As trade war hits, China’s focus should be on steadying growth, and breaking the stop-go fiscal policy cycle
Chen Zhao says Beijing has shown a trend towards tightening liquidity and credit at unfortunate times, leading to the 2015-16 market slump that forced leaders to drastically reverse course. To maintain growth and encourage proper investment, Beijing should focus on reflation, especially given trade tensions with the US
The combination of tight monetary and fiscal policy, together with a strong and expensive yuan, has quickly eroded China’s economic growth. Total social financing, the broadest measure of credit creation, has been contracting.
This has caused broad-based economic weakness: real fixed-asset investment, which is adjusted for inflation, has flirted with contraction for the past few months and retail sales growth has also fallen precipitously lately.
Why has the Chinese government fallen so easily into the recurring trap of untimely policy tightening and subsequent reversals, producing a nagging stop-go pattern for the economy and sporadic financial market instability?
The government has used every moment of economic strength to squeeze money and credit creation, to trim the debt/GDP ratio. Nevertheless, deleveraging should never be about an artificial clampdown on credit creation, as it often is in China.
Most importantly, the countries with very high debt/GDP ratios tend to have very low interest rates. This means that debt/GDP ratio is the wrong metric and a useless gauge for systemic risk for an economy.
Therefore, any artificial curtailment in debt creation will inevitably lead to an “over-saving problem” — savings cannot be funnelled into desired investment. The natural adjustment process to such a problem is a fall in price levels, a drop in output or some combination of the two. This is why every time the PBOC focuses on cutting the leverage ratio of the economy, a credit crunch occurs, and growth suffers.
A falling currency and weakening investor confidence could become self-feeding, leading to a panic that is beyond government control. It cost US$1 trillion in official reserves to intervene in the yuan market in 2015. It would be a much more expensive proposition to contain a panic.
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The policy remedy to the current situation is the same as in 2015 and 2016 – Beijing should take its foot off the brake and refocus economic policy on steadying and stimulating growth. A rapid policy change towards reflation to prop up aggregate demand is made all the more urgent by the US trade war.
Xi’s administration needs to articulate a credible game plan as soon as possible, to deal with a range of economic risks such as falling investment growth, weakening consumption and possible damage to China’s exports from higher US tariffs, followed by aggressive and credible action to stimulate the economy.
Chen Zhao is founding partner and chief global strategist at Alpine Macro. [email protected]