China must not be tempted to repeat the easy money mistakes of the West

It’s no good trying to reflate the economy with even cheaper money when demand is being deflated by a weak global economy, over which Beijing has no control
Beijing must concentrate on generating growth from government investment, such as on infrastructure, transport and telecoms

David Brown

Published: 10:00pm, 3 Jul 2023

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It’s always hard to call a stop when you are getting too much of a good thing. The temptation is to overindulge and binge too freely. But enough is enough when it comes to China’s interest rate easing cycle.

It’s clear the economy is awash with too much cheap and easy money, misallocating key resources and leaving the nation riddled with debt. It’s time to draw a line under monetary super-stimulus, avoid the mistakes Western economies made with years of near-zero interest rates, and get China back on the road to steady monetary policy and sustainable interest rates, stabilising China’s yuan exchange rate in the process.

Reflation is the best way to boost the economy, with a steady stream of well-placed public investment to maximise mainland China’s growth potential. Five per cent economic growth is easily achievable over the next few years, bucking the trend towards what may seem like an inevitable slowdown.

Beijing last cut interest rates by 0.1 percentage points a fortnight ago, lowering the one-year loan prime rate to 3.55 per cent and the five-year rate, a reference for mortgages, to 4.2 per cent, with even more easing expected ahead to help revitalise growth. The economic slowdown in recent months has put Beijing’s 5 per cent growth target for 2023 at risk and more stimulus is needed to put recovery back on track.

But there are serious questions as to whether the marginal move made any difference or was necessary at all.

It’s no good trying to reflate the economy with even cheaper money when demand is being deflated by a weak global economy, over which Beijing has no control. Some economists make the analogy that excessive interest rate easing is like pulling on a heavy brick with a rubber band – the brick doesn’t move until the elastic snaps tight and the brick smacks you in the face with domestic overheating and higher inflation.

China’s inflation outlook might seem benign, with headline consumer prices last month a muted 0.2 per cent higher year on year, but as sure as night follows day, inflation is headed higher unless Beijing puts a lid on excessive domestic credit expansion very soon.

China is not immune to inflation returning with a vengeance, especially if the economy is overprimed with stimulus. Inflation may be low now, but China has borne the brunt of higher inflation in the past, over 5 per cent more recently and over 25 per cent back in the 1990s. Beijing needs to be very careful about what it is trying to achieve with ultra-low interest rates.

And it’s not just interest rates that have come down in recent years. The cash reserve requirement ratio for banks has been repeatedly cut, from a peak of 21.5 per cent in 2011 to 10.75 per cent in March this year.

It’s meant easier access to cheaper borrowing by investors, which has been at the root of China’s debt-laden housing bubble and its subsequent failures as domestic demand has cooled. The housing boom might have boosted economic growth in recent years, but there is little logic now in cutting interest rates further just to reboot the property market in the hope of reviving consumption.

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Average house price inflation in China has sunk from the cyclical peaks of 12.6 per cent in 2016 and 10.7 per cent in 2019, slipping into negative territory when it went as low as minus 1.6 per cent towards the end of last year. To pump up housing demand with lower interest rates now would be a misjudgment if it led to another property bubble with no credible benefit for the rest of the economy.

With China’s debt pile rising to nearly 300 per cent of its gross domestic product in the fourth quarter of last year, according to the Bank for International Settlements, there’s a clear case for stabilisation. More monetary accommodation to ease consumers’ debt-servicing pain would not be the best use of China’s valuable resources. Consumers must learn to live with reasonable interest rates consistent with sustainable, non-inflationary growth for the economy as a whole.

Instead, Beijing should focus on what China does best as a centrally planned economy: concentrate on growth being generated from a government investment-led recovery. The multiplier effects from spending on infrastructure, transport and telecoms will help fast-track China’s growth potential much more reliably than a consumer demand-led growth generated by interest rate giveaways.

The goal should be investing for the future and reinforcing China’s lead as the world’s foremost industrial powerhouse.

David Brown is the chief executive of New View Economics