How China’s falling stock market mirrors its failing economic policy
Chen Zhao says the repeated cycle of fiscal and monetary tightening followed by stimulus measures is largely driven by Beijing’s flawed deleveraging policy, and the drop in stock prices is just the latest phase
Entering 2018, Beijing reversed policy again by tightening monetary and fiscal policy, and total social financing began contracting in March. The Chinese economy has begun weakening anew, with stock prices falling sharply since January. Therefore, China’s economic problems and falling stock prices are self-inflicted.
Most importantly, with the velocity of money falling off sharply around the world since 2008, it takes much more credit creation than before to intermediate the same amount of output. This means debt-to-GDP ratios have been on the rise in almost every country.
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Therefore, if the Chinese government tries to deleverage the economy by shutting off the credit supply, financial disintermediation will follow and excess savings will emerge. This could only lead to a fall in nominal GDP growth. Since 2010, China’s nominal GDP growth has followed a roller-coaster ride, largely mirroring the government’s attempts at credit tightening and subsequent monetary easing.
As for fiscal stimulus, Beijing has merely brought forward planned bond issuances to meet the funding needs of local infrastructure projects. There is little new fiscal stimulus in the pipeline. These are inadequate responses to the ongoing economic slowdown.
In the meantime, the Chinese central bank’s efforts to ease policy are hamstrung by the falling yuan. All this means that a stronger policy response is needed, and fiscal stimulus must be delivered in a timely, aggressive manner. Failing to act risks economic weakness and financial market instability.
The Chinese government should also abandon the outdated idea of deleveraging the economy by cutting off credit. Driving up nominal GDP growth is the most effective way to bring down the leverage ratio for an economy.
Chen Zhao is founding partner and chief global strategist at Alpine Macro. [email protected]