China's Liquidity Trap: Money Flows to Equity and Housing Bubbles

Ren Zeping of Guotai Junan writes:

Money over the money go? China in recent years the money supply growing faster, but the economic growth rate has been declining, financial departing from widening between the entities. 2014 M2 grew 12.2% GDP growth of 7.3% in 2015, M2 grew 13.3%, GDP growth of 6.9% in 2016 from January to February M2 growth of 13.3% expected Q1 GDP growth of around 6.5% in January new yuan loans 2.51 trillion yuan, the first quarter is expected to 4.3 trillion yuan or so, do not send money into the real economy, fall into a liquidity trap. M2 / GDP has quickly climbed to 205.7%. Where's the money? The core may be two to go: First, to maintain the cycle of debt and Ponzi financing rolling , resulting in large capital precipitation currency's velocity V decreases. Second, since the current round of monetary easing cycle turned, first in 2014 - the first half of 2015 boosted the stock market bubble, and then push the second half of 2015 liters of first- and second-tier cities housing bubble core. Financing structure, capital flows and asset-liability ratio circumstances indicate that financing platform, real estate and heavy chemical industry overcapacity formation of the current demand for funds "black hole." Financing these three main areas of government endorsement credit or housing prices is expected to support the financial soft constraints obvious characteristics of the funds is not sensitive to price, credit resources through continuous occupation maintain balance, stiff and dead, rolling become Ponzi financing.

The economy is slowing, while M2 and credit growth increases:

In recent years, rapid growth of the money supply, but the economic growth rate has been declining, departing between finance and the real growing. 2014 M2 grew 12.2%, GDP grew by 7.3% in 2015 to 13.3% M2 growth, GDP growth of 6.9% in 2016 from January to February M2 growth of 13.3% expected Q1 GDP growth of around 6.5% in January new yuan loans 2.51 trillion yuan, the first quarter is expected to around 4.3 trillion yuan, broad money supply and nominal GDP growth rate of real rip constantly queen, super-currency flows into the real economy is not falling into a liquidity trap. M2 / GDP has quickly climbed to 205.7%.

This isn't surprising in light of marginal utility. Debt has marginal utility, and it becomes most obvious with Ponzi debtors who need to increase their borrowing in order to finance their existing principal along with the interest payments. For these borrowers, rising debt has a negative utility: debt increases, but none of the debt is used for growth. The long-term value of the firm is zero as equity is turned into debt, until finally there is no more equity.

He goes on to argue why China will not experience higher inflation (below the jump) , due to the excess capacity and what I call "peak debt" or negative utility. The central bank can only increase the supply of credit and money where there are borrowers. In China's case, that is in equities and then first-tier housing. There is one way China could experience inflation though: via the currency. A lack of confidence in the yuan or significant depreciation would cause prices to rise and increase the demand for credit.

2. China Experience: money supply trend of price changes is a good leading indicator, but it depends on the magnitude of price increases caused by the output gap

Key comparison article 1996-- relationship between money supply and inflation of the past 20 years in 2015.

Delays from conduction, the conduction time delay from the M1 to the CPI of approximately six months, there is a relatively stable relationship between the M1 and the first CPI. However, M1 trough corresponding subsequent deflation are generally, but not necessarily followed by M1 peaks corresponding to inflation.

From volatility point of view, the history of the 1996- 2015 a total of five times appeared M1 growth, the peak is basically the same, CPI volatility of around 22%, however, the same level of M1 growth, has caused great difference.

The first time was in January 1997, M1 reached a peak stage of 22.2%, but then the corresponding CPI trend is all the way down, or even deflation in 1998, in 1998 the deepest deflation CPI-1.5% (9 Yuefen), PPI -5.7% (in October);

The second time was in June 2000, M1 reached a peak stage of 23.7%, but then the corresponding 2001 CPI was always below 2%, in May 2001 CPI reached only 1.7% of the peak;

The third time was in June 2003, M1 reached a peak stage of 20.2%, followed by the corresponding 2004 of moderate inflation , in August 2004 CPI peaking at 5.3% in October PPI reached a peak of 8.4%;

The fourth time was in August 2007, M1 reached a peak stage of 22.8%, followed by the corresponding higher inflation level in February 2008 CPI peaking at 8.7% in August PPI peaking at 10.1%;

Fifth was in January 2010, M1 reached a peak stage of 39% in July 2011 CPI peaking at 6.45%, PPI reached 7.54%.

4 M1 growth history (1997,2000,2003,2007), almost the peak (between 20% -24%), but then they correspond to deflation, not inflation , moderate inflation , higher inflation these four very different price levels (CPI-1.5% -8.7%) .

Thus, changes in the money supply is a good leading indicator of price trends, but the magnitude of the money supply caused by rising prices is uncertain. Visible, elongated historical perspective, the high growth of the money supply is not a sufficient condition to inflation, but a requirement, the money supply can lead to inflation depends on whether they have other conditions.

M1 and CPI relations with China: 1996-2016



Source: National Bureau of Statistics, the People's Bank

The main impact on the money supply from the demand side in the short term, and conduction to the real economy through the production chain, which triggered inflation level will depend on the supply situation in which capacity utilization, output gap situation.

