China’s ‘liquidity trap’ not as dire as predicted
So yes, the risk of a financial crisis remains on the horizon…But if it weren’t for Beijing’s overkill response to the Glboal Financial Crisis, then policymakers might just have been able to pull off the adjustment to a consumption-led model more smoothly
China’s anti-corruption campaign may be adding a new wrinkle to the economic phenomenon known as a liquidity trap.
Usually liquidity traps occur when economic players are fearful to spend money, hoarding their cash in bank deposits. But if the money has been stolen, then sometimes it is even further removed - more than a tonne of cash was unearthed in the house of a mid-tier cadre recently, and another 112 truckloads worth of cash stashed in the house of a general.
Who knows how much corruption cash might be stuffed in mattresses and shoeboxes, and thus removed from the monetary system?
But this is still a drop in the bucket compared to the mounds, in fact virtual mountains, of cash that legally exist in Chinese bank accounts, but cannot be touched.
China’s reserve requirement ratio (RRR) has in recent years been kept in the 20 per cent range for big banks, meaning that most banks have had to set aside a fifth of deposits. This puts a rein on the money-multiplier effect of a banking system - but also theoretically represents a lot of potential firepower if the financial system suffers a shock.
It is a reminder of what a singular situation China is in. We have been talking about a banking crisis for years, yet this is a banking system awash with excess funds after more than a decade in which money supply grew at 15-20 per cent.
A look at China’s nearly US$4 trillion in foreign exchange reserves offers one clue as to the origin of China’s monetary system. As China transformed itself over the years into the “factory of the world,” it accumulated huge foreign exchange earnings.