HONG KONG, July 25 (Reuters Breakingviews) – China is awash with money and its growth is slowing. To avert a prolonged stagnation, President Xi Jinping’s administration may need to spend its way out of the problem. Yet this and other classic remedies to such a malaise may not be effective in Beijing’s “socialist market economy”.
China’s condition may be seen as what economists call a liquidity trap, though the term means different things to different people. Writing a century ago during the Great Depression, John Maynard Keynes described a situation where bond yields fall to a lower limit and individuals hoard cash. In 1998 after Japan’s property bubble burst, its economy slid into recession and monetary policy lost impact as interest rates were close to zero, Paul Krugman warned, opens new tab other countries could face similar problems.
Variations of this crisis are now threatening the world’s second biggest economy. Chinese interest rates are far from zero. The existing benchmark one-year loan prime rate, for instance, is at 3.45% after Monday’s surprise cut. State media outlets also have dismissed, opens new tab concerns about a liquidity trap. Yet some similarities between China today and Japan three decades ago are unmissable.
While most developed economies in the West are trying to tame stubborn inflation, changes in China’s consumer price index have hovered around zero since the beginning of 2023. Just like the Bank of Japan before it, the People’s Bank of China is loosening monetary policy, but prices refuse to respond.
The upshot is a record supply of money. China defines the metric known as M2 as cash in circulation, plus a set of deposits including time deposits to corporates plus household savings. In the period from the founding of the People’s Republic in 1949 until 2013, this measure reached 100 trillion yuan, about $14 trillion at current exchange rates. In the next decade or so until April this year it surpassed 300 trillion yuan, and now exceeds the broad money supply in the United States and Europe combined, according to data provider CEIC. When measured against the size of GDP, money supply in China is also the highest among major economies.
Other signs are grim too. Bank deposits in China hit a record high last year while growth in total social financing, a measure of loan demand, has stalled. Companies are sitting on cash instead of investing; the ratio of interest-paying time deposits to demand deposits in Chinese banks has widened to 70-30 recently from 60-40 in 2017, central bank data shows.
Krugman argued monetary policy will be effective if central bankers “credibly promise to be irresponsible”. This implies forceful action can help if it ends entrenched expectations that economic conditions will worsen. Some of this explains the Chinese central bank’s aggressive clampdown on debt trading. Earlier this month it warned it could short sell “hundreds of billions of yuan” worth of government bonds to tackle a flattening yield curve, a trend that underscores waning faith in the country’s growth potential.
Here the comparison with Japan is strong. The yield on China’s long-dated government debt securities is only slightly higher than those of its wealthier neighbour. When frenetic speculation in May triggered a 25% spike in the price of one of China’s 30-year bonds upon debut, its yield briefly dipped lower than the comparable Japanese sovereign note.
An expansion of fiscal policy follows the Keynesian solution. That bond issue at least signalled that the government is willing to spend: it was part of the 1 trillion yuan special bonds the Ministry of Finance plans to sell this year. The State Council says these issues will continue over “each of the next several years”.
Beijing would be stepping up to fill a growing void. Not only are beleaguered property developers such as China Vanke and Country Garden scrambling to trim debt, individuals are also rushing to repay home loans early; the mortgage-backed securities market shrunk by 65% year-on-year to 363 billion yuan in the 12 months through March, per Fitch Ratings data.
There is no clarity on how much leverage the central government is ready to take on, however. Ramping up spending through difficult times is a tried and tested formula in the People’s Republic. Yet Xi’s administration has not taken out a fiscal bazooka as it did in 2008 during the global financial crisis, when Beijing dished out a 4 trillion yuan stimulus. That suggests it is sanguine about the economic predicament or fears fresh unintended consequences from large-scale spending.
Opening the fiscal taps back then led to structural problems that endure today, including industrial overcapacity and mounting local government debt. This time the challenge is bigger because China is also trying to shift focus to boosting consumer demand and away from property and investment-led growth.
There is one type of spending that will almost certainly help. Party leaders attending last week’s Third Plenum, a key gathering to set medium-term economic policies, approved a resolution calling for building a more comprehensive social security net. Details are lacking but improved social welfare, including on medical and education costs, could give people security to spend instead of saving for an uncertain future.
Beijing is somewhat moving in that direction. It is helping local governments to purchase millions of unsold homes and turning the glut of supply into public housing. An expansion of the programme would require more funding from the central government and a bigger budget deficit than the current cap at 3% of GDP.
China could also prime the pump to crowd in private investment. It might be tempted to cajole cash-rich private sector firms, such as Tencent (0700.HK), opens new tab and Alibaba (9988.HK), opens new tab, to invest in sectors such as tech, hospitals and even real estate. For a more sustained uptick, Xi could redefine the role of the private sector after years of regulatory crackdowns against top entrepreneurs have crushed animal spirits.
For now, Xi appears to be rethinking the role of “market”. The ruling party says it will unswervingly support the development of the non-public sector. However, that assertion in last week’s plenum communiqué is preceded by a promise to “unswervingly consolidate and develop the public sector”. Until Beijing clarifies which of those forces it would like to dominate, China will be short on options to avert a rut.