A man has been arrested by local police in coal-rich Shenmu County of northwest China's Shaanxi Province for spreading rumors that led to a public gathering, local authorities said last Friday.

The rumor-monger surnamed Liu, 53, was involved in underground lending and failed to pay off his ten million yuan worth of loan debt.

He gave vent to his anger by spreading rumors that the economy of Shenmu had suffered a drastic decline and everyone had been collecting debts.

Nearly 800 people gathered at a square to protest on July 15 after the rumors circulated online, a local official said.

Shenmu, a once impoverished county that relied on its husbandry and jujube, ranked among China's top 100 counties for the huge profits of its vibrant mining industry and became a land of millionaires in recent years.

Yet it grabs the headlines as rampant private lending caused a series of crises, especially since coal prices dropped sharply since the second half of last year.

A LAND OF MILLIONAIRES

Zhao Cunfa, 55, president of Shenmu's local coal mining association, set up a collective coal mine in 1992 with an annual output of nearly 100,000 tonnes and involved over 400 villagers as its shareholders.

"The coal mine was unprofitable before 2000. Families in my village could earn 20,000 to 3,000 yuan (3,268 to 4,902 U.S. dollars) annually," said Zhao.

But between 2005 and 2011, the coal price rose from nearly 200 yuan per tonne to around 900 yuan. Zhao's coal mine made a net profit of more than 100 million yuan in 2009.

"Each household in my village bought at least three apartments in Xi'an and Shenmu since they obtained tens of millions yuan worth of spare money at that time," he added.

With a reserve of 50 billion tonnes of high-quality coal, Shenmu went on a path to fast growth and bred many rich people.

The county's total output value surpassed 100 billion yuan in 2012. The per capita disposable income of urban and rural residents rose to 29,316 yuan and 12,537 yuan respectively.

During the boom times, Shenmu became a veritable showroom for luxury cars. Lamborghinis and Ferraris were easy to spot. "Withdrawing money from banks with sacks was common," said a local government official who refused to be named.

Speculation in coal mines became something of a fad.

A judicial official surnamed Jia in Ordos of Inner Mongolia Autonomous Region said a Shenmu coal businessman bought a coal mine in Ordos at a cost of 400,000 yuan. Two years later, he sold it for more than 800,000 yuan. Another year later, this coal mine was sold out again for 1 billion yuan.

"But this businessman had no idea of how to invest his money," Jia said. "He finally put the money into the risky underground loan market."

PRIVATE LENDING BOOMS

According to local residents, nearly half of the population in Shenmu and 70 percent of rural residents give money to private lending in an effort to get a better return than the low deposit rates offered by Chinese banks.

The pawnshops took deposits from locals on the promise of high returns, and then lent the money at higher rates to others. "The interest rate for private lending is around 36 percent to 60 percent on a yearly basis," a coal businessman surnamed Yang said.

Before 2012, many loan sharks lived in hotels in the long term. "The husband solicited business and the wife collected money. Someone even carried a leather bag to conduct the underground loan business," a local government official said. But now some of them have run away.

If someone carries a leather bag, they are usually engaged in speculation, like a broker.

No data is available to explain the scale of this private lending in Shenmu, but this official speculated it could reach nearly 70 billion yuan.

"Sixty percent of lending goes to coal mines, the rest goes to real estate and other industries in Shenmu, Ordos, Sanya and Beijing," he said.

Zhang Xiaochang, known as the Gold King in Shenmu, was arrested by local police in December for illegal fundraising.

He was a silversmith and owned a jewelry shop. Without any knowledge of "paper gold," he speculated on gold and silver futures. Many people in Shenmu found no other investment channels, so they scrambled for opportunities to lend money to Zhang.

"It is very simple," a local resident surnamed Meng said. "Zhang just gave an IOU note with simple information of principal and interest to people."

As told by Yang, many rich people have a low educational background in places like Shenmu and Ordos. They usually spend their spare money on material comforts and lending.

"The locals have no interest in 'small businesses,' such as express delivery, dry cleaning service and chain restaurants. They only focused on coal mines, real estate and loan-sharking, which offered quick money," he said.

HOUSEHOLD FINANCE DILEMMA

Private lending persists for a reason.

According to data released by Shenmu finance office, private enterprises and individual businesses reached 3,030 and 24,949 respectively in 2012. As private enterprises and investment increased, the conventional banking system failed to meet the fund demand.

The local county government speculated that there is 70 billion yuan of private capital in Shenmu at present. However, this money cannot find a better way out.

"Since the financial crisis in 2008, private enterprises have been facing more difficulties," said Gao Haixiong, deputy director of the county development and reform bureau.

Limited by a high credit threshold, many private companies cannot get bank credit support. "After the outbreak of the credit crisis in Shenmu, residents declined to lend money to private companies, whose situations were worsened," Gao said.

Zhang Wei, lawyer in Guojin law firm of Sichuan Province, said that the government should establish village, rural commercial and local banks to lead the investment of local people.

"We should encourage private enterprises to invest in the real economy. The rich should set a goal of being an entrepreneur rather than someone who only makes profits," said Ma Jianfei, a rural development expert with the Shaanxi Provincial Academy of Social Sciences.

He added that people in fast-growing areas should learn about financing and investing to help better manage their money.

Now the price of coal is coming back to earth. Out of 99 mines near Shenmu, only 11 are still operating.

"We put up banners on city streets warning residents of the dangers of participating in informal lending schemes last year, but most people could not resist the lure of big profits, especially when there was no better investment opportunities for them," said county head Huang Jianjun.

"It's a national problem, not just a local issue," he said. "It is time for us to make a difference."