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China: State induced liquidity crunch in order to allocate funds better

Xinhua, the official news agency of the People’s Republic, belatedly explained monetary policy action taken last Thursday, as “It is not that there is no money, but the money has been put in the wrong place”. Although no explicit statement of government policy or intent, Xinhua, considered as an official – in all but name – news agency of the state, explained that the reason the Chinese central bank has allowed interbank lending rates (Shibor) to surge on Thursday was because although banks, the stock market, and SMEs all lacked money, the broad measure of money supply, M2, continued to expand, growing 15.8% year-on-year. M2 accounts for new loans and the easy credit which often falls under the category of “shadow finance”.

The implication of central bank action makes for rational action following macroeconomic indicators, as the overall credit to GDP ratio in China has increased from 120% to almost 200% over the past five years. And, indeed, as stock markets around the world react to this seeming government-induced slowdown, many would point to the lack of options left to officials in Beijing. Such a theory of governmental policy also supports the statement made by the central bank (PBOC) in its second quarterly report, whereby it made clear its intention to make money better serve the real economic and support economic growth.

The facts being that there are centrally mandated government targets for infrastructure and construction spending; and that these targets can only be fulfilled via cheap finance on offer in the shadow sector and by cheap credit offered by millions of Chinese savers, via banks, ill-searching for inflation-beating investment opportunities. The reasons why money is flowing for some and not for others is a product of the boom years of the Chinese economy; what markets are responding to is a realization that the PBOC has itself realized that growing too quickly is a problem in itself.

China headed off a global recession in large part due to the easy availability of loans in renminbi; letting short-term money market rates soar to 28% before Friday of last week is a sign that officials have realized that they have put off the seemingly mandatory damage for too long now; what Beijing is doing now amounts to a ‘detoxification’ of metrics and financials on Chinese balance sheets. In the short-run, the firms that rely on those short-term money markets to fund everyday activities might of course cease to exist, but in the long-run this type of responsible capitalism will strengthen the Chinese economy as resources move to where they are best allocated. Of course, the question then arises as to whether a democratically elected, Western government could take such radical measures – probably not, and so let’s see this as another boon for the Chinese model.

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