China remains a powerful engine of global economic growth. That engine has been and continues to be fueled by massive injections of bank loans into the economy.
So far, China has avoided a credit crunch. Such events typically occur when a country’s central bank slams on the monetary brakes to halt a significant increase in the inflation rate. That hasn’t been a problem in China so far.
Another credit crunch scenario can occur if a country borrows too much from overseas lenders. Various events might unfold to stop the lenders from renewing their loans, especially if they have short-term maturities. Once again, the result is a credit crunch. The Chinese tend to borrow from their own banks, which are mostly funded by Chinese depositors who have a very high savings rate. Consider the following:
(1) Inflation. China’s CPI inflation rate, on a y/y basis, has been hovering around 2.0% since the start of 2014 (Fig. 1). The Chinese economy was showing signs of deflation in recent years, as evidenced by the 14.4% drop in the PPI from August 2011 through February 2016 (Fig. 2). The y/y PPI inflation rate turned positive during October 2016 and has remained so since then, with the latest reading at 3.1% during March. China had a problem with excess capacity that seems to have been resolved.
(2) Bank loans. China’s bank loans increased by a record $2.1 trillion over the 12-month period through March (Fig. 3). Some of that strength was offset by weakness in shadow bank lending, which dropped from a peak of $1.65 trillion during May 2013 to $592 billion over the past 12 months through March (Fig. 4). Over this same period, shadow banking’s share of “social financing” has dropped from a peak of 55% to 22% currently (Fig. 5).
(3) M2. While it is disturbing to see that bank loans have quadrupled to a record $19.8 trillion since February 2009, M2 well exceeds bank loans and has also been rising rapidly. The ratio of M2 to bank loans hovered around 1.55 from 2006 through 2014, before dropping to 1.39 in March of this year (Fig. 6).
(4) Economic activity. While M2 growth has moderated to 8.2% during March from around 10.0% during 2015 and 2016, retail sales growth has been hovering around 10.0% over this same period (Fig. 7). It was 10.1% in March. Somewhat disconcerting is that the ratio of bank loans to industrial production in China has increased from a low of 94 at the end of 2007 to a record high of 178 during March (Fig. 8). This suggests that the Chinese are getting less bang per yuan for their economy. On the other hand, China’s services economy is growing faster than the manufacturing sector, so the ratio may be misleading.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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