Hitting the Limits of Credit

All credit cycles have a natural limit. Debt has a marginal utility and when this is exceeded by marginal costs, borrowing stops. The failure of the Bank of Japan and Federal Reserve over the past 20 years is evidence that the debt-backed monetary system cannot be restarted even when the central bank is using every power it has to grow credit.

Now the limit has been reached in China, where luckily the leadership is unwilling to follow the BOJ and Fed into even more destructive monetary policy. The result is a slowdown in credit, which leads to a slowdown in economic growth.

Goldman Warns Additional Chinese Stimulus Risks Global Financial Stability
Li Cui of Goldman: Given soft domestic momentum, market attention has again turned towards the potential for further monetary easing, including liquidity easing and a cut in interest rates. However, recent experience suggests that monetary easing is likely to have a limited impact on the growth recovery, as we have argued elsewhere. The credit rebound in May-June and the decline in July were entirely driven by short-term borrowing. Long-term borrowing corresponding to corporate capex and infrastructure construction has been muted, and stands at 15.5%yoy, compared with 17.3% at the end of 2013. Thus, long-term investment has continued to decelerate despite monetary easing. Along with the elevated long-term borrowing costs discussed below, this suggests that monetary easing has yet to produce a lasting impact on economic demand. The relief through higher short-term loans has mostly benefited enterprises with working capital needs, in particular companies in sectors with overcapacity.

Monetary easing is likely to have incrementally less of an impact on growth, but a higher cost in terms of financial stability.
Monetary easing is propping up firms that are headed for bankruptcy, not generating a new growth phase of the business cycle.

Selective policy support to continue; we do not expect broad macro easing or an interest rate cut

The slowdown will continue and "the market" is likely to finally get the message sometime before the end of October.

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