Back in October 2012 I wrote a blog post on what I called “My favourite Chinese monetary graph“. In this post I am returning to this topic as I think the monetary developments in China has become increasing worrying.
My focus was on the development in M1:
Imagine a 4% inflation target – this year’s Chinese inflation target – trend real GDP growth 10-11% and money-velocity growth between -1% and 0% then the money supply (M1) should grow by 15-16% to ensure the inflation target in the medium term. This is more or less a description of Chinese monetary policy over the past decade.
Over the past decade People’s Bank of China has been targeting M1 (and M2) growth exactly around 15-16% (give and take a bit…). Overall the PBoC has managed to hit its money supply target(s) and that has more or less ensured nominal stability in in China over the past decade.
I find it useful to track the growth of M1 versus two idealized targets path of 15% and 16% going back to 2000. This is my favourite graph for the Chinese economy.
This is how the updated M1 graph looks today:
Back in October 2012 the actual level of M1 had just broken below the 16% trend line and since then M1 has kept inching downward compared to both the 16% and 15% trend lines and recently we have broken 15% tend line. This is obviously a very crude measure of monetary conditions in China, but I nonetheless think that the indication is pretty clear – monetary conditions are clearly getting tighter in China and I think it is fair to say that monetary conditions are disinflationary rather than inflationary.
Since my October 2012-post distress has clearly increased in the Chinese money markets and growth worries have certainly increased. Furthermore, given it is hard to ignore the connection between the continued tightening of monetary conditions in China and the turmoil we have seen in Emerging Markets over the past 6-12 months – after all China is a global monetary superpower.
It is time to ease Chinese monetary conditions
I think that is totally appropriate that the People’s Bank of China (PBoC) initiated monetary tightening in early 2010 and overall the tightening has been warranted – even though it has had negative market implications for particularly some Emerging Markets. However, it is obviously not the task of the PBoC to conduct monetary policy for Brazil or Turkey for that matter. However, I think it is now pretty clear that Chinese monetary conditions has become too tight for China.
However, the PBoC has been extremely reluctant to step up monetary easing. In my view there are overall two reasons for this. First, PBoC obviously is worried that it could “reflate the bubble”. Second, the Chinese policy makers clearly seem to think that Chinese trend real GDP growth has declined and I would certainly agree that Chinese trend growth likely is closer to 7-8% y/y than to 10%.
So there likely has been good reason for a more cautious monetary policy approach in China, but if we indeed assume that Chinese trend growth has declined to for example 7-8% and money velocity on average decline 0-1% per year and the PBoC wants to hit 2-4% inflation over the medium-term then M1 needs to growth by at least 9-13% (7+0+2 and 8+1+4).
Since October 2012 – when I put out my original post – Chinese M1 has actually averaged 9%, which is in the lower end of the range I think is necessary to avoid monetary policy to becoming excessively tight. Furthermore, it should be noted that the increased financial distress in China over the past year likely is pushing down both money velocity and the Chinese money multiplier, which in itself is disinflationary.
Concluding, I think there is little doubt that Chinese monetary conditions are becoming excessively tight – so far it is probably not catastrophic, but I can’t help thinking that the risk of nasty credit events increase significantly when economies go from a boom to a disinflationary weak growth scenario – said in another way I really fear is a “secondary deflation”.
PS A look at M2 growth would likely paint a slightly less scary picture.
PPS The growth rate of M1 in January 2014 was extremely weak (1.2% y/y). I am not certain what to make of the numbers, but it was what really got me to write this blog post.
TravisV
/ February 17, 2014Lars,
I have to say, I find this topic very confusing. Yes, looking at your graph, it seems like the PBOC is tightening. But then, click on this data for PPI and CPI over the past two years: http://www.aastocks.com/en/forex/market/dbindepth.aspx?country=1&theme=6
To me, it looks like the scary tightening was happening in August to October of 2012. PPI was falling 2.5% to 3.5% on an annualized basis.
Now, PPI isn’t falling as fast as it was in late 2012. And CPI is growing faster than it was then.
Doesn’t that indicate that the PBOC has loosened rather than tightened over the past 15 months?
Lars Christensen
/ February 17, 2014TravisV,
I totally agree that judging from Producer Prices monetary policy seems to have become increasingly deflationary back in 2012, where PPI was falling rather dramatically.
However, I would hardly say that there is any indication at all the the PBoC is tightening. Hence, the LEVEL of PPI continues to decline indicating continued tightening of monetary conditions in China. In fact we are now significantly undershooting the pre-2008 trend of PPI. Hence, prior to 2008 PPI grew 2-2.5% %y/y.
Starting at the end of 2010 the LEVEL of PPI has continued to decline.
I have in fact written a post on this topic last year. See here: http://marketmonetarist.com/2013/07/09/pboc-governor-zhou-xiaochuan-should-give-jeff-frankel-a-call-he-is-welcome-to-call-me-as-well/
TravisV
/ February 17, 2014I understand that inflation is substantially slower than the historical long-term trend. However, the rate of inflation is also substantially faster than it was 15 months ago.
Both of those facts can be true.
Therefore, it is rather difficult for me to tell whether the PBOC is currently tightening.
