China Money Too Tight to Mention

Since China's policymakers have a close knowledge of the pressures in the financial system (local govt loans, property loans etc), and since they also have the money squirrelled away to deal with them (the 16.76tr yuan in reserved deposits), a hard landing should be avoided. That judgement depends, of course, on policymakers doing the right thing at the right time.

The overall message from February's monetary data is that the time is getting shorter. The immediate worry is the renewed collapse in M1 growth, which fell to just 3.1% YoY in January, and managed only the limpest of recoveries to 4.3% in February. These are the lowest growth numbers in China's recent economic history (including the worst days of 2008/09), and reflect a genuine sequential fall rather than a high base of comparison. What we're looking at is a collapse in liquidity preference which in turn reflected a collapse in transactional and speculative demand for money. Further along the logic-line, this shows up in sharply slowing retail sales (they rose only 14.7% YoY during Jan-Feb, down from an average of 17.1% last year).

But the more pressing worry is that the slowdown in broader money totals signal a real deterioration in the underlying cashflows of the private sector. One can see this most easily by looking at the cashflows of the banking system, simply by measuring the difference between changes in deposits (cash in) and loans (cash out).

As the chart shows, since the middle of last year, the 12m measure of cashflow (before changes in reserve requirements) deteriorated sharply, from around +4.5tr yuan to under 2tr yuan currently. In fact, on a 3m basis,banks' cashflows have been persistently negative since September, and on a 6m basis have been negative since November.  

But that's not the end of the story, since for the last few years, PBOC has simply commandeered that cashflow by raising (or lowering) deposit reserve ratios. Once those actions have been taken into account, we discover bank cashflow was negative throughout 2011 and has remained sharply negative in 2012. Only with the lowering of reserve ratios has this been (very modestly) reversed over the last three months.

Squeeze banks' cashflow enough, and the message gets through not only to the banks but to their customers too. The result? I construct a monetary conditions indicator for China which takes into account monthly deviations from trend or long term averages for monetary aggregates, real interest rates, the yield curve and for movements in the Rmb (vs the SDR). Here's what it looks like now:  

Although the plunge has been less dramatic, the squeeze of the last year has led Chinese monetary conditions to a place as bad as we say in late 2008. Policy reversal is needed, and soon.