated market. These capital controls are precisely what pisses the rest of the world off: the whole point of the WTO and trade treaties is that you don't get to pull this garbage. When you factor in the multipliers etc. across the world, China has skimmed huge sums of cash off the top of the global market. [1]

[0] https://currenxie.com/blog/how-to-take-advantage-of-the-cny-...

[1] https://twitter.com/adamscrabble/status/1094717028009689089

Also, China is not a democracy, and much of their growth has been driven centrally. It's debatable how long it can be sustained, and it behaves very differently from open markets in an oligarchy.

Different rules apply.

It's not an awful idea, all in all.

But it's also rational to worry that it increases overall financial system leverage and that poorly-regulated pseudo-securitized debt could sustain financial bubbles and lead to worse collapses. It also creates a rather difficult problem for a credit manager being asked to accept payment in third-party IOUs.

The instruments we point at as big contributors to the 2008 housing market collapse were better regulated, rated, and more readily exchangeable than CABs.

"Commercial Paper" was a large part of the 2008 recession. Particularly, GE blamed it for lack of ability to create short term debt.

Right, if the ability to roll it over suddenly goes away, then it would create knock-on effects.