How liquidity evaporates from China
Beijing is unlikely to pump water to fill its tanks amid uncontrolled infrastructure spending
Bill Phillips was a New Zealand engineer who in 1949 accidentally became an economist by being the first to model how cash flows around the economy using water, pumps, valves, tanks and connecting pipes.
Professor Phillips (better known for the Phillips Curve relating wages to unemployment) modelled liquidity in flows representing spending, taxes, investment and exports. If he got it wrong, he either got his feet wet or the tanks ran dry.
Computers have made liquidity statistics accurate but no easier to understand. The recent release of the mainland's credit figures is a perfect example of how not to look at the exact figures, but the trends. Not only did the creation of new credit fall 19 per cent, but M2 money supply growth has shrunk to the lowest levels since records began. Total social financing, the widest measure of financing, dropped 9 per cent over the year. Phillips' model would be drying out.
We can see it in empty tower blocks, empty train platforms and obsolete power stations
In the past few months, real estate, trust lending, fixed-asset investment, export growth, factory managers' optimism and consumption have all been weak, if not significantly so. Combined with falling liquidity, it is no surprise that the latest annual gross domestic growth figure was reported at a low 7.4 per cent.
The rapid 20-year growth in exports had provided great domestic liquidity, much of which went into the property market. In the past decade, massive leverage by local governments, who were largely responsible for uncontrolled infrastructure building, resulted in an economy awash with debt.
The mainland is largely a closed economy with minimal leakage so the Phillips pipes had to become larger and the tanks bigger to take on this liquidity boom.
The difficulty of accurately calculating the mainland's liquidity results from the unknown size of the shadow banking system in which non-banks borrow, lend and invest like a real bank but at market rates and outside the official regulated system. This market is calculated variously as 70 per cent of the mainland's GDP, or 20 per cent of all credit.
But in reality, no one knows - except that it is significant. This black market has developed to allow market-based funding of smaller enterprises and individuals. It appears strange to have such a tightly regulated banking environment on the mainland when you can game the system so readily.