Photographer: SeongJoon Cho/Bloomberg

China's Monetary Turbocharger Is Running at an All-Time High

  • Ratio between M2 and base money signals robust credit demand
  • More efficient stimulus use also stores up risks for economy

For every yuan that the People’s Bank of China injects into the nation’s financial system, it’s up to the banks to decide how far they stretch it in the form of loans to the economy.

Right now, they’re working overtime.

China’s money multiplier -- the ratio between the broadest measure of money in use, M2, and base money created by the central bank -- has climbed to the highest on records that date to 1997, data compiled by Bloomberg show. Each yuan of base money is being turned into more than 5 in the real economy.

The turbocharged multiplier is helping compensate for the drainage of cash caused by Chinese savers and companies venturing abroad. It’s also helping economic growth hold comfortably above the government’s target for at least 6.5 percent this year, even as China’s leadership tries to rein in excessive leverage in the financial system.

Yet the fact that the PBOC is getting more bang for its yuan doesn’t say anything about the productivity of the uses to which the money is put, according to Bloomberg Intelligence Chief Asia Economist Tom Orlik. Wasteful or risky lending could backfire on the economy -- with the ratings cut by Moody’s Investors Service this week highlighting such concerns.

Read about China’s first downgrade by Moody’s since 1989

Looking forward, the government’s efforts to stem the issuance of risky debt may curb the money multiplier, in which case the PBOC may need to step in more via open market operations to ensure there’s enough cash sloshing around to keep the economy humming, according to a recent report by China International Capital Corp. economists led by Eva Yi.

A further headwind: the cost of borrowing on the interbank market has risen above the rate at which banks lend to their best customers, cutting into profit margins. If lenders stop doling out loans, the money multiplier could decelerate just as abruptly as it accelerated.

Given its financial deleveraging goal, the PBOC may allow money supply to grow slightly below the annual target of around 12 percent, but it won’t allow it to slow too abruptly, according to Zhu Qibing, chief macro economy analyst at BOC International China Ltd. in Beijing.

Jin Bei, a researcher at the government-backed Chinese Academy of Social Sciences, has written that potential economic growth will be lower than 6 percent in the period to 2020, and growth will slow until then. If he’s right, those forces may overpower whatever the multiplier can do.

"The money multiplier is coming close to the limit in April" because banks can’t lend out all the money they have on hand, Zhu said. “Credit expansion is very likely to slow.”

— With assistance by Yinan Zhao

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