P.S.: Here in the U.S., while NGDP has only grown ~4.0% the past year, that represents a substantial easing relative to NGDP growth expectations in 2009 and 2010. Which is why stock prices are way higher.
Benjamin Cole
/ February 19, 2014Excellent blogging—of the world’s major central banks only the PBoC has been growth-oriented for the past 20 years—I hope they are not getting central bankeritis-phobia complex, that is an obsession with inflation.
jamesxinxlondon
/ February 19, 2014Lars. Surely you need to at least have a paragraph addressing what to do about Chinese banking? The sector is trading on a multiple of 5x current years’ earnings, and generally below book value. It tells you there is massive market distrust of the quality of Chinese banks’ loan books. Yet the system keeps piling on the credit growth, both official and shadow (see those Total Social Finance figures as a % of GDP).
http://shadowpboc.com/2014/02/17/one-chart-to-show-china-is-not-deleveraging-at-all/
The market is implying about 10% of Chinese bank loan books are bad, versus stated 1% levels. I hear what you say about monetary conditions, but some sort of banking clean up is needed too.
Tom Brown
/ February 20, 2014Lars, rookie question here (perhaps), but I’ve noted that Sumner doesn’t seem to care anything about “credit” (which is what a significant portion of M1 is composed of in the US, right?: checkable bank deposits?). Is M1 similar in China?
Scott seems completely focused on “base money”: Electronic bank Fed deposits and physical paper reserve notes and coins (both vault cash and in circulation). Sometimes I see this designated “MB.” In the US anyway, M1, M2, M3 and MZM specifically exclude the reserve (electronic Fed deposits & vault cash) portion of MB, so they are definitely NOT supersets (if the following wikipedia article is to be believed):
http://en.wikipedia.org/wiki/Money_supply
Why focus on M1 instead of MB? Is M1 in China something other than what I’m supposing it is? Do you differ with Scott at all on this? Have I read Scott correctly in the 1st place?
Bambino
/ February 23, 2014So you want to know the truth behind slow M1 ? *insert suspense music*
It signals that the ICOR Effect is dying because all the new credit is used either for rerolling old loans (cases like “add 20% to the loan for the intresst” when the loan is rolled) also the loans are taken make up the negative cashflows of all those SOEs that burn money like coal.
I work in the railway bussiness, the chinese have 2 of the 3 biggest train manufacturers in the world (CSR, CNR) , which are also our customers.
So i get a lot communication with our china reps and as well as with reps of the chinese mfcs, what i hear is that virtually every railway project bleeds money, negative cashflows on all but the most frequent lines, the funny thing is, while in the west, they loss is covered by the public, as public transportation is seldom profitable, in china, they all just take out more loans to cover the outflows. In my book taking out credit to cover losses is the econimicy highway to banking hell of crushing banks with recovery rates in low double digits. Now i assume this not just the rail bussiness, this is happening in the countrywide scale.
jamesxinxlondon
/ February 24, 2014Bambino. Don’t worry, it’s not so unlike the West. The banks are almost all majority state owned. Their losses will eventually be covered by the public purse. Those very low bank valuations show that the “market” understands this very well. That said, you are right that it is no way to run a country. Subsidies should be out in the open and not hidden inside quasi-stae companies, railways or banks.
Benjamin Cole
/ March 3, 2014In English, there may be a problem in China as their banks lend heavily to business and infrastructure and real estate, and not enough to consumers….so when they want to cool off those sectors, they clamp down on the banks…but that tightens the money supply, leading to recession or slower growth…
they need a transmission belt for easier money to result in more consumer spending…maybe the USA does too.
TravisV
/ March 4, 2014Lars,
Is China easing monetary policy now? The Shanghai Composite increased substantially yesterday. Also this: http://www.businessinsider.com/pimco-tweet-2014-3
TravisV
/ March 9, 2014Yikes, inflation in China is slowing! Here are some comments from Ting Lu:
“Low inflation could be good news for markets as monetary tightening is definitely not justified,” said Ting Lu, an economist at Bank of America-Merrill Lynch.
“Low inflation gives the People’s Bank of China more room to ease the liquidity situation and tame rising rates.”
http://www.reuters.com/article/2014/03/09/us-china-economy-cpi-idUSBREA2803920140309
http://seekingalpha.com/news/1615793-chinese-exports-unexpectedly-plunge-inflation-eases
TravisV
/ March 9, 2014These sentences might be worth a post / criticism:
http://www.reuters.com/article/2014/03/09/us-china-economy-cpi-idUSBREA2803920140309
“No analysts believes China will launch another big-bang government spending package to stimulate the economy, given the country is still suffering from the repercussions of its last pump-priming package in 2008/09 worth 4 trillion yuan.
Instead, analysts think the government may keep interbank rates low to support lending, and increase spending in areas that support a new Chinese economy, such as the environment.”
TravisV
/ August 11, 2014Lars,
Is China easing monetary policy now? See below:
http://www.bloomberg.com/news/2014-08-10/china-loosens-monetary-conditions-in-test-of-credit-power.html
http://www.bloomberg.com/news/2014-08-11/asian-stocks-rebound-from-biggest-decline-since-may.html