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Super-fast money growth set to ease
By Research group Standard Chartered Bank |
April 26, 2012, Thursday
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Print Edition
Print Edition
While the US Federal Reserve and the European Central Bank grab all the attention with their quantitative easing, the People's Bank of China has become the dominant force in global money creation.
It has been widely noted that China's stock of M2 - a broad measure of money, including deposits and money in circulation - is now the largest in the world, totaling about US$13.8 trillion at the end of February.
In our view, the much more important variable is China's marginal contribution to global money supply. China was responsible for 52 percent of new M2 creation globally in 2011. This is not a recent phenomenon. In the three years after the global financial crisis began, 48 percent of new M2 globally was in the yuan. Forget about World Bank President Zoellick's successor. People's Bank of China chief Zhou Xiaochuan is already the world's banker.
Bank-dominated
Why does China generate so much M2? One possible explanation is that China's financial system is bank-dominated, so it tends to generate more M2 than capital-market-based financial systems. When banks accept deposits and lend out funds, M2 is generated in the process. This theory has its adherents, though the cross-country evidence for a correlation between high levels of M2 and the dominance of the banking system is limited.
Another possible explanation is China's unique response to economic slowdowns. When China's economy slows, the government generates demand, and the banks lend, often with an implied government guarantee. In more orthodox economies, fiscal stimulus is run through the budget rather than the banking system, and, in slowdowns, the banks there are cautious. Moreover, in China, monetary and fiscal stimulus tends to end up being excessive because of the need for consensus among policy makers before tightening polices can be implemented. Regular bursts of fast M2 growth build up a bigger base.
A final reason for the large stock of M2 can be traced to the period between 2002 and 2011, when China's central bank massively expanded its balance sheet in order to "defend" the yuan as foreign exchange flooded into the country.
Many in Beijing despair about irresponsible money printing by the Fed and ECB. One result of these measures has indeed been the expansion of these two central banks' balance sheets. However, the PBOC has a jump on both the Europeans and Americans. Its balance sheet has grown eightfold since 2002, ending last year at US$4.5 trillion. That compared with US$3.5 trillion for the ECB and US$3 trillion for the Fed. With the peg, and later the slow-crawling peg, China "imported" the Fed's loose monetary policy, both before and after the crisis.
New phase
China entered a new phase of M2 growth in 2012. The phase of super-fast expansion of the central bank balance sheet may have come to an end, thanks to the slowdown in foreign-exchange inflows. This leads to slower loan growth because many banks have hit their loan-to-deposit ratio limits.
At present, we do not believe the central bank's credit quota is constraining loan growth. Indeed, the bank's quiet loosening agenda since December 2011 has brought down interest rates.
The central authorities are apparently not too worried about overall momentum, even with lower-than-expected first quarter GDP.
Recent conversations with clients across different industries suggests that while growth is slow, there is still growth - and that there are no clear signals of further deceleration or acceleration. Although data are sparse, the labor market still appears firm, with wages across manufacturing and many parts of the services sector rising by 10 percent this year. So, as a friend from the central bank put it, "Why would we want to loosen if there is no employment problem?" Indeed!
Clearly, though, there is the potential for another negative shock from Europe and a more marked deceleration in the housing sector. In the short run, if the government wants to move to a moderately stimulative stance, it could approve more new government projects and - more importantly - ease financing constraints on these projects.
A recent visit to a coastal Tier 2 city suggested that commercial banks are continuing to lend to some infrastructure projects, such as city metro construction, but not to others, such as infrastructure projects without revenue streams, like urban roads.
The long-term solution to the infrastructure-financing bottleneck is for local government investment vehicles to raise debt based on their own future receivables. This will require price reform. In the medium term, many in Beijing, including the Ministry of Finance, would like local governments to sell their own industrial holdings in order to raise cash and repay outstanding loans. In the short term, easing credit conditions for local investment vehicles likely means giving banks a little more flexibility in lending to them.
