Will China's 'money garrote' strangle the global economy?

HONG KONG — In this new era of all-powerful central banks, it is hard for investors to look past who will be next to take out the big gun of quantitative easing. This week, all eyes are on the European Central Bank, which follows the Bank of Japan as the latest of the major monetary-policy makers to embark on its own aggressive bond-buying program. In contrast, China appears to be entering a “new normal” era, in which its central bank only has a pea-shooter. While most headlines at the ongoing National Peoples Congress meeting focused on the “approximately 7%” economic growth target, the benchmark money-supply growth target of 12% was also the lowest in decades. Another part of China’s new normal is not just lower growth, but also an era where the central bank is no longer able to magically speed its money-printing presses. Conventional wisdom holds that the People’s Bank of China (PBOC) has a gargantuan monetary arsenal, given that the country has the world’s largest stash of foreign reserves at $3.89 trillion. This cash mountain is routinely used to justify how Beijing has nearly unlimited firepower to backstop its economy. But according to some analysts, this reserve accumulation is merely a byproduct of another form of quantitative easing. Rather than strength, its size indicates just how staggeringly large China’s domestic credit expansion has become in recent decades. According to strategist Albert Edwards at Société Générale, such foreign-reserve accumulation — which typically takes place in emerging markets — is equivalent to quantitative easing. The PBOC’s historic mass-printing of money to buy foreign currency and depress the yuan’s value is little different from what the Federal Reserve and others have done, Edwards said. This would mean that China has already embarked on a major monetary expansion after three decades of trade surpluses and reserve accumulation. Furthermore, the recent reversal in such reserve accumulation points to a significant turning point in monetary conditions. Indeed, Joe Zhang, author of “Inside China’s Shadow Banking System,” argues that China’s credit expansion has in fact been far more aggressive than the quantitative easing attempted in the U.S. or Europe.

Zhang, a former PBOC official, calculated that China’s money supply is already 372% of what it was at the beginning of 2006. And if you add up official data between 1986 and 2012, China’s benchmark M2 money supply has grown at a compound rate of 21.1%.

While 7% economic growth is slow for China compared to the double-digit rates of the past, such data makes 12% money-supply growth looks positively measly.

Another reason to believe that China is at the tail end of a huge monetary expansion is found in a recent study by McKinsey & Co. advisers. They estimated that total credit in China’s economy has quadrupled since 2008, reaching 282% of gross domestic product.

But now the conditions that enabled this debt habit have turned.

Edwards argues that foreign-exchange accumulation by central banks is the key measure of global liquidity to pay attention to — and it is currently in free-fall. Further, while markets are focusing on the ECB’s easing announcement, they are missing this Chinese liquidity garrote that is strangling the global economy, he says.

Data from the IMF shows that central-bank foreign-reserve accumulation has been declining rapidly. China is at the center of this, with a $300 billion annualized decline over the last six months, according to Edwards.

The stress point for China is now its currency, which has fallen to a 28-month low against the dollar.

The dilemma facing the PBOC is how to keep growth and liquidity sufficiently strong, while also maintaining its loose currency peg to a resurgent dollar .

As China defends its currency regime, it must do the opposite of printing new money: using foreign reserves to buy yuan  , contracting money supply in the process.

Such a gradualist depreciation of the yuan is likely to stoke fears of capital flight. Despite China’s strong February export figures and trade surplus, the market remains concerned about the yuan’s value as U.S. and China interest-rate policies appear set to diverge.

While the Federal Reserve is expected to raise rates as early as the summer, China has just cut key rates for a second time.

Meanwhile, the other complicating factor is China’s credit expansion in the latter years of its credit boom was not just domestic. Over $1 trillion was raised overseas.

This debt will become more onerous as the U.S. dollar rises, especially when many Chinese corporation have only yuan-based revenues.

The question for investors is where China’s liquidity squeeze will be felt next.

It has already sent a range of hard commodities plummeting and caused steep falls in business at the baccarat tables of Macau and the high-end malls of Hong Kong. Potential future casualties to consider include real estate and high-yield Chinese corporate bonds.

Craig Stephen is a MarketWatch columnist and author of the column, "This Week in China".

source msn.com

Share this

shadek