Monday, 19 October 2009

PBOC Backing Itself Into A Corner

While the Chinese Composite may be lagging in this global equity market frenzy, Chinese economic data is certainly fuelling it. Last week’s monetary data from the PBOC confirmed the willingness of Chinese policymakers to throw all they can at the economy in a bid prolong the current economic boom they are borrowing from the future.

M2 money supply grew by 29.3% y-o-y in September, up from 28.4% in August, and new loans rose to CNY516.7bn (see chart above). This is a truly shocking rate of monetary expansion, and unless the laws of economics have changed, it is fostering a bubble that could jeopardise China’s long-term growth story.

V-Shaped Recovery, But At What Price?
True, the economy is growing rapidly at present as a direct result of this wave of liquidity. Recent import data and figures for electricity consumption (which rose 10.2% y-o-y in September according to the China Electricity Council) suggest a V-shaped recovery is well underway. However, loose monetary policy is exacerbating the current imbalance between consumption and production, while fuelling a destructive asset bubble. This is because new money is being directed overwhelmingly towards investment spending and speculation rather than consumption. Also, the future burden of rising non-performing loans in the banking system (resulting from the rise in malinvestment associated with rapid credit expansion) will likely be felt by consumers, who will be forced to accept a higher loans-deposits spread to recapitalise the banking sector.

Addicted To Credit
This puts the PBOC in a tight spot to say the least. In order for monetary policy to continue to support the real economy, credit growth will have to accelerate. A moderation in the rate of credit expansion, as Hayek explained, will result in recessionary symptoms. A slowdown would thus jeopardise the entire Asian and global economic recovery. On the other hand, an acceleration of credit growth would further fuel the unsustainable bubble, deepen the consumption-investment imbalance, and sow the seeds for an economic and financial crisis.

The Chinese government appears to be banking on a timely recovery in global demand that would allow exports to pick up the slack as it cools investment spending next year. However, global demand of the kind seen 18 months ago is not coming back. The only reason Chinese exports are currently rebounding is because Chinese imports are temporarily boosting the economies of its main trading partners. Once China itself begins to apply the brakes, there will be no driver of demand to soak up the increased supply. What the government needs to do is bite the bullet and take the recession that is due. This is the only way that the economy will be able to reorganise itself into a sustainable production model. At present, though, this seems highly unlikely.

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