The report was written by Standard Chartered Bank economists Jinny Yan, John Calverley, Lan Shen, Li Wei and Stephen Green. Shanghai Daily condensed the article.
It has been widely noted that China's stock of M2 - a broad measure of money, including deposits and money in circulation - is now the largest in the world, totaling about US$13.8 trillion at the end of February.
In our view, the much more important variable is China's marginal contribution to global money supply. China was responsible for 52 percent of new M2 creation globally in 2011. This is not a recent phenomenon. In the three years after the global financial crisis began, 48 percent of new M2 globally was in the yuan. Forget about World Bank President Zoellick's successor. People's Bank of China chief Zhou Xiaochuan is already the world's banker.
Bank-dominated
Why does China generate so much M2? One possible explanation is that China's financial system is bank-dominated, so it tends to generate more M2 than capital-market-based financial systems. When banks accept deposits and lend out funds, M2 is generated in the process. This theory has its adherents, though the cross-country evidence for a correlation between high levels of M2 and the dominance of the banking system is limited.
Another possible explanation is China's unique response to economic slowdowns. When China's economy slows, the government generates demand, and the banks lend, often with an implied government guarantee. In more orthodox economies, fiscal stimulus is run through the budget rather than the banking system, and, in slowdowns, the banks there are cautious. Moreover, in China, monetary and fiscal stimulus tends to end up being excessive because of the need for consensus among policy makers before tightening polices can be implemented. Regular bursts of fast M2 growth build up a bigger base.
A final reason for the large stock of M2 can be traced to the period between 2002 and 2011, when China's central bank massively expanded its balance sheet in order to "defend" the yuan as foreign exchange flooded into the country.
Many in Beijing despair about irresponsible money printing by the Fed and ECB. One result of these measures has indeed been the expansion of these two central banks' balance sheets. However, the PBOC has a jump on both the Europeans and Americans. Its balance sheet has grown eightfold since 2002, ending last year at US$4.5 trillion. That compared with US$3.5 trillion for the ECB and US$3 trillion for the Fed. With the peg, and later the slow-crawling peg, China "imported" the Fed's loose monetary policy, both before and after the crisis.
New phase
China entered a new phase of M2 growth in 2012. The phase of super-fast expansion of the central bank balance sheet may have come to an end, thanks to the slowdown in foreign-exchange inflows. This leads to slower loan growth because many banks have hit their loan-to-deposit ratio limits.
At present, we do not believe the central bank's credit quota is constraining loan growth. Indeed, the bank's quiet loosening agenda since December 2011 has brought down interest rates.
The central authorities are apparently not too worried about overall momentum, even with lower-than-expected first quarter GDP.
Recent conversations with clients across different industries suggests that while growth is slow, there is still growth - and that there are no clear signals of further deceleration or acceleration. Although data are sparse, the labor market still appears firm, with wages across manufacturing and many parts of the services sector rising by 10 percent this year. So, as a friend from the central bank put it, "Why would we want to loosen if there is no employment problem?" Indeed!
Clearly, though, there is the potential for another negative shock from Europe and a more marked deceleration in the housing sector. In the short run, if the government wants to move to a moderately stimulative stance, it could approve more new government projects and - more importantly - ease financing constraints on these projects.
A recent visit to a coastal Tier 2 city suggested that commercial banks are continuing to lend to some infrastructure projects, such as city metro construction, but not to others, such as infrastructure projects without revenue streams, like urban roads.
The long-term solution to the infrastructure-financing bottleneck is for local government investment vehicles to raise debt based on their own future receivables. This will require price reform. In the medium term, many in Beijing, including the Ministry of Finance, would like local governments to sell their own industrial holdings in order to raise cash and repay outstanding loans. In the short term, easing credit conditions for local investment vehicles likely means giving banks a little more flexibility in lending to them.
The report was written by Standard Chartered Bank economists Jinny Yan, John Calverley, Lan Shen, Li Wei and Stephen Green. Shanghai Daily condensed the article.
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