But not all analysts are convinced the formula will work as well the third time around.
In the first place, Chinese policymakers are likely to be much more cautious in applying the stimulus. The previous two stimulus programs led to an explosion in China’s corporate debt over the past decade, to the point where debt owed by non-financial firms now stands at 170 per cent of gross domestic product, the highest level among leading economies.
This perilously high debt burden means Chinese policymakers are reluctant to spark a further round of borrowing by debt-laden state-owned companies and local governments.
But there is another, much more pressing, consideration that the PBoC must keep in mind as it weighs up monetary easing.
Washington and Beijing are engaged in terse trade negotiations aimed at averting a full-scale trade war. That means the PBoC must move very tentatively when it comes to monetary easing, for fear of sending the yuan sharply lower.
The Trump administration has repeatedly warned China against using a weaker currency to gain a competitive advantage. As a result, the last thing Beijing wants to do now is to irritate Washington by allowing the Chinese currency to weaken through the psychologically important level of seven yuan per US dollar. (The yuan is at present trading at 6.86 to the US dollar.)
This extreme sensitivity about the exchange rate limits the extent to which the PBoC can ease monetary policy in response to flagging economic activity. The Chinese central bank can’t afford to cut benchmark interest rates, for example, for fear that such an escalation of monetary stimulus would trigger capital outflows, which would put downward pressure on the yuan.
Indeed, some analysts believe the PBoC’s determination to prop up the yuan against the greenback – which forces the bank to buy yuan and sell US dollars – has resulted in tighter Chinese monetary conditions.
They point out that the growth in the country’s M2 money supply continues to dwindle, falling to 8 per cent year-over-year in November and matching the lowest annual growth rate in at least two decades.
Since economic activity depends on the availability of money and credit, this sharp slowdown in M2 growth – which has been been consistently in the teens or 20s for the past decade – bodes ill for a pick-up in economic activity.
In his latest newsletter, independent investment strategist Russell Napier points out that the Chinese central bank, just like its US counterpart, is now in the process of shrinking the size of its balance sheet. In the US, this process is known as “quantitative tightening”, or QT.
“In November 2018, the PBoC’s assets contracted by 0.94 per cent year on year. They have contracted by 2.0 per cent since August 2018. The key driver of such a contraction occurs as the PBoC enters the foreign-exchange market to prevent the exchange rate deviating from its target rate,” Napier writes.
“A contraction in assets means a contraction in liabilities and, if we look at the specific liability that is key in determining domestic liquidity – reserve money – it has contracted by 0.4 per cent year on year and 4.9 per cent from its peak in December 2017. That’s QT.”
Napier calculates that that since Chinese bank reserves hit their peak at the end of 2017, about $US233 billion in liquidity has been drained from the Chinese banking system.
This is about half the $US469 billion decline in the total reserves of the US banking system over the same period, as the US Federal Reserve has progressively reduced the size of its massive bond portfolio.
But Napier argues there is a huge difference in the impact of the US and the Chinese quantitative tightenings. That is because “the Fed’s QT is reducing the level of excess reserves in the banking system, whereas the PBoC’s QT is reducing the level of fully utilised reserves in their banking system”.
As a result, he argues, “the monetary impact of China’s QT should thus be much more powerful than US QT as it should directly impact the ability of Chinese commercial banks to expand their balance sheets”.
Napier notes that the contraction in bank reserves is beginning to show up in higher market interest rates. Since August 2018, the three-month SHIBOR rate (the interest rate at which banks lend to other banks in the Shanghai interbank market) has climbed from 2.79 per cent to a peak of 3.39 per cent. (The three-month SHIBOR rate is now about 3.1 per cent.)
As Napier points out: “If monetary policy is about the price and quantity of money, China’s broad money growth is at the lowest level recorded, at least since World War II, and the price of money is rising.”
In the second half of 2018, he argues, market action began to reflect this tightening in Chinese monetary policy.
“Chinese interest rates rose, China’s money-supply growth slowed, commodity prices declined, Chinese manufacturing was contracting by year end, global growth expectations declined, and the valuation of global growth assets shifted decidedly lower.”
Napier predicts that Chinese monetary policy tightening will continue this year, unless the Chinese central bank abandons efforts to prop up the currency or the country sees a sudden large inflow of foreign capital.
But, he warns, previous episodes of Chinese QT have been painful. “The last contraction in PBoC assets was from February 2015 to December of that year, and the MSCI World index [a broad index of developed market stocks] declined by 19 per cent from its 2015 high to its low in the first quarter of 2016.The impact of commodity prices was even greater, with the price of crude down 57 per cent.”
But, as Napier notes, back then, markets were reacting only to Chinese QT. Now they have to deal with the double whammy of Chinese QT at a time when the Fed’s balance sheet is shrinking by $US50 billion a month.
“While the Fed can stop QT, the PBoC can only stop should it see a sudden and major improvement in its external accounts, or should it abandon its exchange-rate policy. The former looks unlikely, making the latter very probable.”
It’s a classic catch-22 dilemma for Chinese policymakers. Until Beijing allows the Chinese currency to float freely, the Chinese central bank will have limited room for any manoeuvre when it comes to monetary easing.
But, Napier warns, a weaker yuan will produce “initially, major deflationary consequences in the US and across the world”.