Money supply will lead to inflation and the extent, we must look at the total amount of the output gap (actual level of economic growth from the potential growth level of how far), it also depends on the structure of the output gap (actual growth rate in each industry from the level of potential growth how far). If the aggregate supply and demand chain stretched too tight, it will lead to overall inflation , if only part of the chain is stretched too tight, it will lead to structural inflation .

1) the total amount of the output gap and inflation level

1996-2007 4th high growth in money supply led to very different reason why the price level, mainly because of four high growth in money supply, respectively, corresponding to the economic recession in the mid-cycle stage, early stage of recovery, medium-term recovery and economic prosperity late, respectively, at different levels of economic growth, the output gap and the background of supply and demand.

1997--1998, China is in a downward phase of the economic cycle, the output gap at the bottom, so the high growth of M1 does not change the downward direction of the price;

2000--2001, China is in the initial stage of economic recovery since 1993 has just ended a long-term recession, the output gap is still low, so the high growth of M1 may have changed the direction of prices, but did not initiation of inflation ;

2003--2004 in China's medium-term economic recovery, the output gap narrowed significantly, so this led to high growth of M1 moderate inflation ;

2007--2008 China's economic boom is at the peak of demand and supply chain significantly tightened, so that led to higher levels of inflation .

China's output gap and inflation



Note: The output gap = real economic growth - potential economic growth.

2) the structure of the output gap and inflation level

After the high growth of the money supply out, always looking for a breakthrough, supply and demand of money supply caused by the degree of impact and bottlenecks departments together determine the degree of short-board level of volatility in prices.

From the perspective of structure, 1997--1998 and 2000-2001 years, gone from the macroeconomic adjustment since 1993 for eight years and two external economic crisis, the various production sectors can have serious excess capacity to absorb the money supply strong.

2003-2004, 2001, driven by domestic demand in the economy started, domestic department chain is gradually tightened.

From 2007 to 2008, since 2005 after the explosive growth of exports, external demand chain sector has also been tightened.

Inflation will generally choose the elasticity of supply is small, the price elasticity of demand for single high sensitivity and cost-sensitive industry as a breakthrough, such as resources, energy, land, agricultural, labor, food.

3. prices moderate recovery, but it does not challenge the inflation

1) Chinese inflation and long-term trends in the situation

Since the reform and opening up 30 years of a number of fundamental changes in the macroeconomic environment and performance characteristics of Chinese inflation have happened, mainly in:

Macroeconomic environment to the shortage economy surplus economy. On the one hand the domestic supply capacity significantly enhanced, on the other hand the ability to take advantage of foreign markets improved significantly. In particular, the New Century [ -0.55% funding research report ] since, regardless of the degree of macroeconomic structural bottlenecks like the overall level is still the bottleneck Meidianyouyun traditional industries than in the past has declined markedly.

Asset markets to absorb currency markedly increased. In 2015 more than 200 trillion market value of the real estate market, the Shanghai and Shenzhen stock market capitalization of about 50 trillion yuan.

Macro-control has improved significantly. As China's market economy gradually improved. The central government is more mature in terms of grasp of market economy, macro-control means richer, inflation is also a more profound understanding, like the 1980s due to the serious policy mistakes caused by inflation substantially no longer appear.

In summary, since the reform and opening up China's inflation has undergone several major changes: the shortage economy under inflation in excess of the economy under inflationary change; the real economy, inflation mainly to the real economy inflation parallel with the asset price bubble transition; from the inside nature of inflation to the input and cost-push of inflation changes.

2) 2016: inflation will not come

On the whole, judging future inflation situation should adopt a "comprehensive school" point of view: a look at the current extent of the impact of money supply on short-term needs; Second, look at the current supply and demand situation, including the structure of the total output and the output gap by industry gap; Third, look at the trend of foreign commodities, the dollar exchange rate; four to see short-term base factors, seasonal factors, factors such as weather.

Money supply, the monetary interest rate cuts since 2014 RRR constantly loose, M1, M2 brief rebound, but the monetary velocity decline, credit crunch, ample liquidity failed to transfer to the real economy, the formation of liquidity, "the damming Lake ", pushing stocks, bonds, and other front-line housing asset prices.

From the supply and demand fundamentals, the beginning of 2016 by the real estate investment sales rebounded replenishment business, government, etc. to promote the steady growth, economic recovery in small cycles, but the demand side is weak rebound in heavy industry, processing and trade sectors severe overcapacity.

From the international situation, since May 2014, by weak demand and a strong dollar Chinese influence, commodity prices plummeted. $ 2,016 since the beginning of the stage weakness superimposed Chinese housing market pick up, commodity prices rebound.

From the short-term factors, the food, the pork price, rent and other prices, CPI rebounded slightly since the beginning of 2016.

Comprehensive judgment, taking into account the dollar staged weaker rebound in commodity prices, currency over the housing market to attract funds, economic small cycles rise, domestic overcapacity, financing structure and economic structure does not match the other factors, in 2016 inflation will be modest recovery expected CPI of between 2.5% to 3%, but will not exceed 3% of the cordon continued. This means that such a modest price recovery in favor of marginal improvement in corporate profits, but it still does not lead to tightening of monetary policy shift. Due to the monetary transmission mechanism sluggish real economy, monetary policy can not effectively solve the structural and institutional problems currently facing China's economy, which depends on the supply-side reform essay.

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