Chinese Subprime Worries: M2 Growth Exceeds Estimates, Severe Bifurcation in Real Estate

The headline to the post is a translation of this article from iFeng: 中国版次贷忧虑：M2高于预期 楼市严重分化, by economist Li Xunlei of Haitong Securities. He discussed how M2 growth is accelerating and M2 the growth target was raised because the government is worried supply-side reforms are long-term, but the threat of economic crisis is immediate. The uptick in the M2 growth target is the first uptick since the 2009 stimulus (and the uptick in growth is also the first since the last time there was significant depreciation pressure on the yuan, back in late 2011 and early 2012).

Slower money supply growth is needed for deleveraging, but the government is concerned about systematic risks stemming from defaults. Capital is flowing into housing though, causing leverage and debt to rise. This is raising concerns about Chinese-style subprime, that China will stray from the path to reform.

Originally I thought the M2 growth target would be set at 12% for the following reasons: First, after 10 years, the M2 growth target was reduced year by year, up to the same. In fact, from 2013-2014 to 2015, M2 growth fell from 13% down to 12%, corresponding GDP target is lowered from 7.5% to 7%. So, this year's GDP target moved slightly downward, an unchanged M2 target reflects prudent monetary policy.

Second, this year's reform objectives include deleveraging, to target production capacity, so the monetary policy should not be more relaxed than last year. We need to implement tight monetary policy to deleverage and reduce overcapacity.

Third, on January 22 the central bank liquidity management seminar convened, Assistant President Zhang Xiaohui proposed that "supplementary liquidity tool selection, slow implementation of the RRR." Also, the central bank's fourth quarter monetary policy report clearly said 2015's double-drops [interest rate and RRR cuts] exacerbated capital outflows and currency depreciation.

Meanwhile, the central bank governor Zhou Xiaochuan 26 in the Shanghai press conference that monetary policy front with quite a few, and now this point in time to be greater emphasis on the application of fiscal policy, emphasizing the application of structural policy. In China, monetary policy mainly regulates aggregate demand. In addition to aggregate demand policy to continue to do more emphasis on structural reforms the supply side, more emphasis on the supply side needs to be done.

It is for these reasons, I thought the government work report this year will keep the growth rate of M2 at 12%. But the unexpected RRR cut yesterday, indicating the State Council in adamant about stimulating economic growth. Perhaps because of the supply-side structural reforms are long-term goals, and the current goal is to dispatch any threat of systemic risk debt defaults may cause.

By the end of 2015, broad money (M2) balance of 139.23 trillion yuan, up 13.3%; narrow money ( M1 ) balance of 40.1 trillion yuan, an increase of 15.2%. The government work report clearly targets M2 of 13%, while in January M2 is more than 14%. Visible, M2 growth was not because of foreign exchange debt and the RRR cut, instead it showed the ability of commercial banks to expand credit remains strong, but also that the real economy still has great demand for capital.

Therefore, the M2 growth rate back to 12%, probably will lead to the risk of funding breaks. The target of 13% was chosen to reflect a robust and appropriate and flexible policy orientation.

RRR Cut Effects Will Still Appear

First, as a counter-cyclical policy, helping to prevent the economic downturn.

GDP growth will be lower in the first quarter of this year, in addition to its downward trend in the first quarter of last year, the financial sector contribution was 30% of growth last year year, the financial contribution will be substantially reduced this year, so the high base effect also leads to greater economic decline. I think this may be counter-cyclical policy in 2009 with a four trillion stimulus ratio. Because if raising the M2 growth target is a fait accompli, it is the first time in six years.

Second, expanding the money multiplier to hedge foreign exchange outflow

The RRR cut releases monetary base of about 700 billion, help hedge funds outflow, because since January the decline in foreign exchange is expected to be about 700 billion. In addition, it helps to improve the monetary multiplier, since the end of 2015 the total amount of base money was 27.64 trillion yuan (wherein Currency 6.99 trillion yuan, the bank deposit reserve 20.65 trillion yuan), compared with the previous year dropped 1.77 trillion yuan, a decline of 6%. This is the first annual decline in base money over the past decade. The main cause of decline is the decline in foreign exchange.

Third, help achieve one of the five goals: reduce inventory

People's Daily, January 4 interview the authorities, authorities pointed out that the supply-side structural reforms to do addition, subtraction, addition example, is the real estate inventory reduction. Although first-tier cities housing prices from the second quarter of last year began to rise, but third- and fourth-tier inventory did not fall, instead it rose. If you continue to maintain high growth in M2, which together with the positive fiscal policy has a structural role, the destocking effect should be more pronounced.

Could this lead to high inflation this year?

Recently indeed CPI has an upward trend, but I for on am not persuaded by inflation logic. From historical data, M2 growth rate increases have a strong correlation with housing prices, mainly because M2 corresponding to household wealth and property income, and residents pay income mainly corresponds to GDP.

If GDP does not grow, the income growth is also difficult to upgrade, then the causes of the CPI rise is not established. From historical data, CPI and GDP growth correlation really big, but little to do with M2 growth. The figure is the growth difference between M2 and nominal GDP, you will find, near zero or negative, inflation usually occurs, such as 1994, 2004, 2007 and 2010. At present, the growth difference is still increasing.

Therefore, this year's CPI is expected to rise, if maintained at between 2-3%, can only be regarded as a low inflation. If you say so continue to loosen, enable the PPI to rise, alleviate the problem of excess production capacity, while also maintaining the asset bubble is not broken, it would be too wishful thinking.

It's not US-style QE, It's Chinese-style subprime

So far in 2009, M2 is not only the scale of China surpassed the United States, and nearly twice that of the United States. Some people say that this is the Chinese version of QE. But no matter how to assess, in the face of the economic problems, whether it is loose monetary policy, fiscal policy or active, we can not solve this problem.

Three rounds of US QE, the premise is clearing, that enterprises, financial institutions and individuals to deleverage. Then slowly releverage. China is currently leverage up and adding leverage, creating bubbles the midst of a bubble, adding debt upon debt. This makes it difficult to achieve the target deleveraging and deflate the bubble. If we say, relaxed environment contribute to the smooth progress of the reform, but often reluctant to leave the over-relaxed environment.

Therefore, most people are worried about the rise in first- and second-tier city housing prices, worried about third- and fourth-tier city governments introduced preferential real estate policies, fear that this will be the Chinese version of subprime.

To get around the long-term problems, proposed and implemented a number of programs, but also paid a heavy price, still did not solve this problem. So eventually we need to return to the theme of reform and think about how to deflate the bubble, reduce over production, and deleverage. Reform is the only positive solution, even though more than 10 years ago, we all knew it.