The interbank lending rate in China rose to as high 7% late last week as liquidity management at the nation’s smaller banks has weakened. This cash crunch contributed to the first government bond auction failure (not selling the entire amount issued) in two years. A lack of deposit funding for small banks has caused an asset-liability mismatch at lenders across the country, leading to a cash crunch when customers request their funds. To satisfy these requests, banks tap the money market system, which led to the spike in short-term rates. Chinese banks are facing other problems as well, as the massive lending programs they have embarked on appear to be coming under fire. The ratings agency Fitch has a report out today claiming the Chinese credit bubble is unprecedented in size and scope and risks causing havoc in the overall Chinese economy. We will be watching this story closely as developments in the Chinese economy will have an impact not only on the U.S. economy and interest rate environment, but for economies all around the globe.